Cost & Management Accounting –I

Chapter I: Introduction
Every organization has a set of goals and a need for information to make decisions in pursuing
their goals. Decision making is selecting the best alternative course of action to solve the
problem at hand. The information needed for decision making can be come from various sources
like economists, financial experts, marketing personnel, accountants and others. From the above
information sources, the accounting system is the principal/major and the most credible
quantitative information source.

Accounting is an information system that takes economic transactions and events (both financial
and non-financial) such as sales and materials purchases and processes the data into information
helpful to managers and other internal as well as external users of it. Processing any economic
transactions/ events means collecting, categorizing, summarizing and interpreting it. Accounting
as an information system can be divided in to two broad classes that are financial and
managerial.

Therefore, this chapter is intended to describe the meaning and objectives of cost accounting that
is one and the major part of managerial accounting and to see the difference between financial
and managerial accounting.

1.1 Purpose of Accounting Systems

Accounting information system: is an information system that process financial and non-
financial data and provides useful information to internal and external users that help them to
make better decisions. Broadly AIS is classified in to two: financial and managerial accounting
systems. Financial accounting information is used to communicate organization’s financial
position and operating results to investors, banks, suppliers, regulators, and other outside parties.
Management accounting information helps managers make decisions to fulfill an organization’s
goals.

1.2 Management Accounting, Financial Accounting and Cost Accounting

Managerial accounting: measures, analyzes and reports financial and non-financial information
that help managers and other internal users make decisions to fulfill the goals of an organization.
Much of managerial accounting involves gathering information about costs for planning and
control decisions. Therefore, the out puts of managerial accounting system are special reports,
product costs, customer costs, budgets, performance reports, and even personal communication.

Financial accounting: measures, analyzes and records business transactions and provides
financial statements that are based on the generally accepted accounting principles/GAAP for
external users.

Cost accounting: is an accounting system that measures, analyzes and reports financial and non-
financial information in relation to the costs of acquiring and using resources in an

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organization. It deals with identification, accumulation, allocation and control/management of

cost. Cost and revenue are the concerns of any organization hence managers must understand
how revenues and costs behave or risk losing control.

Cost accounting is intended to provide information both for financial accounting and
management accounting. For example, calculating the cost of a product is a cost accounting
function that answers financial accounting’s inventory-valuation needs and management
accounting’s decision-making needs (such as deciding how to price products and choosing which
products to promote). Hence, cost accounting is considered as a bridge between financial and
management accounting. Cost accounting information can also be used to make decisions related
to strategy formulation, research and development, budgeting, production planning, and
pricing among others.

The study of modern cost accounting yields insights into how managers and accountants can
contribute to successfully running their businesses. It also prepares them for leadership roles.
Modern cost accounting takes the perspective that collecting cost information is a function of the
management decisions being made. Thus, the distinction between management accounting and
cost accounting is not so clear-cut, and they are often used interchangeably.

Financial accounting versus managerial accounting

Table 1.1Summary of the difference between financial and managerial accounting
Primary users
Purpose of the information
Rules of measurement and
reporting/ flexibility of
practices
Time dimension
Timeliness of Information
Focus of information
Nature of information
Financial accounting
external users such as investors,
banks, regulators, Suppliers and others
to communicate financial positions
and operating results of an
organization to external user
Structured and often controlled by
GAAP
Focus on historical information with
some
Predictions
Often available only after an audit is
complete
Emphasis on whole organization
Monetary information, objective,
reliable, precise/accurate
Managerial accounting
managers, employees and other
internal users
help managers to make decisions
to achieve organizational goals
Relatively flexible (no GAAP
constraints). Highly managed by
the cost-benefit principle
Many projections and estimates;
historical information also
presented
Available quickly without the need
to wait for an audit
Emphasis on an organization’s
projects, processes, and
subdivisions
Mostly monetary; but also
nonmonetary
Information, subjective, relevant,
less precise

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1.3 Planning and Control Decisions

Planning comprises selecting organization goals and strategies, predicting results under various
alternative ways of achieving those goals, deciding how to attain the desired goals, and
communicating the goals and how to achieve them to the entire organization. Management
accountants serve as business partners in these planning activities because of their understanding
of what creates value and the key success factors.

The most important planning tool when implementing strategy is a budget. A budget is the
quantitative expression of a proposed plan of action by management and is an aid to coordinating
what needs to be done to execute that plan.

By providing the necessary information regarding to the sales volume, profit margins and costs
of each courses of action, management accounting play a problem solving role. Therefore, after
selecting the best alternative course of action, budgets are usually prepared under the direction of
the controller, who is the manager in charge of accounting department.

Controlling is the managerial activity of monitoring a plan’s implementation and taking

corrective action as needed. By accumulating data and preparing performance report that
describes how the organization is doing and how well it is implementing its strategies,
management accounting plays a scorekeeping role. It involves ensuring the plan is actually
carried out and is appropriately modified as circumstances change.

