Management Accounting

product: 4490 | course code: c370

 Management Accounting
Centre for Financial and Management Studies
SOAS University of London
First edition: 2014; Revised: 2017

All rights reserved. No part of this course material may be reprinted or reproduced or utilised in any form or by any electronic,
mechanical, or other means, including photocopying and recording, or in information storage or retrieval systems, without written
permission from the Centre for Financial & Management Studies, SOAS University of London.
 Management Accounting
Module Introduction and Overview

Contents
1
Module Objectives 2

2
The Module Authors 2

3
Module Structure 2

4
Overview of the Module 4

5
Learning Outcomes 5

6
Study Materials 5

7
Teaching and Learning Strategy 6

8
Assessment 6

 Management Accounting

1 Module Objectives
Welcome to the module Management Accounting. Accounting information is a
fundamental resource for enabling managers to make decisions. This module
emphasises a critical understanding of the accounting numbers, the underlying
assumptions behind those numbers, and the choice of accounting tools and tech-
niques that will best suit managers information needs. The aim of the module is to
equip line managers primarily in business (but also public-sector agencies) with the
ability to prepare budgets, develop business cases for capital investment, calculate
prices and exercise cost control.

2 The Module Authors

Matthew Haigh PhD (Macquarie) has had careers in public-sector auditing, char-
tered accountancy and internal auditing. He has researched and lectured in eight
European countries and currently holds a Senior Lectureship in Accounting at the
University of London. He holds qualifications in chartered accountancy and certi-
fied information systems auditing. His roles in commercial and public-sector
organizations have focussed on the production, review and audit of management
and financial accounting information.
Dr Alexa Simm is an Accountancy Consultant specialising in accountancy educa-
tion. As a professionally qualified Chartered Public Financial Accountant, she has
extensive experience, having previously worked as a professional trainer for the
Chartered Institute of Public Finance and Accountancy and as a University Senior
Lecture. Having previously worked as an external auditor, her PhD was in man-
agement accounting making her well suited to authoring this module.

3 Module Structure
The module consists of eight units, each of which comprises a set of readings,
questions and exercises.

Unit 1 Management Accounting Context and Performance Measurement

1.1 Introduction to Management Accounting
1.2 Centralisation and Decentralisation
1.3 Divisional Performance and the Controllability Construct
1.4 Balanced Scorecard
1.5 Case Study
1.6 Feedback on Case Study
1.7 Summary

Unit 2 Pricing and Production-Volume Decisions

2.1 Pricing Strategy
2.2 Relevant Costs for Pricing Decisions
2.3 Finding the Break-Even Point Cost-Volume-Profit Analysis
2.4 Achieving a Target Profit Using Break-Even Analysis
2.5 Using Contribution to Make Decisions
2.6 Segmental Profitability Analysis for Closing-Continuation Decisions

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 Module Introduction and Overview

2.7 Case Study

2.8 Feedback on Case Study
2.9 Summary and Practice Tasks

Unit 3 Production Decisions, the Value Chain and Production Capacity

3.1 The Value Chain
3.2 Production Capacity
3.3 Theory of Constraints, Relevant Cost, Opportunity Cost
3.4 The Outsourcing Decision
3.5 Costing Orders
3.6 The Product-Mix Decision
3.7 Environmental Costs
3.8 Case Study
3.9 Feedback on Case Study
3.10 Summary and Practice Tasks

Unit 4 Volume-Based Cost Systems

4.1 The Problem of Allocating Production Costs
4.2 Variable Costing and Absorption Costing
4.3 Process Costing
4.4 Job Costing
4.5 Case Study
4.6 Feedback on Case Study
4.7 Summary

Unit 5 Activity-Based Cost Systems I

5.1 Costing Environment
5.2 Types of Activities Facility-Level, Customer-Level, Product-Level, Batch-Level, Unit-
Level
5.3 Steps in Designing an Activity-Based Cost System
5.4 Worked Example and Questions
5.5 Summary

Unit 6 Activity-Based Cost Systems II

6.1 Activity-Based Costing in Service Companies
6.2 Organisation-Level Factors Affecting Activity-Based Costing Systems
6.3 Case Studies
6.4 Feedback on Case Studies
6.5 Summary and Practice Tasks

Unit 7 Capital Investment Decisions

7.1 Introduction to Capital Investment Decisions
7.2 Accounting Rate of Return
7.3 Payback
7.4 Discounted Cash Flow Techniques
7.5 Taxes and Price Inflation
7.6 Case Study
7.7 Summary

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 Management Accounting

Unit 8 Budgeting
8.1 Budgeting - An Introduction
8.2 Cash Budgets
8.3 Budgetary Control
8.4 Is Budgeting Necessary?
8.5 Summary

4 Overview of the Module

This module introduces some of the core techniques used in management account-
ing as well as exploring what management accounting actually involves.
Unit 1 sets the scene for the module by defining and explaining key terms used in
management accounting. The unit looks at what management accounting actually
is, what it involves and how it differs to financial accounting. You will then consid-
er how an organisation may be structured before exploring how the performance of
individual elements of an organisation may be assessed. Performance measurement
incorporating both financial and non-financial elements is then discussed, with the
balanced scorecard explored as one such method. Finally the unit considers the
development and use of the balanced scorecard through a case study.
Unit 2 considers the use of accounting information to support product-pricing
decisions. The unit begins by introducing pricing strategies, then moves on to the
analysis of costs that are relevant for pricing decisions. The unit covers decisions
involving the relationship between product price and the levels of production
volume, breakeven analysis, target rate of return and segmental profitability. A case
study considers segmental profitability for an example company to close the unit.
Unit 3 investigates the production decision from two perspectives the value chain,
and full and spare production capacity. You will learn how the value chain concept
allows managers to distinguish different types of costs and obtain information
relevant for outsourcing, purchasing and product-mix decisions. The types of
decisions faced by firms experiencing fully utilised capacity and spare capacity are
identified and contrasted. In the process, you will learn about opportunity costs and
the theory of constraints, and how to apply these concepts in production decisions.
You will also consider environmental costs and their impact on production costs.
Unit 4 aims to illustrate how managers can allocate relevant costs of production to
products and services. The unit begins by distinguishing between various types of
product costs, and introduces the concept of a cost driver. The unit then illustrates
how to use production-volume cost systems where appropriate for example,
inventory costing. In particular, job costing and process costing will be analysed.
After learning about the basic volume-based production costing system in Unit 4,
you turn in Units 5 and 6 to examine a more complex, more accurate but more
costly production costing system known as activity-based costing.
Unit 5 introduces systems of activity-based costing (ABC), which are increasingly
used by organisations because they are generally believed to report more accurate
costs, which may lead to improved decisions on labour usage, product mix, pricing,
order acceptance, and customer relationships.

