SIMAD University

Chapter one
Introduction
Lecturer : Yusuf Hussein
Mohamed

Outline of Chapter 1
Introduction
Managerial Accounting: Decision Making and
Control
Design and Use of Cost Systems
Marmots and Grizzly Bears
Management Accountants Role in the
Organization
Evolution of Management Accounting: A
Framework for
Change
Vortec Medical Probe Example
Outline of the Text
1-2

OBJECTIVE ONE
MANAGERIAL ACCOUNTING: DECISION
MAKING AND CONTROL
Information system
Internal accounting system
Control system

Definitions
Information Systems
An information system(IS) is typically considered to be
a set of interrelated elements or components that
collect(input), manipulate(processes), and disseminate
(output) data and information and provide a feedback
mechanism to meet an objective.

Information system
As firms grow from single proprietorships to
large global corporations with tens of
thousands of employees, managers lose the
knowledge of enterprise affairs gained from
personal, face-to-face contact in daily
operations. Higher-level managers of larger
firms come to rely more and more on formal
operating reports.

Opportunities
1. Enhanced global competitiveness
2. Capture market opportunities
3. Support corporate strategy
4. Enhance worker productivity
5. Improve quality of goods and services

Challenges
1. Workforce downsizing
2. Information overload
3. Employee mistrust
4. Difficult to built
5. Security breaches

Internal accounting system

The internal accounting system, an important
component of a firms information system,
includes budgets, data on the costs of each
product and current inventory, and periodic financial
reports.
In many cases, especially in small companies,
these accounting reports are the only formalized
part of the information system providing the
knowledge for decision making.

Continue
In general, owners want high profits and
employees want easier jobs, high wages
and more fringe benefits. To control this
conflict senior managers and owners
design systems to monitor employees
behavior and incentive schemes that
reward employees for generating more
profit. Not for profit organizations face
similar conflicts.

Internal accounting systems

serve two purposes:
To provide some of the knowledge
necessary for planning and making
decisions ( decision making)
To help motivate and monitor people in
organizations ( control)
The most basic control use of accounting is
to prevent fraud and misappropriation.

The characteristics an internal

accounting system
Provide the information necessary to
identify the most profitable products or
services and the pricing and marketing
strategies to achieve the desired volume
levels.
When combined with the performance
evaluation and reward systems, create
incentives for managers to maximize firm
value.

The characteristics an internal

accounting system
Support the financial accounting and tax
accounting reporting functions.
Contribute more to firm value than it costs.

Control system
Control system includes performance
measures and incentive compensation
systems, promotions, demotions and
terminations, security guards and video
surveillance or watch, internal auditors,
and the firms internal control system. The
most basic control use of accounting is to
prevent fraud and embezzlement

Decision Making - Product

Management
Examples
Add new product
Terminate an existing product line
Accept or reject special order
Related Topics
Operations management
Budgeting - capital and operating
Just-in-time (JIT)
1-14

Decision Making - Pricing

Examples
Set selling price to achieve desired profits
Set selling price to achieve positive cash flow
Related Topics
Marketing
Microeconomics - Price Theory
Corporate Finance
1-15

Decision Making - Cost Control

Examples
Add new equipment
Change production process
Make internally versus buy externally (outsource)
Related Topics
Process engineering
Management information systems
Activity-based costing (ABC)
1-16

Control - Performance Evaluation

Examples
Performance bonuses depend on accounting
results
Benchmarking: comparisons to industry leaders
Related Topics
Organizational behavior
Human resources management
1-17

Discussion
let us assume that a manager has to sell a
custom-built machine owned by the
business and has recently received a bid for
it. This machine is very unusual and there
is no ready market for it. What nformation
would be relevant to the manager when
deciding whether to accept the bid? How
reliable would that information be?

Answer
The manager would probably like to know the current
market value of the machine before deciding whether or
not to accept the bid. The current market value would be
highly relevant to the final decision, but it might not be
very reliable because the machine is unique and there is
likely to be little information concerning market values.
Where a choice has to be made between providing
information that has either more relevance or more
reliability, the maximization of relevance tends to be the
guiding rule.

