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Introduction to Management Accounting

The accounting process

Economic activities

Accounting links decision makers with economic activities and with the results of their decisions.

Accounting information

Actions (decisions)

Decision makers

Information System
Cost & Revenue Determination Job costing Process costing ABC Sales Assets & Liabilities Plant and equipment Loans & equity Receivables, payables & cash Cash Flows From operations From financing From investing

Information Users Investors Creditors Managers Owners Customers Employees Regulatory agencies -SEC -IRS -EPA

Decision Support CVP analysis Performance evaluation Incremental analysis Budgeting Capital allocation Earnings per share Ratio analysis

Interpret and record business transactions.

Basic Functions of an Accounting System

Payment

Car

Interpret and record business transactions.

Basic Functions of an Accounting System


Classify similar transactions into useful reports.

Summarize and communicate information to decision makers.

Objectives of External Financial Reporting


The primary external users of financial information are investors and creditors.

Cash Flow Prospects nvestors Creditors Return on Periodic Periodic nvestment dividends interest Sale of Repayment of ownership at a loan at a Return of future date future date nvestment

(Specific)

Information about economic resources, claims to resources, and changes in resources and claims.

Objectives of Financial Reporting

Information useful in assessing amount, timing and uncertainty of future cash flows.

Information useful in making investment and credit decisions.


(General)

Objectives of External Financial Reporting


Balance Sheet Income Statement
Statement of Cash Flows

The primary financial statements.

Financial Statements: A Lens to View Business

Financial Statements

Characteristics of Externally Reported Information


A Means to an End Usefulness Enhanced via Explanation Broader than Financial Statements

Based on General Purpose Assumption

Historical in Nature

Results from Inexact and Approximate Measures

Internal Users of Accounting Information


 Board of Directors  Chief Executive Officer  Chief Financial Officer  Vice Presidents  Business Unit Managers  Plant Managers  Store Managers  Line Supervisors

Typical Simple Organization Chart


Board of Directors (Owners) Chief Executive Officer (CEO) Business Unit Manager Plant Manager Plant Accountant Plant Manager Plant Accountant V.P. Human Resources V.P. Information Services Chief Financial Officer (CFO)

What is Management Accounting?


Accounting for Planning, Control, and Evaluation

Management Accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources. Management accounting also comprises the preparation of financial reports for nonmanagement groups such as shareholders, creditors, regulatory agencies and tax authorities.

Information about decision-making authority, for decision-making support, and for evaluating and rewarding decision-making performance.

Information useful in assessing both the past performance and future directions of the enterprise and information from external and internal sources.

Objectives of Managerial Reporting

Information useful to help the enterprise achieve its goal, objectives and mission.

Characteristics of Management Accounting Information


Timeliness A Means to an End Identify DecisionMaking Authority

Measures of Efficiency and Effectiveness

Oriented Toward Future

Integrity of Accounting Information


Institutional Features Generally Accepted Accounting Principles (GAAP) Financial Accounting Standards Board Securities and Exchange Commission Internal Control Structure Audits

The Functions of Management


Planning Acting Controlling

Feedback

Why Do We Have Accounting Systems?

Accounting systems are artifacts. They are created by men to help accomplish tasks. Audited statement reduce investors risk.
Audited statements allow a company to borrow capital from someone else. Records and internal financial controls safeguard the companys assets Balance Sheets allow the comparison of Assets, Liabilities and Owners Equity. Income Statements describe the change in Owners Equity from operations.

Types of Accounting Information


Financial Tax

Managerial

Needs Determine the Form of Accounting Data


Managers need changing information to meet changing needs!
Types of Accounting Systems
Financial Accounting
Rules and procedures Accounting information systems and internal controls Auditing

Cost Accounting
Product costing Activity-based costing

Management Accounting
Decision support Organizational control Cost management Profit management Investment management Individuals Partnerships and corporations Estate and trusts International taxation Special tax issues and topics

Tax Accounting

The Three Management Functions


Questions asked:
What do I want to do? How can I do it? Am I getting it done? How well did I do it?