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 Module Introduction and Overview

Unit 6 continues the study of ABC and gives you more insight in the use of the
model including some of its organisational implications. The unit ends with two
case studies looking at the use of ABC in real-life situations.

Unit 7 looks at the topic of strategic investment decision-making, by comparing and

evaluating several methods that managers can use to prepare and evaluate capital
expenditure proposals and projects. This unit examines three groups of planning
and evaluation tools: the accounting rate of return, payback and discounted cash
flow techniques. You will learn how to apply these techniques in a range of relevant
questions, as well as to discuss their respective uses, advantages and criticisms.
Unit 8 focuses on the management accounting area of budgeting. The unit explores
what budgeting actually is, what budgeting involves and the different types of
budgeting. The unit then looks at how to prepare a profit and cash budget, as well
as highlighting the differences between them. Following the preparation of budg-
ets, the unit then goes on to consider the use of the budgets in achieving budgetary
control, through the calculation and interpretation of variances. Finally the unit
considers alternative views on budgeting, as to whether budgeting is actually
necessary and different approaches such as Beyond Budgeting.

5 Learning Outcomes
When you have completed your study of this module, you will be able to:

discuss and apply performance measurement measures, including the
balanced scorecard

explain the ways in which divisional performance might be measured

identify and apply relevant costs in marketing, pricing and product mix
decisions

apply and discuss job-costing, throughput-costing and process-costing
techniques

make decisions that take account of quality management and environmental
costs

apportion overhead costs to products and services using a range of methods,
including absorption costing

apply appropriate capital investment appraisal methods

discuss, construct and interpret budgets.

6 Study Materials
This study guide is your main learning resource for the module as it directs your
study through the eight study units. Each unit includes recommended reading from
the nominated textbooks below and from the Module Reader.

Textbooks
Paul Collier (2015) Accounting for Managers: Interpreting Accounting Information for
Decision-Making, Fifth Edition, Chichester UK: John Wiley & Sons Ltd.

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 Management Accounting

Anthony A Atkinson, Robert S Kaplan, Ella M Matsumara, S Mark Young (2012)

Management Accounting: Information for Decision Making and Strategy Execution,
Sixth Edition, Harlow UK: Pearson Education.

Readings
You are provided with a range of academic journal articles, extracts from supple-
mentary texts, articles written by academics and taken from the financial press, and
a number of simulation lessons. This material comprises the Readings an essential
part of this module.

7 Teaching and Learning Strategy

As mentioned above, the module uses a range of examples and case studies to
illustrate the theoretical principles and assist you to understand and use manage-
ment accounting information. Review questions and exercises are included in the
module to facilitate your learning.
The module is structured around eight units. It is expected that studying each unit,
including the recommended readings and activities, will take between 15 and 20
hours per week. However, these timings may vary according to your familiarity
with the subject matter and your own study experience. You will receive feedback
through comments on your assignments and there is a specimen examination paper
to help you prepare for the final examination.

8 Assessment
Your performance on each module is assessed through two written assignments and
one examination. The assignments are written after week four and eight of the
module session and the examination is taken at a local examination centre in Octo-
ber.

Preparing for Assignments and Exams

There is good advice on preparing for assignments and exams and writing them in
Sections 8.2 and 8.3 of Studying at a Distance by Talbot. We recommend that you
follow this advice.
The examinations you will sit are designed to evaluate your knowledge and skills in
the subjects you have studied: they are not designed to trick you. If you have
studied the module thoroughly, you will pass the exam.

Understanding assessment questions

Examination and assignment questions are set to test different knowledge and skills.
Sometimes a question will contain more than one part, each part testing a different
aspect of your skills and knowledge. You need to spot the key words to know what
is being asked of you. Here we categorise the types of things that are asked for in
assignments and exams, and the words used. All the examples are from the Centre
for Financial and management Studies examination papers and assignment ques-
tions.

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 Module Introduction and Overview

Definitions
Some questions mainly require you to show that you have learned some concepts, by setting out
their precise meanings. Such questions are likely to be preliminary and be supplemented by more
analytical questions. Generally Pass marks are awarded if the answer only contains definitions.
They will contain words such as:


Describe

Contrast


Define

Write notes on


Examine

Outline


Distinguish between

What is meant by


Compare

List

Reasoning
Other questions are designed to test your reasoning, by explaining cause and effect. Convincing
explanations generally carry additional marks to basic definitions. They will include words such as:


Interpret


Explain


What conditions influence


What are the consequences of


What are the implications of

Judgement
Others ask you to make a judgement, perhaps of a policy or of a course of action. They will include
words like:


Evaluate


Critically examine


Assess


Do you agree that


To what extent does

Calculation
Sometimes, you are asked to make a calculation, using a specified technique, where the question
begins:


Use indifference curve analysis to


Using any economic model you know


Calculate the standard deviation


Test whether
It is most likely that questions that ask you to make a calculation will also ask for an application
of the result, or an interpretation.

Advice
Other questions ask you to provide advice in a particular situation. This applies to law questions
and to policy papers where advice is asked in relation to a policy problem. Your advice should be
based on relevant law, principles and evidence of what actions are likely to be effective. The
questions may begin:


Advise


Provide advice on


Explain how you would advise

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 Management Accounting

Critique
In many cases the question will include the word critically. This means that you are expected to
look at the question from at least two points of view, offering a critique of each view and your
judgment. You are expected to be critical of what you have read.
The questions may begin:


Critically analyse


Critically consider


Critically assess


Critically discuss the argument that

Examine by argument
Questions that begin with discuss are similar they ask you to examine by argument, to debate
and give reasons for and against a variety of options, for example


Discuss the advantages and disadvantages of


Discuss this statement


Discuss the view that


Discuss the arguments and debates concerning

The grading scheme: Assignments

The assignment questions contain fairly detailed guidance about what is required.
All assignment answers are limited to 2,500 words and are marked using marking
guidelines. When you receive your grade it is accompanied by comments on your
paper, including advice about how you might improve, and any clarifications about
matters you may not have understood. These comments are designed to help you
master the subject and to improve your skills as you progress through your pro-
gramme.