OBJECTIVE TWO
DESIGN AND USE OF COST SYSTEMS
Managers make decisions and monitor subordinates
who make decisions. Both managers and accountants
must acquire sufficient familiarity with cost systems to
perform their jobs. Accountants (often called
controllers) are charged with designing, improving, and
operating the firms accounting systeman integral
part of both the decision-making and performance
evaluation systems. Both managers and accountants
must understand the strengths and weaknesses of
current accounting systems

Design - Multiple Role of

Accounting
Study Figure 1-1.
Figure 11 shows the functions of the
accounting system. The accounting
system supports both external and internal
reporting systems
Main point: Accounting reports are used
for multiple purposes.

1-21

Characteristics An internal accounting system

1. Provides the information necessary to assess the profitability

of products or services and to optimally price and market

these products or services
2.Provides information to detect production inefficiencies to
ensure that the proposed products and volumes are
produced at minimum cost.
3. When combined with the performance evaluation and reward
systems, creates incentives for managers to maximize firm
value.
4. Supports the financial accounting and tax accounting
reporting functions. (In some instances, these latter
considerations dominate the first three.)
5. Contributes more to firm value than it costs

Design - External Reports

Users of external reports
Shareholders, bondholders, and analysts (SEC,
FASB)
Taxing authorities (IRS, states, etc.)
Regulatory authorities (GASB, etc.)
Board of directors
Objectives in external reporting
Comparability between firms
Historical accounting
Auditors can verify reports
1-23

Design - Internal Reports

Users of internal reports
Managers at all levels
Objectives of internal reporting
Useful for decision making about future activities
Measure performance that is relevant to the firm
Focus on projects or processes within a firm

1-24

Design - Conflicting Goals

Control
Incentives to motivate behavior changes
Tendency to ignore information not specifically
included in incentive system
Report good numbers to satisfy top
management
Decision making
Want to avoid distorted information
Estimates useful to plan future activities
1-25

OBJECTIVE THREE

MARMOTS AND GRIZZLY BEARS

Continue
Economists and operating managers often criticize
accounting data for decision making. Accounting data are
often not in the form managers want for decision making.
For example, the book value of a factory (historical cost
less accumulated accounting depreciation) does not
necessarily indicate the market or selling value of the
factory, which is what a manager wants to know when
contemplating shutting down the factory.
Consider the parable of the marmots and the grizzly
bears: Since the bears survive, the benefits of
consuming marmots must exceed the costs.

Design - Evolution
Economic Darwinism:
Over the long term systems survive in
competitive markets when the benefits exceed
or equal the costs of maintaining those
systems.
Survival does not imply optimality.
Better systems may exist, but have not yet
been discovered.
1-28

major problems with their current

cost system.
Provides inadequate information for product costing/pricing
53%
Lack of information for management decision making 52%
Unsatisfactory operating performance measures 33%
Lack of information for valid worker performance evaluation
30%
Performance measures are not meaningful for competitive
analysis 27%
Performance measures are inconsistent with firm strategy

18%

Discussion
Imagine that you are the chief executive of
the Jubba ariways .What kinds of nonfinancial information may be relevant to
help you evaluate the performance of the
business for a particular period

Here are some possibilities, although there

are many more that might have been chosen
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.

volume of passengers transported to various destinations

average load factor (that is, percentage of total passenger
seats occupied) per trip
market share of air passenger travel
percentage of total passenger volume generated by these
new routes
aircraft turnaround times at airports
punctuality of flights
levels of aircraft utilization
number of flight cancellations
percentage of baggage losses
levels of customer satisfaction
levels of employee satisfaction
percentage of bookings made over the internet
maintenance hours per aircraft

OBJECTIVE FOUR

MANAGEMENT ACCOUNTS ROLE IN

THE ORGANIZATION

Management Accountants
Role in the Organization
To better understand internal accounting
systems, it is useful to describe how firms
organize their accounting functions. No single
organizational structure applies to all firms.
Figure 12 presents one common organization
chart. The design and operation of the internal
and external accounting systems are the
responsibility of the firms chief financial officer
(CFO)