Management functions:
Planning for the future (Strategic) Planning for the future (Operational) Monitoring and controlling the present Evaluating the past

Characteristics of Management Accounting Systems Key Ideas:


The costs and benefits of better decisions One set of books for many different uses Enhanced information quality for better decisions

Financial and Managerial Accounting


Financial Accounting Managerial Accounting Users of Accounting Information

Shareholders Creditors Government General Public Management

Management

Financial Accounting
Users: Characteristics:

Financial Statements

External Users and Management Objective Prepared according to GAAP Prepared periodically Business entity

Managerial Accounting
Users: Characteristics:

Management Reports

Management Objective and subjective Prepared according to management needs Prepared periodically or as needed Business entity or segment

Data Characteristics of Financial vs. Managerial Accounting


Financial Accounting rules are set by users who agree among themselves on the regulations for (GAAP). This is hard data, objectively verifiable, that must meet audit criteria to be acceptable. It is therefore considered reliable. Managerial Accounting rules are set within the company to accomplish management objectives related to adding value to the company. This is data that could be soft, or estimates, that must only improve the value of decisions more than the cost of information. Managerial accounting data must only be relevant for management decisions.

The Professional Management Accountant Professional Certifications


Certified Public Accountant (CPA) Certified Management Accountant (CMA) Certified Internal Auditor (CIA) Certified Information Systems Auditor (CISA) Certified in Financial Management (CFM) Chartered Accountant (CA)

Professional Characteristics of The Management Accountant


Most Important
Work ethic Analytical and problem solving skills Interpersonal skills Listening Spreadsheet abilities Understanding the business Understanding bottom line implications of management decisions Writing Familiarity with business processes Interpreting financial statements Measuring and reporting revenues and expenses Accruals, deferrals, and adjusting journal entries

Least Important

Characteristics of Management Accounting


Providing Accounting Information Cause and Effect Analysis Use of special techniques and concepts Taking important decisions Achieving of objectives No fixed norms followed Increase in efficiency Supplies information but not decision Concerned with forecasting

Objectives of Management Accounting


Planning and policy formulation Helpful in controlling performance Helpful in organizing Helpful in interpreting Financial Statements Motivating employees Helps in making decisions Reporting to management Helps in coordination Tax administration

Limitations
Based on accounting information Lack of knowledge Intuitive decisions Not an alternative to administration Personal bias

The Differences Between Managerial and Financial Accounting

Primary Users
Financial Investors Creditors Government authorities Management Internal managers of the business

Purpose of Information
Management Financial Help investors, Help managers plan and control creditors, and business others make operations investment, credit, and other decisions

Focus and Time Dimension


Management Financial Relevance Reliability, objectivity, and focus on the past

Type of Report
Financial Financial statements restricted by GAAP Management Internal reports not restricted by GAAP; determined by cost-benefit analysis

Verification
Financial Annual independent audit Management No independent audit

Scope of Information
Management Financial Detailed reports Summary reports primarily on parts of the on the company company as a whole

Behavioral Implications
Management Financial Concern about Concern about how reports will adequacy of affect employees disclosure behavior

Service, Merchandising, and Manufacturing Companies


Merchandising Service resells products Provides previously bought intangible services, rather from suppliers than tangible products

Service, Merchandising, and Manufacturing Companies


Manufacturing Company: uses labor, plant, and equipment to convert raw materials into finished products Materials inventory Work in process inventory Finished goods inventory

Describe the value chain and classify costs by value-chain functions.

The Value Chain


Research and Development Service Product And Service Process Design

Customer Focus

Distribution Marketing

Production

Basic concepts:
1. Control: Elements of a control system: A detector or a sensor a device that measures what is actually happening? An assessor: a device that determines the significance of what is actually happening by comparing it with some standard or expectation

Basic concepts..
An effector: a device that alters the behaviour if the assessor indicates the need to do so. A communication network: a device that transmits the information between the detector and the assessor and between the assessor and the effector. 2. Management: 3. Systems: a prescribed and usually repetitious way of carrying out an activity or a set of activities.

Examples:
Body Temperature Detector / Sensor Assessor Effector Communication network Sensory nerves Brain Muscles and organs Nerves Automobile Driver Eyes Brain Foot Nerves

Contrast with simpler control processes


Standards are not preset. Management control is not automatic Management control needs coordination among individuals The connection from perceiving the need for action to determining the action required to obtain the desired result may not be clear. Much management control is self control.

Characteristics of Control
Managerial Function Forward Looking Continuous Activity Related to planning Essence of control is action

Task control
Is the process of assuring that specified tasks are carried out efficiently and effectively. transaction oriented task control is scientific

Task Control Vs. Management Control


TC is scientific, but MC can never be reduced to a science TC focuses on specific tasks, but MC focuses on organization units MC is concerned about broadly defined activities were as TC is on specific tasks.

