WHAT IS MANAGEMENT ACCOUNTING?

Management accounting is a system of measuring and

providing operational and financial information that guides managerial action, motivates behaviors,
and supports and creates the cultural values necessary to achieve an organization’s strategic
objectives. There are four key ideas contained in this definition of management accounting. These
ideas capture the nature, scope, purpose, and attributes of management accounting. 1. By nature
management accounting is a measurement process. 2. The scope of management accounting
includes financial information, such as cost, and operational information, such as percentage of
defective units produced. 3. The purpose of management accounting is to help an organization reach
its key strategic objectives. It is not meant for mandated financial and tax reporting purposes. 4.
Good management accounting information has three attributes:

■Technical—it enhances the understanding of the phenomena measured and provides relevant
information for strategic decisions.

■Behavioral—it encourages actions that are consistent with an organization’s strategic objectives.
■Cultural—it supports and/or creates a set of shared cultural values, beliefs, and mindsets in an
organization and society.

NATURE AND SCOPE OF MANAGEMENT ACCOUNTING

Management-accounting systems report the results of operations using financial and nonfinancial
measures. These systems also help project and plan future operations. The Reel Tape Inc. story
contains several examples of information that managers need. These include better product cost
data and metrics of on-time delivery of products. These items exemplify two of the many measures
dealt with in management accounting. Cost is an example of a measure expressed in financial terms,
while on-time delivery is an example of an operational measure. Learning the procedures for
measuring, collecting, reporting, interpreting, and presenting these data to managers is the subject
matter of managerial accounting. There are formal procedures that govern the measurement
process. However, applying these procedures poses problems since there are many alternative
methods of measuring the same phenomenon. For example, product cost or customer profitability
can be computed in several ways. Similarly, quality can be measured using a variety of methods.
Each alternative is a valid measure, and each may be useful under certain conditions. Understanding
these multiple methods of measurement, and knowing when and how to use them, is a major part
of studying management accounting.

PURPOSE OF MANAGEMENT ACCOUNTING— THE STRATEGIC TRIANGLE

The fundamental purpose of management accounting is to help an organization achieve its strategic
objectives. Meeting these objectives satisfies the needs of its customers and other stakeholders.
Typical stakeholders include shareholders, creditors, suppliers, employees, and labor unions.
Strategy is the way that a firm positions and distinguishes itself from its competitors. Positioning
refers to the selection of target customers or markets. Distinctions are made on the three
dimensions of quality, cost, and time. Different customers have different expectations about the
features and performance reliability (quality) they want in a product, the price (cost) they are willing
to pay, and when and how quickly they want the product or services delivered (time).
■ THE NATURE OF STRATEGIC MANAGEMENT ACCOUNTING

To have strategic value, management accounting must help accomplish the three strategic
objectives of quality, cost, and time by providing information that:

1. Links the daily actions of managers to the strategic objectives of an organization.

2. Enables managers to effectively involve the entire extended enterprise of customers, suppliers,
dealers, and recyclers in achieving the strategic objectives.

3. Takes a long-term view of organizational strategies and actions.

Linkage to daily actions.

Achieving strategic goals requires linking the daily actions of everyone in an organization to the
larger strategic objectives.

Management accounting performs a similar function for individuals in an organization. It provides

operational and higher management with the information that helps them do their job and achieve
the quality, cost, and time objectives of the organization.

■ Management accounting information helps managers achieve quality goals by measuring and
reporting the resources used in preventing defects; the cost of reworking defective units; the cost of
doing warranty repairs; lost sales from selling poor quality products; new investment needed for
increasing product quality; and by determining whether the spending on quality is producing
tangible financial benefits.

■ Examples of information that helps managers attain the strategic objective of cost management
include reporting resources consumed by the products produced during a period; measuring
resources consumed by activities performed in a period; analyzing factors that drive or cause costs
to be incurred; analyzing product profitability; analyzing suppliers’ cost structures; and comparing
(benchmarking) their cost against competitors’ costs.

■ Management accounting helps attain the strategic objective of time by measuring and reporting
lost sales and profits from late product introductions; costs of delayed deliveries from suppliers;
sales from new versus old products; response time to ship customer orders; and unused capacity
available for new product introductions.

TTRIBUTES OF A GOOD MANAGEMENT-ACCOUNTING SYSTEM

Management accounting emphasizes three key attributes of good management-accounting

information: the technical, behavioral, and cultural attributes. These three attributes represent the
attribute triangle shown in Exhibit 4. The attributes are explained in the following text. Technical
attributes refer to the measurement-related qualities desired in managementaccounting
information.
All good measurements have two key technical properties: decision relevance and process
understanding.

■ Decision relevance.