Postgraduate Assignment Marking Criteria

The marking criteria for your programme draws upon these minimum core criteria,
which are applicable to the assessment of all assignments:


understanding of the subject


utilisation of proper academic [or other] style (e.g. citation of references, or use of proper
legal style for court reports, etc.)


relevance of material selected and of the arguments proposed


planning and organisation


logical coherence


critical evaluation


comprehensiveness of research


evidence of synthesis


innovation / creativity / originality
The language used must be of a sufficient standard to permit assessment of these.
The guidelines below reflect the standards of work expected at postgraduate level.
All assessed work is marked by your Tutor or a member of academic staff, and a
sample is then moderated by another member of academic staff. Any assignment
may be made available to the external examiner(s).

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 Module Introduction and Overview

80+ (Distinction). A mark of 80+ will fulfil the following criteria:

very significant ability to plan, organise and execute independently a research project or
coursework assignment;


very significant ability to evaluate literature and theory critically and make informed judge-
ments;


very high levels of creativity, originality and independence of thought;


very significant ability to evaluate critically existing methodologies and suggest new ap-
proaches to current research or professional practice;


very significant ability to analyse data critically;


outstanding levels of accuracy, technical competence, organisation, expression.

7079 (Distinction). A mark in the range 7079 will fulfil the following criteria:


significant ability to plan, organise and execute independently a research project or course-
work assignment;


clear evidence of wide and relevant reading, referencing and an engagement with the con-
ceptual issues;


capacity to develop a sophisticated and intelligent argument;


rigorous use and a sophisticated understanding of relevant source materials, balancing
appropriately between factual detail and key theoretical issues. Materials are evaluated di-
rectly and their assumptions and arguments challenged and/or appraised;


correct referencing;


significant ability to analyse data critically;


original thinking and a willingness to take risks.

6069 (Merit). A mark in the 6069 range will fulfil the following criteria:


ability to plan, organise and execute independently a research project or coursework assign-
ment;


strong evidence of critical insight and thinking;


a detailed understanding of the major factual and/or theoretical issues and directly engages
with the relevant literature on the topic;


clear evidence of planning and appropriate choice of sources and methodology with correct
referencing;


ability to analyse data critically;


capacity to develop a focussed and clear argument and articulate clearly and convincingly a
sustained train of logical thought.

5059 (Pass). A mark in the range 5059 will fulfil the following criteria:


ability to plan, organise and execute a research project or coursework assignment;


a reasonable understanding of the major factual and/or theoretical issues involved;


evidence of some knowledge of the literature with correct referencing;


ability to analyse data;


shows examples of a clear train of thought or argument;


the text is introduced and concludes appropriately.

4049 (Fail). A Fail will be awarded in cases in which there is:

limited ability to plan, organise and execute a research project or coursework assignment;


some awareness and understanding of the literature and of factual or theoretical issues, but
with little development;


limited ability to analyse data;


incomplete referencing;


limited ability to present a clear and coherent argument.

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 Management Accounting

2039 (Fail). A Fail will be awarded in cases in which there is:

very limited ability to plan, organise and execute a research project or coursework assign-
ment;


failure to develop a coherent argument that relates to the research project or assignment;


no engagement with the relevant literature or demonstrable knowledge of the key issues;


incomplete referencing;


clear conceptual or factual errors or misunderstandings;


only fragmentary evidence of critical thought or data analysis.

019 (Fail). A Fail will be awarded in cases in which there is:

no demonstrable ability to plan, organise and execute a research project or coursework
assignment;


little or no knowledge or understanding related to the research project or assignment;


little or no knowledge of the relevant literature;


major errors in referencing;


no evidence of critical thought or data analysis;


incoherent argument.

The grading scheme: Examinations

The written examinations are unseen (you will only see the paper in the exam
centre) and written by hand, over a three hour period. We advise that you practise
writing exams in these conditions as part of your examination preparation, as it is
not something you would normally do.
You are not allowed to take in books or notes to the exam room. This means that
you need to revise thoroughly in preparation for each exam. This is especially
important if you have completed the module in the early part of the year, or in a
previous year.
Details of the general definitions of what is expected in order to obtain a particular
grade are shown below. These guidelines take account of the fact that examination
conditions are less conducive to polished work than the conditions in which you
write your assignments. Note that as the criteria of each grade rises, it accumulates
the elements of the grade below. Assignments awarded better marks will therefore
have become comprehensive in both their depth of core skills and advanced skills.

Postgraduate Unseen Written Examinations Marking Criteria

80+ (Distinction). A mark of 80+ will fulfil the following criteria:


very significant ability to evaluate literature and theory critically and make informed judge-
ments;


very high levels of creativity, originality and independence of thought;


outstanding levels of accuracy, technical competence, organisation, expression;


shows outstanding ability of synthesis under exam pressure.

7079 (Distinction). A mark in the 7079 range will fulfil the following criteria:


shows clear evidence of wide and relevant reading and an engagement with the conceptual
issues;


develops a sophisticated and intelligent argument;


shows a rigorous use and a sophisticated understanding of relevant source materials, balanc-
ing appropriately between factual detail and key theoretical issues.

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 Module Introduction and Overview

materials are evaluated directly and their assumptions and arguments challenged and/or
appraised;


shows original thinking and a willingness to take risks;


shows significant ability of synthesis under exam pressure.

6069 (Merit). A mark in the 6069 range will fulfil the following criteria:


shows strong evidence of critical insight and critical thinking;


shows a detailed understanding of the major factual and/or theoretical issues and directly
engages with the relevant literature on the topic;


develops a focussed and clear argument and articulates clearly and convincingly a sustained
train of logical thought;


shows clear evidence of planning and appropriate choice of sources and methodology, and
ability of synthesis under exam pressure.