Performance reports of different activities prepared by the management accountant also help to
direct managers’ future attention to situations that need to be resolved. And alert managers to
opportunities that would add value to the organization. In other words management accounting
information play attention direction role.
1.4 The Value Chain of Business Functions

The value chain describes the linked set of activities that increase the usefulness (or value) of
the products or services of an organization (value-added activities). Management evaluates
activities by how they contribute to the final product’s service, quality, and cost. Management
accounting information help for costing of services, products, departments and other objects of
interest to management in the value chain. In general, the business function in the value chain
includes:
A) Research and development: the creation and development of ideas related to new
products, services, or processes
B) Design: the detailed development and engineering of products, services, or processes
C) Production: the collection and assembly of resources to produce a product or deliver a
service
D) Marketing: the process that informs potential customers about the attributes of products
or services, and leads to the purchase of those products or services

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E) Distribution: the process established to deliver products or services to customers

F) Customer service: product- or service-support activities provided to customers
Note: management accountants track the costs incurred in each value-chain category. Their goal
is to reduce costs in each category and to improve efficiency. They help managers to coordinate
the business function of the value chain and facilitate cost planning and control through the use
of budgets and performance reporting.

1.5 Cost-benefit Philosophy and Behavioral Considerations

Cost-benefit approach is used in resource allocation decisions. Resources should be spent if they
are expected to better attain company goals in relation to the expected costs of those resources.
According to this approach the expected benefits from spending of resources should exceed the
expected cost. Therefore, cost-benefit balance is the primary consideration in choosing among
management accounting systems and methods.

For instance, if managers want to install budgetary system to an organization, first they have to
know the benefits from installation of this system (compels managers to plan ahead, compare
actual to budgeted information, learn, and take corrective action). Also the costs of installation
have to be considered such as investments in software and training are easier to quantify. Others,
such as the time spent by managers on the budgeting process, are harder to quantify. The
manager has to decide whether to install or not after comparing the cost and benefit of the
system.

Behavioral and technical considerations

A management accounting system has two simultaneous missions, one technical and one
behavioral. Technical considerations help managers make wise economic decisions by providing
them with desired information in an appropriate format at the preferred frequency. On the other,
hand behavioral considerations motivate managers and other employees to aim for goals of an
organization.

1.6 Organizational Structure and the Management Accounting

Organizational structure is the structure of authority throughout an organization. This structure is

shown by using organization chart. Organization chart is a visual diagram of a company’s
organizational structure that depicts formal lines of reporting, communication and
responsibilities between managers.

An organization chart also depicts line and staff positions in an organization. A person in a line
position is directly involved in achieving the basic objectives of the organization. A person in a
staff position, by contrast, is only indirectly involved in achieving those basic objectives. Staff
positions provide assistance to line positions or other parts of the organization, but they do not
have direct authority over line positions.

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The chief financial officer (CFO) is a member of the top management team who also occupies a
staff position. The CFO is responsible for providing timely and relevant data to support planning
and control activities and for preparing financial statements for external users.

In the modern world due to the technological advancement, some organizations use teams
include both line and staff management so that all inputs into a decision are available
simultaneously. Therefore, growing numbers of management accountants spend the bulk of their
time as internal consultants or business analysts within their companies.

There are different staff management teams under CFO that include:

Controllership/chief accounting officer —includes providing financial information for reports

to managers and shareholders, and overseeing the overall operations of the accounting system
Treasury—includes banking and short- and long-term financing, investments, and cash
management
Risk management—includes managing the financial risk of interest-rate and exchange-rate
changes and derivatives management
Taxation—includes income taxes, sales taxes, and international tax planning
Investor relations—includes communicating with, responding to, and interacting with
shareholders
Internal audit—includes reviewing and analyzing financial and other records to attest to the
integrity of the organization’s financial reports and to adherence to its policies and procedures

1.7 Ethical Considerations in Management Accounting

Practitioners of management accounting and financial management have an obligation to the

public, their profession, the organizations they serve, and themselves to maintain the highest
standards of ethical conduct. Practitioners of management accounting and financial management
shall not commit acts contrary to these standards nor shall they condone the commission of such
acts by others within their organizations.

Institute of Management Accounting/IMA statement of ethical professional practices

Practitioners of management accounting and financial management shall behave ethically. A

commitment to ethical professional practice includes overarching principles that express our
values and standards that guide our conduct.

Principles

IMA’s overarching ethical principles include: Honesty, Fairness, Objectivity, and Responsibility.
Practitioners shall act in accordance with these principles and shall encourage others within their
organizations to adhere to them.

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Standards

A practitioner’s failure to comply with the following standards may result in disciplinary action.

Competence: Each practitioner has a responsibility to:

1. Maintain an appropriate level of professional expertise by continually developing knowledge

and skills.

2. Perform professional duties in accordance with relevant laws, regulations, and technical
standards.

3. Provide decision support information and recommendations that are accurate, clear, concise,
and timely.

4. Recognize and communicate professional limitations or other constraints that would preclude
responsible judgment or successful performance of an activity.

Confidentiality: Each practitioner has a responsibility to:

1. Keep information confidential except when disclosure is authorized or legally required.

2. Inform all relevant parties regarding appropriate use of confidential information. Monitor
subordinates’ activities to ensure compliance.

3. Refrain from using confidential information for unethical or illegal advantage.

Integrity: Each practitioner has a responsibility to:

1. Mitigate actual conflicts of interest. Regularly communicate with business associates to avoid
apparent conflicts of interest. Advise all parties of any potential conflicts.

2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically.

3. Abstain from engaging in or supporting any activity that might discredit the profession.

Credibility: Each practitioner has a responsibility to:

1. Communicate information fairly and objectively.

2. Disclose all relevant information that could reasonably be expected to influence an intended
user’s understanding of the reports, analyses, or recommendations.

3. Disclose delays or deficiencies in information, timeliness, processing, or internal controls in

conformance with organization policy and/or applicable law.

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