Management Accountants
Role in the Organization
Management accounting measures and reports financial
and non-financial information that helps managers make
decisions to fulfill the goals of an organization
Managers use management accounting information to
choose, communicate and implement strategy
coordinate product design, production and marketing decisions

Management accounting focuses on internal reporting

Management accounting is future oriented

 The purpose of management accounting in the

organization is to support competitive decision
making by collecting, processing, and
communicating
information
that
helps
management plan, control, and evaluate
business processes and company strategy

OBJECTIVE FIVE
EVOLUTION OR DEVELOPMENT OF
MANAGEMENT ACCOUNTING:
FRAMEWORK FOR CHANGE

Continue
Management accounting has evolved with
the nature of organizations. Prior to 1800,
most businesses were small, familyoperated organizations. Management
accounting was less important for these
small firms. It was not critical for planning
decisions and control reasons because
the owner could directly observe the
organizations
entire
environment
(Zimmerman, 2011).

Continue
Only as organizations grew larger would
management accounting become more
important. Most of todays modern
management accounting techniques was
developed in the period from 1825 to 1925
with the growth of large organizations.

Continue
Since 1975, two major environmental
forces have changed organizations and
caused managers to question whether
traditional
management
accounting
procedures (pre-1975) are still appropriate.
These environmental forces are:
Factory automation and computer/
information technology
Global competition.

Evolution of Management Accounting:

A Framework for Change
Business Environment
Business Strategy
Organizational Architecture
Decision-Right Assignment
Performance Evaluation
Reward System
Incentives and Actions
Firm Value
1-40

Example - Vortec Special Order

With no overtime and congestion
Current
With Order Incremental
Units produced and sold
100,000
102,000
Total Revenue and Costs
Sales ($5.00 regular,
$4.00 special)
$ 500,000
$508,000
Cost of sales ($4.50, $4.47)
450,000
455.940
Administrative expenses
- 27,500
- 27,500
Net profit before taxes
$ 22,500 $ 24,560

2,000
$ 8,000
-5,940
0
$ 2,060

Incremental revenue (2,000 units x $4.00)

$8,000
Total cost @ 102,000 units (102,000 x $4.47) $455,940
Total cost @ 100,000 units (100,000 x $4.50) 450.000
Incremental cost of 2,000 units
-5,940
Incremental profit of 2,000 units
$2,060

1-41

OBJECTIVE SIX

VORTEC SPECIAL ORDER

Example - Vortec Special Order

With overtime and congestion
Current

With Order Incremental

Units produced and sold

Total Revenue and Costs
Sales ($5.00 regular,
$4.00 special)
8,000
Cost of sales ($4.50, $4.08 on
additional 2,000)
Administrative expenses
Net profit before taxes

100,000

102,000
$ 500,000

2,000
$508,000

450,000
458,160
- 27,500
- 27,500
$ 22,500 $ 22,340

-8,160

0
$ - 160

Incremental revenue (2,000 units x $4.00) $8,000

Total cost @ 102,000 units (100,000 x $4.50)
plus (2,000 x $4.08)
458,160
Total cost @ 100,000 units (100,000 x $4.50)
450.000
Incremental cost of 2,000 units
-8,160
Incremental profit of 2,000 units
- 160

1-43

Example - Beware of Average

Costs
Average cost per unit at current production
volume is usually not an accurate estimate of
the cost per unit at other levels of production.
Production costs include:
fixed costs that do not change with volume
variable costs that do change with volume
Costs may increase when production volume is
near or above normal operating capacity.
1-44

Example - Consider Opportunity

Costs
Opportunity costs measure what the
firm forgoes when it chooses a specific
action
Consider what a firm forgoes by
accepting a special order

1-45

Example - Supplement Accounting

Data
Supplement historical cost accounting
data with other knowledge
Could include:
expected customer demands
competitors plans
future technology
government regulation
1-46

Example - Accounting Data for

Evaluation
When managers have incentives to
maximize performance on one
particular accounting measure, firm
profits are not necessarily maximized.
Reducing average manufacturing costs
per unit does not always maximize profit
Maximizing total revenue does not always
maximize profit
1-47

Continue
Problems
P1, P2, P3, P4, P5, P6, P7, P8,P9 and P10
All concept questions

Comments and Suggestions

THANKS