5059 (Pass). A mark in the 5059 range will fulfil the following criteria:


shows a reasonable understanding of the major factual and/or theoretical issues involved:


shows evidence of planning and selection from appropriate sources;


demonstrates some knowledge of the literature;


the text shows, in places, examples of a clear train of thought or argument;


the text is introduced and concludes appropriately.

4049 (Fail). A Fail will be awarded in cases in which:

there is some awareness and understanding of the factual or theoretical issues, but with little
development;


misunderstandings are evident;


there is some evidence of planning, although irrelevant/unrelated material or arguments are
included.

2039 (Fail). A Fail will be awarded in cases which:

fail to answer the question or to develop an argument that relates to the question set;


do not engage with the relevant literature or demonstrate a knowledge of the key issues;


contain clear conceptual or factual errors or misunderstandings.

019 (Fail). A Fail will be awarded in cases which:

show no knowledge or understanding related to the question set;


show no evidence of critical thought or analysis;


contain short answers and incoherent argument.
[201516: Learning & Teaching Quality Committee]

Specimen exam papers

CeFiMS does not provide past papers or model answers to papers. Modules are
continuously updated, and past papers will not be a reliable guide to current and
future examinations. The specimen exam paper is designed to be relevant and to
reflect the exam that will be set on this module.
Your final examination will have the same structure and style and the range of
question will be comparable to those in the Specimen Exam. The number of ques-
tions will be the same, but the wording and the requirements of each question will
be different.
Good luck on your final examination.

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 Management Accounting

Further information
Online you will find documentation and information on each years
examination registration and administration process. If you still have questions, both
academics and administrators are available to answer queries.
The Regulations are also available at www.cefims.ac.uk/regulations/, setting out
the rules by which exams are governed.

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 Module Introduction and Overview

DO NOT REMOVE THE QUESTION PAPER FROM THE EXAMINATION HALL.

UNIVERSITY OF LONDON

CENTRE FOR FINANCIAL AND MANAGEMENT STUDIES

MSc Examination
91DFM C370

INTERNATIONAL BUSINESS ADMINISTRATION

Management Accounting
Specimen Examination

This is a specimen examination paper designed to show you the type of examination you will have at
the end of this module. The number of questions and the structure of the examination will be the
same, but the wording and requirements of each question will be different.

The examination must be completed in THREE hours.

Answer Question 1, plus ONE question from Section A and ONE question from Section
B. You must answer THREE questions in total. The examiners give equal weight to each
question; therefore, you are advised to distribute your time approximately equally
between three questions.

PLEASE TURN OVER

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 Management Accounting

Answer THREE questions. You must answer Question 1, plus ONE question
from Section A and ONE question from Section B.

(All students must answer THIS question)

1 The Firs Company sells fir trees, with 30% of customers paying in
cash at the time of purchase and the remaining 70% taking advantage
of credit offered. Of the credit customers, 80% pay in the month
following purchase with the remaining 20% paying two months after
purchase. The following sales revenue is estimated in the forthcom-
ing months:

September October November December January February March April

580,000 620,000 780,000 930,000 520,000 490,000 570,000 580,000

Purchases by the Firs Company are 80% of sales revenue (not cash
received) each month. The Firs Company is offered one months
credit so pays in the month after purchase.
Other costs for the Firs Company comprise:

Salaries/ wages are 132,000 each month, paid in the month they
are incurred.

Electricity/ gas charges total 8,000 per year and are paid in four
equal quarterly amounts in January, April, July and October.

Running costs of 4,000, paid in the month they are incurred.
The Firs Company is planning to buy a new delivery van at a cost of
25,000 in February and to pay for it outright in the month of pur-
chase. This will replace the existing delivery van which will be sold
for scrap of 2,500 in the same month.
!
! ! !
! ! !Firs!!!!! !
!
!
! !!! !
! ! !!
! !  !
  !
!November!!
 !! !!  !  !
!
 !! !  

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 Module Introduction and Overview

SECTION A
(Answer ONE question from this section)

2 A company manufactures wooden tables of a standard size and plans

to make 50 tables each month. Each table is budgeted to use 8 kg
wood at a cost of 6 per kg and 24 hours of direct labour at a cost of
12 per hour.
For August 2016, the company actually made 55 tables using 550 kg
of wood costing 3,190 and 1,430 hours of direct labour costing
16,445. There was no opening or closing inventory of wood.
a) Explain variance analysis and how it may be used.
(30% of total marks for Question 2)
b) Calculate the following variances and explain what the calcu-
lated variances show.

Materials price variance

Materials quantity variance

Direct labour rate variance

Direct labour efficiency variance
(70% of total marks for Question 2)

3 A company that makes and sells garden machinery has a new

Managing Director, who is concerned that the LMX lawnmower is
not a profitable product. The Managing Director has requested that
each product (including the LMX lawnmower) should be making a
profit of at least 10,000 each year.

--- -
-
--
----
-'"$ ) (-
----
-- -'& --
 -
- -'"!--(-----
--%)# -
-(-
*-

-- -)-
-- - --

-
--number- ----,
- --
--
---
+-
- (-
- - - - (60% of total marks for Question 3)
*-

-
--- -
 ---
(-
- - - - (40% of total marks for Question 3)-

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 Management Accounting

4 A new machine at a manufacturing company has been purchased to

increase production. The machine has been purchased in year 0 for
180,000 and will be sold for 12,000 in 5 years time at the end of its
useful economic life.
Revenue based on production by the new machine is estimated to be
30,000 in year 1. Volume is expected to remain constant, but selling
price (and therefore revenue) is expected to increase by 5% per year.
Running costs are estimated to be 4,000 in year 1. Inflation for run-
ning costs is estimated at 2% per year.
The company evaluates capital investments using a nominal cost of
capital of 5%. Ignore taxation.
Calculate the net present value (NPV) of the new machine. Explain
your findings, and your treatment of inflation.