A measure is decision relevant if the information it provides changes and improves decisions.
Further, the change should be positive, that is, it improves payoff from that decision. If management
information is ignored or does not enter into management decisions, then it lacks decision
relevance. For example, many accounting systems continue to collect and report detailed
information about labor usage in a factory even after automation has made labor costs an
insignificant proportion of total costs. That information is processed and stored, unused by anyone.

■ Process understanding.

Traditionally, management accounting was based on the principle of “responsibility-accounting”

which focuses on measuring results and assigning them to individuals or organizational units. This
reflects a philosophy of managing people and units. Today managers understand that results are a
function of how work processes are organized. A work process is a connected set of tasks performed
to produce products or services. Since work flows horizontally, that is, across organizational units,
and a responsibility-accounting system measures

Management accounting and strategy I n many organisations in the 21st century management
accountants play an important strategic role by contributing to the organisation’s formulation and
implementation of strategy and by helping managers improve the organisation’s competitive
advantage. To make sense of this role we introduce some basic strategy concepts: ■ mission
statement ■ vision ■ objectives ■ strategies. Let’s define each of these terms. Many organisations
prepare a mission statement that defines the purpose and boundaries of the organisation

Management accounting: contributing to strategy Management accountants should tailor

information to support the formulation and implementation of their organisation’s strategies.
Strategic planning Strategic planning is the term given to long-term planning, usually undertaken by
senior managers, with a three- to five-year timeframe. Strategic planning involves making corporate
strategy decisions about the types of businesses and markets in which the organisation operates,
and business (or Management Accounting: Information for Managing Resources and Creating Value
15 MG15903 ch01.qxp 9/4/08 16:47 Page 15 competitive) strategy decisions about how the business
is to compete within its particular markets. Strategic planning draws on a wide range of
management accounting information from the costing, budgeting and performance measurement
systems, as well as information from special studies internal and external to the organisation.
Implementing strategies Once strategies have been formulated, managers at all levels of the
organisation share the responsibility for implementing them. Management accountants can play an
important role in this process using the planning and control systems described below. Long-term
plans need to be linked to the budgeting system, to produce annual budgets that support the
organisation’s strategies. Likewise, performance measurement systems can be used to compare
actual outcomes to budgets and other targets that focus on the organisation’s strategic objectives.
Management accounting: contributing to competitive advantage Well-managed organisations focus
their objectives and strategies on building and maintaining sources of competitive advantage. To be
an effective contributor to strategy, the management accounting information should be shaped
around the organisation’s sources of competitive advantage. If a firm competes primarily on the
basis of low cost, its management accounting information should focus on product costs and tight
cost control. If a firm follows a differentiation strategy, the focus should be on performance around
the sources of differentiation such as quality, delivery, time, flexibility and innovation. For example,
the management accounting reports at Steers monitor costs, but they also provide a lot of
information about product and process innovation, and about people—a key driver of customer
service (and ultimately of quality and innovation). With an increasing emphasis on strategy in
organisations, several such strategic management accounting techniques have evolved since the
1990s. These include performance measurement systems that focus directly on aspects of business
strategy, and techniques for improving the organisation’s competitive advantage through modern
process improvement and cost management, with an emphasis on reducing costs while also
enhancing customer value. Planning and control Planning and control systems are a vital element of
management accounting. As part of strategy implementation, organisations need to put in place
plans to set the direction of the organisation, and control systems to ensure that operations are
proceeding according to plan. Planning and control systems provide the framework for effective
resource management to generate customer and shareholder value. Planning is a broad concept
that is concerned with formulating the direction for future operations. Plans are necessary so an
organisation can consider and specify all of the resources that will be needed in the future—whether
financial or non-financial. Planning activities occur at many levels within an organisation. As
described above, many organisations develop strategic plans that normally involve a three- to five-
year timeframe. However, most organisations also prepare short-term or operational plans, called
budgets
Implementing plans: information for decisions Almost every organisation has some sort of
plans, whether detailed budgets or something less formal, and managers are responsible for
implementing these plans (and sometimes for adapting them to take account of unplanned
circumstances). Planning, implementing plans and controlling requires managers to make many
decisions; and to make decisions, managers need information. Many decisions made by
managers occur frequently, so information to support these decisions, such as budgets,
performance reports and product costs, is prepared on a regular basis. However, management
accounting information is also needed to support non-routine decisions. For example, in making
decisions about the development and implementation of their project, the Steers leadership
team relied on information drawn from regular management accounting reports, such as sales
performance and product and store costs. However, the project also required a lot of additional
information that was not available from routine management accounting reports, such as
estimates of the costs of new store designs, costs of new product lines, estimated uptake of new
ideas by franchisees, and so on. Management accounting systems are designed to produce
frequently required information (often for control purposes), but need to be flexible enough to
generate some of the information that is needed for decisions that occur very infrequently, or
only once. Controlling Effective resource management must also include systems for control.
Control involves putting in place mechanisms to ensure that operations proceed according to
plan and that objectives are achieved. There is sometimes confusion between the terms
‘planning’ and ‘control’, probably because of their interdependence. Plans will not be effective
unless there is some way of ensuring that they are achieved. This is the role of control and
control systems. Control systems are the systems and procedures that provide regular
information to assist with control.