Revenue Centers
Here output (revenue) is measured in monetary terms, but no formal attempt is made to relate it to the input (expense or cost). Marketing or Sales Departments They are measured against quotas or targets

Expense Centers
Whose inputs are measured in monetary terms, but whose outputs are not. Here there are two types: 1. Engineered Expense Center 2. Discretionary Expense Center

Engineered Expense Center


Are those for which right or proper amount can be estimated with reasonable reliability. They can be normally found in manufacturing operations.

Discretionary Expense Center


Includes administrative and support units. Eg: Accounting, Legal, Marketing .. It does not mean that managements judgment as the optimum cost, but rather reflects managements decisions regarding certain policies: whether to match or exceed the marketing efforts of the competitor, amount to be spend on R&D Here the difference between budget and actual expense is not a measure of efficiency.

Profit Center
A profit center is an organization unit in which both revenues and expenses are measured in measured in monetary terms. In setting up a profit center a company devolves decision making power to those lower levels that possess relevant information for making expense/ revenue trade off. This move can increase the speed of decision-making, improve the quality of decisions, focus greater attention on profitability Business units and profit centers are not synonymous.

Advantages of Profit Centers


Quality of the decisions may improve Speed of operating decisions may be improved Relieved of day-to-day decision making Managers are free to use their imagination Excellent training ground as they are like independent companies Consciousness increases Profitability of individual components Competitive performance

Difficulties in Profit Centers


Loss of control Quality of decision may be reduced Competition may be unhealthy Divisionalization may impose additional costs Competent GMs may not exist in functional organizations Emphasis on short run profitability Maximizing the individual profits do not mean the profit of the whole company is maximized.

Business Units as Profit Centre


Constraints on Business Unit Authority:
To realize the full benefits of profit centre concept, the business unit manager has to be given full autonomy like that of a president of a independent company. such autonomy is not feasible.

Business Units as Profit Centre..


Constraints from other Business Units:
Managing a profit centre in terms of control over three types of decisions:
Product decision make or buy Marketing decision where, how, how much to sell Procurement or sourcing decision where to obtain or manufacture?

Business Units as Profit Centre..


Constraints from Corporate Management:
Can be grouped into 3 types:
Those resulting from strategic considerations Those resulting because uniformity is required Those resulting from economies of centralization

Other Profit Centers


Functional Units
Marketing Manufacturing Service and Support Units

Measuring Profitability
Types of Profitability Measures:
Contribution Margin Direct Profit Income before Taxes Net Income

Revenues

Investment Centers
Control system applies monetary measures to both inputs and outputs and to the investment used within the responsibility centre itself. A responsibility center is an organization unit that is headed by a manager who is responsible for its activities a.nd results

Cost concepts
Cost is the value of the sacrifice made to acquire goods and services, measured in monetary terms by the acquisition of assets or incurrence of liabilities at the time of the benefits are acquired.

Cost Classification
Elements of a product / Product Cost:
Materials
Direct Materials Indirect Materials

Labour
Direct labour Indirect labour

Factory Overhead

Relationship production
Prime Costs Conversion Costs

Cost Classification..
Relationship to Volume: Variable Costs Fixed Costs Mixed Cost Semi variable costs Step cost (like FC eg: 3 supervisors for 42 workers) Ability to trace: Direct Cost Indirect Cost Department where incurred: Production Departments Service Departments

Cost Classification..
Functional Areas:
Manufacturing Costs Marketing Costs Administrative Costs Financing Costs

Period Charged to Income:


Product costs Period costs (eg: salary)

Cost Classification..
Relationship to planning, controlling and Decision Making:
Standard and Budgeted Costs Controllable and non-controllable costs Committed and discretionary Fixed costs Relevant and irrelevant costs Opportunity costs Shut down costs

Product Costing
Product costing is the process of tracking and studying all the various expenses that are accrued in the production and sale of a product, from raw materials purchases to expenses associated with transporting the final product to retail establishments. It is widely regarded as an extremely important component in evaluating and planning overall business strategies.

Cost elements of Product Costing


Developing and maintaining supplier relationships. Transportation costs Sales and freight terms Payment terms Costs to receive, process, or make ready, including unloading, counting, inspection, and inventory costs, as well as expenses associated with disposal of packaging and other product protection/transportation materials. Logistics expenses

Cost elements of Product Costing


Production costs accrued in actual manufacture of goods. Warranty costs. Quality costs, Lot size costs, including inventory and cash flow costs associated with lots of varying size. Supplier inventory. Overhead costs of supplier and customer transactions, including billing, collection, payment preparation, and receiving processes. Product improvement and modification. Regulatory/environmental costs