SECTION B
(Answer ONE question from this section)

5 Critically compare the use of job costing and process costing.

6 Critically discuss the use of alternative responsibility centres.

7 Provide advice to the Board of a chemical company on the relevance

of environmental costs to a production decision.

8 Critically discuss the use of activity-based costing systems.

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Management Accounting
Unit 1 Management Accounting
Context and Performance
Measurement

Contents
1.1
Introduction to Management Accounting 3

1.2
Centralisation and Decentralisation 4

1.3
Divisional Performance and the Controllability Construct 6

1.4
Balanced Scorecard 9

1.5
Case Study 11

1.6
Summary 13

References 14

 Management Accounting

Unit Overview
Unit 1 sets the scene for the module by defining and explaining key terms
used in management accounting. The unit first looks at what management
accounting actually is, what it involves, and how it differs from financial
accounting. We then consider how an organisation may be structured, and
then explore how the performance of individual elements of an organisation
can be assessed. The unit then considers how performance measurement
should incorporate both financial and non-financial elements, and explores
how the balanced scorecard achieves this. Finally the unit examines how a
company can develop and use the balanced scorecard through a case study.

Learning Objectives
When you have completed your study of this unit, including the recommend-
ed readings and activities, you will be able to

discuss the key qualities that management accounting information
should possess

compare and contrast financial accounting and management accounting

distinguish between centralisation, decentralisation and
divisionalisation

distinguish between and explain responsibility centres, cost centres,
profit centres, and investment centres

discuss the controllability principle, and divisional performance
measures of absolute profit, return on investment (ROI), and residual
income (RI)

calculate the ROI and RI

explain and apply the balanced scorecard.

critically discuss the assumptions underlying the balanced scorecard

Reading for Unit 1

Textbooks
Paul Collier (2015) Accounting for Managers: Interpreting Accounting
Information for Decision Making, extracts from Chapters 1, 4 and 15.
Anthony Atkinson, Robert Kaplan, Ella Matsumara and Mark Young (2012)
Management Accounting: Information for Decision Making and Strategy
Execution, sections from Chapters 2 and 11.

Module Reader
Hanne Nrreklit (2000) The balance on the balanced scorecard a critical
analysis of some of its assumptions.

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 Unit 1 Management Accounting Context and Performance Measurement

1.1 Introduction to Management Accounting

In this module you will study management accounting in a variety of indus-
tries, contexts and countries. Before this, though, it is essential that you
understand what management accounting actually is, and what the manage-
ment accounting function means to an organisation.
The requirement for firms to produce and publish financial reports, regulated
by governmental agencies, is known as financial accounting. It is the account-
ing information that is produced for use internally by managers within an
organisation that is referred to as management accounting, and this is the
focus of this module.
The following reading provides a definition of management accounting, and
compares the characteristics of management accounting and financial ac-
counting.

Reading
Anthony Atkinson,
Robert Kaplan, Ella
Matsumara and Mark
Please turn to your textbook by Atkinson et al. and read pages 26 to 28, ending with the Young (2012)
Management
section IN PRACTICE: Definition of Management Accounting. Accounting, Chapter 2

 Make notes as you work through this reading, and be sure you understand the The Balanced
Scorecard and Strategy
Map, sections cited.
definition of management accounting and the attributes of both management accounting
and financial accounting.

From the reading above, you should now have an understanding of manage-
ment accounting information, as well as what management accounting
actually is. The key difference between management accounting and financial
accounting is one of focus.

Management accounting is focused on internal uses, such as producing
information for use in cost budgets, labour hiring plans, and sales
forecasts.

Financial accounting is focused on external uses, such as producing
information that meets the demands of tax authorities, and the
information required by stock exchanges, lenders and shareholders on
the assets and liabilities of a business.
The following reading considers these two accounting strands further.

Reading
Paul Collier (2015)
Accounting for
Managers, Chapter 1
Please turn to your Collier textbook, Chapter 1, and read the following three sections: The Introduction to
Accounting, sections
role of financial accounting, The role of management accounting, and The relationship
cited.
between financial accounting and management accounting (pages 710 and 1214).

 As you study these sections, make notes of the key differences between financial
accounting and management accounting, paying attention to their objectives, organisa-
tional functions and the actual information items produced.

From the above readings you should now have a good understanding of the
elements of financial accounting and management accounting, and of the

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similarities and differences between them. The following table provides a

useful summary. However, you may find it helpful to annotate this table
further and add some additional notes from your understanding of the earlier
readings.

Table 1.1 Management and Financial Accounting

Management accounting Financial accounting

Also known as Management information Statutory accounts, financial
statements, annual accounts,
annual returns
Main users Internal users such as managers External users such as investors,
lenders, suppliers, tax authorities
Information provided Decided by management to best Established by legislation and
and format of this suit the requirements of the regulations
information business
Detail provided Considerable detail Broad overview
Reporting frequency As frequently as required: daily, Annual, and quarterly or half-yearly
weekly, monthly for large businesses
Time horizon Past and future periods (forecasts) Past periods (backward-looking)
Audit and tax Not used for external audit or Often audited and used for tax
taxation authorities. May be used calculations
for internal audit purposes
As mentioned earlier, this module is concerned with management accounting.
However, it is useful to keep in mind the focus of management accounting,
and how it differs from financial accounting. One of the uses of management
accounting within an organisation is performance measurement you should
recall this from the management accounting definition in the reading earlier
in this section. In the rest of this unit we are going to consider performance
measurement. Before we can do this, it is important for us to gain an under-
standing of organisational structure.

1.2 Centralisation and Decentralisation

The way organisations are structured can affect organisational performance.
The degree of control over operations and operational reporting that is given
to managers may also create motivational and potential behavioural issues.
Management accounting can be looked at as a technology, or set of practices,
that influence and are influenced by the organisational structure that is
adopted. Two key ways an organisation may be structured are decentralised
and centralised. We will look at each of these in turn.

Centralisation
Centralisation occurs when decision-making is reserved for senior managers.
Typically, centralisation works effectively in organisations that enjoy stable
environments and technologies and where customer requirements are well
understood.

