Introduction to Management Accounting

The accounting process

Economic activities

Accounting ³links´ 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 .

and changes in resources and claims. Objectives of Financial Reporting Information useful in assessing amount. Information useful in making investment and credit decisions. (General) . timing and uncertainty of future cash flows.(Specific) Information about economic resources. claims to resources.

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 .

Information Services Chief Financial Officer (CFO) . Human Resources V.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.P.

and Evaluation .What is Management Accounting? Accounting for Planning. Control.

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

for decision-making support. Objectives of Managerial Reporting Information useful to help the enterprise achieve its goal. .Information about decision-making authority. 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 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. ± Records and internal financial controls safeguard the company¶s assets ± Balance Sheets allow the comparison of Assets. They are created by men to help accomplish tasks. . ± Income Statements describe the change in Owners¶ Equity from operations. Audited statement reduce investors risk. ± Audited statements allow a company to borrow capital from someone else. Liabilities and Owner¶s Equity.

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) .

and adjusting journal entries ‡ Least Important .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.

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 .

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

Focus and Time Dimension Management Financial ‡ Relevance ‡ Reliability. and focus on the past . objectivity.

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. rather from suppliers than tangible products . and Manufacturing Companies Merchandising Service ‡ resells products ‡ Provides previously bought intangible services. Merchandising.

and equipment to convert raw materials into finished products ‡ Materials inventory ‡ Work in process inventory ‡ Finished goods inventory . and Manufacturing Companies Manufacturing Company: ‡ uses labor.Service. Merchandising. plant.

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 .

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: 1.

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

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 .

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

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

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

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

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

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

Profit Center ‡ A profit center is an organization unit in which both revenues and expenses are measured in measured in monetary terms. improve the quality of decisions. ‡ 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. . focus greater attention on profitability«« ‡ Business units and profit centers are not synonymous. ‡ This move can increase the speed of decision-making.

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 GM¶s 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. .

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

Business Units as Profit Centre«. how. how much to sell ‡ Procurement or sourcing decision ± where to obtain or manufacture? .. ‡ 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.

.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 .

nd results .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.

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

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 .

‡ 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«..

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 ..Cost Classification«. ‡ Relationship to planning.

It is widely regarded as an extremely important component in evaluating and planning overall business strategies. . from raw materials purchases to expenses associated with transporting the final product to retail establishments.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.

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

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

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