Activity 1

Explain the relationship between an organisation’s mission statement, vision and strategies. Select a
well-known company to illustrate your answer.

Budgeting and management accounting

zero based budgeting (ZBB)
Definition

Method for preparing cash flow budgets and operating plans which every year must start from
scratch with no pre-authorized funds. Unlike the traditional (incremental) budgeting in which past
sales and expenditure trends are assumed to continue, ZBB requires each activity to be justified
on the basis of cost-benefit analysis, assumes that no present commitment exists, and that there
is no balance to be carried forward. By forcing the activities to be ranked according to priority,
ZBB provides a systematic basis for resource allocation.

zero-Base Budgeting
Overview of Zero-Base Budgeting

A zero-base budget requires managers to justify all of their budgeted expenditures, rather than
the more common approach of only requiring justification for incremental changes to the budget or
the actual results from the preceding year. Thus, a manager is theoretically assumed to have an
expenditure base line of zero (hence the name of the budgeting method).

In reality, a manager is assumed to have a minimum amount of funding for basic departmental
operations, above which additional funding must be justified. The intent of the process is to
continually refocus funding on key business objectives, and terminate or scale back any activities
no longer related to those objectives.

The basic process flow under zero-base budgeting is:

1. Identify business objectives

2. Create and evaluate alternative methods for accomplishing each objective
3. Evaluate alternative funding levels, depending on planned performance levels
4. Set priorities

The concept of paring back expenses in layers can also be used in reverse, where you delineate
the specific costs and capital investment that will be incurred if you add an additional service or
function. Thus, management can make discrete determinations of the exact combination of
incremental cost and service for their business. This process will typically result in at least a
minimum service level, which establishes a cost baseline below which it is impossible for a
business to go, along with various gradations of service above the minimum.

Advantages of Zero-Base Budgeting

There are a number of advantages to zero-base budgeting, which include:

 Alternatives analysis. Zero-base budgeting requires that managers identify alternative

ways to perform each activity (such as keeping it in-house or outsourcing it), as well as
the effects of different levels of spending. By forcing the development of these
alternatives, the process makes managers consider other ways to run the business.
 Budget inflation. Since managers must tie expenditures to activities, it becomes less likely
that they can artificially inflate their budgets – the change is too easy to spot.
 Communication. The zero-base budget should spark a significant debate among the
management team about the corporate mission and how it is to be achieved.
 Eliminate non-key activities. A zero-base budget review forces managers to decide which
activities are most critical to the company. By doing so, they can target non-key activities
for elimination or outsourcing.
  Mission focus. Since the zero-base budgeting concept requires managers to link
expenditures to activities, they are forced to define the various missions of their
departments – which might otherwise be poorly defined.
 Redundancy identification. The review may reveal that the same activities are being
conducted by multiple departments, leading to the elimination of the activity outside of the
area where management wants it to be centered.
 Required review. Using zero-base budgeting on a regular basis makes it more likely that all
aspects of a company will be examined periodically.
 Resource allocation. If the process is conducted with the overall corporate mission and
objectives in mind, an organization should end up with strong targeting of funds in those
areas where they are most needed.

In short, many of the advantages of zero-base budgeting focus on a strong, introspective look at
the mission of a business and exactly how the business is allocating its resources in order to
achieve that mission.

Disadvantages of Zero-Base Budgeting

The main downside of zero-base budgeting is the exceptionally high level of effort required to
investigate and document department activities; this is a difficult task even once a year, which
causes some entities to only use the procedure once every few years, or when there are significant
changes within the organization. Another alternative is to require the use of zero-base budgeting
on a rolling basis through different parts of a company over several years, so that management
can deal with fewer such reviews per year. Other drawbacks are:

 Bureaucracy. Creating a zero-base budget from the ground up on a continuing basis calls
for an enormous amount of analysis, meetings, and reports, all of which requires additional
staff to manage the process.
 Gamesmanship. Some managers may attempt to skew their budget reports to concentrate
expenditures under the most vital activities, thereby ensuring that their budgets will not be
reduced.
 Intangible justifications. It can be difficult to determine or justify expenditure levels for
areas of a business that do not produce “concrete,” tangible results. For example, what is
the correct amount of marketing expense, and how much should be invested in research
and development activities?
 Managerial time. The operational review mandated by zero-base budgeting requires a
significant amount of management time.
 Training. Managers require significant training in the zero-base budgeting process, which
further increases the time required each year.
 Update speed. The extra effort required to create a zero-base budget makes it even less
likely that the management team will revise the budget on a continuous basis to make it
more relevant to the competitive situation.