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 Unit 1 Management Accounting Context and Performance Measurement

Decentralisation
Decentralisation occurs when decision-making responsibility is delegated
from senior management to employees at lower levels of the organisation.
Decentralisation is effective for organisations in which:

environments, technologies and customer requirements are constantly
changing

employees have the skills and knowledge to accept decision-making

employees understand the organisations objectives so that they can
make decisions that are consistent with those objectives.
Linked with decentralisation are responsibility centres, which are basically
sub parts of an organisation, or may be considered to be like a small business
within a larger organisation. The managers of the responsibility centres are
responsible for running their centre in the best interests of the larger organisa-
tion.
The next two readings introduce some of the key terminology in this area.

Reading
Paul Collier (2015)
Accounting for
Managers, Chapter 15
Please turn to your Collier textbook and read the section Structure of business organiza- Performance
Evaluation of Business
tions on pages 31719. Please also turn to your Atkinson et al. textbook and read the Units, sections cited.
section The Motivation for Decentralization on pages 48890.
Anthony Atkinson,

 Make notes on the following key terms, ensuring that you understand each term and Robert Kaplan, Ella
Matsumara and Mark
the difference between them: Young (2012)
Management

Responsibility centre Accounting, Chapter 11
Financial Control,

Cost centres sections cited.

Profit centres

Investment centres
You may also find it helpful to think through the following questions when making your
notes on this reading:

What one additional element do investment centres have in comparison to profit
centres?

What one additional element do profit centres have in comparison to cost centres?

As you will have noted, the above reading distinguishes between cost centres,
profit centres, and investment centres.

An investment centre is a responsibility centre whose employees control
its revenues, costs, and the level of investment. The investment centre is
essentially an independent business.

A profit centre is a responsibility centre whose employees control
revenues and costs but not the level of investment; central senior
management usually controls the level of investment. Most outlets of
fast food restaurant chains are profit centres. Numerous organisations
evaluate units as profit centres even though the corporate office controls
many aspects of their operations, so that the profit centre managers do
not totally control revenues and costs. You will consider this control
issue further in the next section (section 1.3).

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A cost centre is a responsibility centre whose employees control its costs

within budget limits.
You can see that each level of responsibility centre (going from cost to profit
to investment centre) includes an additional element of control. The use of a
decentralised organisational structure requires methods for measuring
performance of these divisions or responsibility centres. In the next section we
explore divisional performance in more detail.

1.3 Divisional Performance and the Controllability Construct

In section 1.2 we introduced the concept of decentralisation. Before moving on
with this section, it is important to note that decentralisation and divisionali-
sation are different concepts:

Decentralisation empowers managers of organisational branches and
units with decision-making authority. Such authority can extend to cost
management, capital investment management, or authority over both.

Divisionalisation extends decentralisation, adding responsibility over
revenue management e.g. setting sales targets.
Now we are in a position to explore how organisations can measure the
performance of their divisions. We will focus on three main methods: absolute
profit, return on investment (ROI), and residual income (RI), looking at each
in turn.

Absolute profit
Absolute profit compares the profit level achieved by a division in any one
period to its expected (or budgeted) performance level.

Return on investment (ROI)

Return on investment is the rate of return achieved on the capital employed
or invested. It is measured as:
ROI = (operating profit capital employed) 100
For example, if a divisions operating profit is 400,000 and their capital
employed is 2,000,000, then the ROI can be calculated as:
ROI = (400,000 2,000,000) 100 = 20%
A ROI of 20% means that for every 100 of capital invested by the division, a
return of 20 is made.

Residual income (RI)

Residual income is the profit that remains after being adjusted for the cost of
capital. Cost of capital is basically the cost that an organisation incurs to fund
all of its investments.
We have provided a very brief introduction to these three key performance
measures. The next reading provides further information on these measures,
and also considers the difference between decentralisation and divisionalisa-
tion.

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 Unit 1 Management Accounting Context and Performance Measurement

Reading Paul Collier (2015)

Accounting for
Please now study Collier, Chapter 15, the section The decentralized organization and Managers, Chapter 15
Performance
divisional performance measurement on pages 32023 (including the sub-sections Evaluation of Business
Absolute profit, Return on investment and Residual income) and the section Compari- Units, sections cited.
son of methods on page 326.

 Make notes on the purposes for financial reporting at the divisional level, and ensure
that you understand the ROI and RI examples.

When applying any of these three performance measures (absolute profit, ROI
and RI) it is useful to keep in mind the overall purpose in terms of trying to
evaluate the performance of the business unit and its managers.
It may be helpful to go through the example from the above reading to
reinforce your understanding. We will focus on Division A.
Division A has:

1,000,000 of depreciated capital assets (which might consist of
productive property, plant and equipment).

200,000 operating profit in one reporting period (usually a financial
year)
To calculate residual income, a charge is taken from Division As operating
profit in the form of a percentage of Division As capital assets. This percent-
age represents the cost of capital for the entire organisation, in this example.
The cost of capital is determined as the cost of accessing debt (such as obtain-
ing bank loans and issuing debentures) and the cost of issuing equity share
securities. For this module you do not need to know the detail of calculating
the cost of capital, but you do need to know how to apply it in this context. In
this example the cost of capital is given as 17.5% (per annum).
Therefore the calculation would be the cost of capital multiplied by the capital
assets:
17.5% 1,000,000 = 175,000.
This 175,000 is then deducted from the operating profit of 200,000 to give
the residual income:
RI = 200,000 175,000 = 25,000.
We can compare the RI of 25,000 for Division A with the RI of
50,000 for
Division B. Division B made a higher operating profit than Division A, but the
RI for Division B is lower than the RI for Division A. In fact RI for Division B
is reported as a loss. We can explain this by observing that Division B had a
greater level of capital invested. This example illustrates how the three
measures highlight different aspects of performance.
You will return to use the cost of capital later in the module (Unit 7) when
you study capital investment.
Please answer the following exercise to reinforce and test your understanding
of calculating ROI and RI.

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 Exercise
Please turn to your Collier textbook and attempt Questions 15.1 and 15.2 on page 332.

You will find the answers to these questions towards the back of your Collier
textbook on page 493, but please attempt the questions yourself before you
check your answers.
In this section you have studied the three performance measures of absolute
profit, ROI and RI. However, in using these measures or any means of
performance assessment it is essential that the managers of a business unit
or division are only held accountable or responsible for those items that are
within their control. For example, should a manager of a cost centre be
assessed on capital investment decisions? (You might find it helpful to think
back to the different types of responsibility centres.) This question forces us to
examine the issue of controllability.

Reading Paul Collier (2015)

Please turn to your Collier textbook and read the section Controllability on pages 32324. Accounting for
Managers, Chapter 15

 Make notes on the principle of controllability and controllable profit, and ensure that Performance
Evaluation of Business
you understand the importance and implications of these concepts. Units, sections cited.

Divisional controllable profit explained in the above reading provides a

solution to the problem of controllability and performance measurement for
divisional managers. This new measure of divisional profit requires the
identification of overhead costs that divisional managers can control. These
controllable overhead costs are deducted from divisional contribution, pro-
ducing controllable profit at the divisional level. This divisional controllable
profit figure can then be used to evaluate divisional performance using any of
the three performance measures you looked at earlier in the unit: namely
absolute profit, ROI or RI.
Now please try the following exercise which demonstrates why a divisional
managers performance assessment may have implications for the company
as a whole.

 Exercise
Please turn to your Collier textbook and attempt Question 15.3 on page 332.

You will find the answer to this question towards the back of your Collier
textbook on pages 49394.
Using the ROI, the Green Division would not want to accept the investment
because it would reduce its ROI. However, it would be financially beneficial
for the Company as a whole because the return is above the cost of capital (or
the cost of the investment). This shows the complex nature of divisional
performance measurement, and indeed the decisions made by divisional
managers.

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 Unit 1 Management Accounting Context and Performance Measurement

The performance measures (absolute profit, ROI and RI) you have studied so
far in relation to the performance of divisions or business units have been
financially focussed. Undoubtedly financial measures provide important
information. However, financial performance is not the whole story and it is
important that organisations also assess their non-financial performance. In
the following section you will consider one method that incorporates both
financial and non-financial performance measures the balanced scorecard. The
balanced scorecard may be used at the division, department or company
level.

1.4 Balanced Scorecard

As mentioned above, purely financial measures are useful in understanding
performance, but they do not provide a complete picture, and other factors
are also critical to the success of a business. However, managers tend to focus
most on financial measures, mainly because they are the easiest to calculate.
One method used by organisations to combine financial and non-financial
measures is the balanced scorecard, developed by Robert Kaplan, one of the
authors of your textbook, Management Accounting.
Balanced scorecards are often represented in a 2
2 grid, as demonstrated in
Table 1.2, with performance measures considered across four areas. The idea
of the grid arrangement is that the four corners are balanced in terms of
importance.

Table 1.2 Balanced scorecard

Financial measures Customer/client measures

Internal business process measures Learning and growth measures

For organisations applying the balanced scorecard in practice, the four per-
spectives may be tailored to make them more relevant to the individual
organisation. In many organisations that use balanced scorecards, the perfor-
mance rubrics chosen reflect the organisations profile, mission and specific
objectives.
Example
Arup is a leading international engineering group that is very dependent on
their professional staff and the organisations design skills.
Arup has applied the following four perspectives in their own balanced
scorecard:

Financial measures

Customer/client measures

Design process measures

Staff measures

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You can see that Arup has modified the Internal business process measures
in the standard balanced scorecard (and illustrated in Table 1.2 above) to
Design process measures as this is more relevant to their business. Further-
more Learning and growth measures has been modified to Staff measures.

 Exercise
Try to find out if your own organisation, or an organisation you are interested in, uses the
balanced scorecard.
If it does, what perspectives, objectives and measures have been included in the balanced
scorecard?
And if it does not, is there a reason why?

There is no one correct answer to this exercise, because the answers will
depend on your chosen organisation. However, it is interesting to see how the
theory relating to tools like this are adopted in practice, and the tools are often
easier to understand if they are considered in relation to an organisation with
which you are familiar. Later in this unit (Section 1.5) you will look at the
balanced scorecard for a case study organisation.
The following readings provide more insight into the use of the balanced
scorecard.

Readings Paul Collier (2015)

Accounting for
Managers, Chapter 4
Collier Chapter 4, Non-financial performance measurement (pages 5864) Management Control,
Accounting and its
Atkinson et al. Chapter 2, The Balanced Scorecard (pages 4347) Rational-Economic

 Make notes as you study these readings, particularly noting the link with organisa-
Assumptions, and
Anthony Atkinson,
Robert Kaplan, Ella
tional strategy and the fundamental questions that the four perspectives of the balanced Matsumara and Mark
scorecard address. Young (2012)
Management
Also, take note of the example objectives and performance measures that may be included Accounting, Chapter 2
across the four perspectives. The Balanced
Scorecard and Strategy
Map, sections
cited.Please turn to
As you will have noted, the balanced scorecard is strongly linked to an your two textbooks and
organisations strategy. Indeed, an organisations strategy, mission and vision read the following
sections.
should be the starting point from which the four perspectives are derived.
Within each of the four perspectives, objectives and performance measures
should be compiled which consequently provide a balanced perspective for
performance measurement for the organisation or division. However, it is
important that the number of performance measures in each perspective (and
in total) are limited. Kaplan and Norton (referenced in the reading from
Chapter 4 in your Collier textbook) suggest three or four measures in each
perspective, giving a total of between 12 and 16 overall.
As with many theories and tools, there are criticisms of the balanced score-
card. The following reading explores some of these criticisms, by focusing in
particular on the underlying assumptions of the balanced scorecard.

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Readings
Hanne Nrreklit (2000)
The balance on the
balanced scorecard a
Please turn to your Module Reader and study the article titled The balance on the bal- critical analysis of some
of its assumptions
anced scorecard a critical analysis of some of its assumptions by Nrreklit.
reprinted in the Module

 Make notes as you work through this reading and in particular consider the following Reader from
Management
Accounting Research.
issues:

Cause and effect relationship


What is assumed by the balanced scorecard?

What are the criticisms of this?

How is the balanced scorecard different to other approaches?

Is a time lag present in the balanced scorecard? Why is this time dimension an issue?

Are the measures on the balanced scorecard linked?

How does the empirical research support or contradict the relationships proposed
within the balanced scorecard?

Strategic Control Model


How does the balanced scorecard relate to stakeholders and the organisations exter-
nal environment, such as technological developments?

How does the balanced scorecard relate to managers and employees?

What are the arguments for or against the relationships assumed within the balanced
scorecard?

This is a lengthy journal article. However, it provides a useful insight into

some of the criticisms of the balanced scorecard. This is beneficial for several
reasons. Firstly, it gives you a fuller understanding of the balanced scorecard.
It is important to recognise within your studies that models or techniques are
not faultless, and will usually have both supporters and critics. Secondly, this
article provides a good example from a referenced academic journal of the
sort of reading you should be referring to during your studies, and in particu-
lar to support the writing of your assignments for this module.
Although it is not necessary to have a detailed answer to each of the above
questions, it is important to have an insight into some of the criticisms of the
balanced scorecards underlying assumptions.
The following section considers the development and use of the balanced
scorecard within a case study.

1.5 Case Study

You will now look at a case study in your Atkinson et al. textbook which
examines the development of the balanced scorecard by an example compa-
ny. This case study builds on your analysis of the balanced scorecard earlier
in this unit, and provides greater insight into the performance measures that a
company may develop for each of the four perspectives.

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Reading
Anthony Atkinson,
Robert Kaplan, Ella
Matsumara and Mark
The details of the case, Pioneer Petroleum, are in Chapter 2 of your textbook by Atkinson Young (2012)
Management
et al. Please read the section Strategy Map and Balanced Scorecard at Pioneer Petroleum Accounting, Chapter 2
on pages 6066. The Balanced
Scorecard and Strategy
 As you study this case, try to answer the following questions: Map, sections cited.

1 What four perspectives did Pioneer Petroleum (PP) include in their balanced score-
card?
2 Discuss the objectives and performance measures that PP include in their balanced
scorecard for each perspective. Consider how these objectives and measures relate to
the companys strategy and how the company identified and chose them.
3 How does the PP balanced scorecard compare to the theory studied earlier in this
unit?

Feedback on Case Study

This section provides suggested answers to the questions raised in section 1.5.
However, please ensure that you answer the questions yourself before read-
ing on.
1 What four perspectives did Pioneer Petroleum (PP) include in their balanced
scorecard?
PP applied the standard four perspectives of financial, customer, process and
learning and growth.
2 Discuss the objectives and performance measures that PP include in their balanced
scorecard for each perspective, including how these relate to the companys busi-
ness.
Within the Financial perspective:

Increase return on capital employed to 12% through improved
productivity (cost reduction and asset intensity) and growth (volume
and non-gasoline sales).

The growth theme was strongly linked to a customer-driven strategy
associated with convenience sales.

Volume growth was defined in relation to the industry growth rate and
the percentage of volume in premium grades. This objective was
therefore also linked to the companys strategy of trying to increase
their proportion of sales of premium product grades.

A total of five objectives and seven measures were included for this
perspective.
Within the Customer perspective:

Success on this was measured by its market share among specific
segments which linked clearly with the companys strategy.

Measures included fulfilling the customer value propositions for these
segments and strengthening dealer and distributor relationships.

PP undertook considerable research to identify the elements of
performance measure for this perspective.

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 Unit 1 Management Accounting Context and Performance Measurement

A total of two objectives and four measures were included for this
perspective.
The Process perspective involved:

Strategic objectives developed in each of the four process themes for the
company

A total of eight objectives were included for this perspective (you will
notice this is quite high in comparison to the 12 to 16 suggested by
Kaplan and Norton for the balanced scorecard as a whole).

The objectives/measures supported PPs differentiated strategy with
consumers and dealers, its financial objectives for cost reduction and
productivity, and its social responsibilities.

A total of eight objectives and twelve measures were included for this
perspective.
And in the Learning and Growth perspective:

A motivated and prepared workforce was the foundation strategy for
this perspective.

Objectives were developed across three areas: develop core
competences and skills; provide access to strategic information; and to
engage and empower employees.

A total of three objectives and three measures were included for this
perspective.
3 How does the PP balanced scorecard compare to the theory studied earlier in this
unit?
The balanced scorecard developed by PP adopted the standard four perspec-
tives initially proposed by Kaplan and Norton.
A total of 18 objectives and 26 measures were included in the balanced
scorecard across the four perspectives. This is greater than the 1216 recom-
mended by Kaplan and Norton. One of the aims of the balanced scorecard is
to limit the number of performance measures by prioritisation. However, it is
clear that PP have developed the measures from the companys strategy.
The above answers are brief and indicative, and it is expected that your notes
will be more detailed. However, the most important aspect is that the case
study reinforces your understanding of this material, by demonstrating how
an example company has developed a balanced scorecard. You should be
aware of what the balanced scorecard approach is intended to achieve, how
companies can adapt the method to suit their own strategies, and the extent to
which the way the scorecard is being used will influence the potential ad-
vantages and disadvantages of this method.

1.6 Summary
This unit has helped set the scene for your study of the rest of the module, by
introducing you to what management accounting actually is and the infor-
mation it should comprise. One of the elements of management accounting is
performance measurement, and this unit has explored various ways to
measure financial and non-financial performance at both the divisional and

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 Management Accounting

organisation level. You should now understand the measures of absolute

profit, return on investment (ROI) and residual income (RI), as well as the
balanced scorecard.
The readings, practice questions and case study demonstrated the use of both
theory and examples to support your learning. You should now be ready to
move on to Unit 2, where you will study an important aspect of management
accounting: pricing.

References
Atkinson Anthony, Robert Kaplan, Ella Matsumara and Mark Young (2012)
Management Accounting: Information for Decision Making and Strategy Execution,
Sixth Edition, Harlow Essex UK: Pearson Education Limited.

Collier Paul (2015) Accounting for Managers: Interpreting Accounting Information

for Decision Making, Fifth Edition, Chichester UK: John Wiley & Sons.

Nrreklit Hanne (2000) The balance on the balanced scorecard a critical

analysis of some of its assumptions, Management Accounting Research, 11, pp.
6588.

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