Business Management Study Manuals Diploma in Business Management MANAGERIAL ACCOUNTING The Association of Business Executives 5th Floor, CI Tower St Georges Square High Street New Malden Surrey KT3 4TE United Kingdom Tel: + 44(0)20 8329 2930 Fax: + 44(0)20 8329 2945 E-mail: info@abeuk.com © Copyright, 2008 The Association of Business Executives (ABE) and RRC Business Training All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form, or by any means, electronic, electrostatic, mechanical, photocopied or otherwise, without the express permission in writing from The Association of Business Executives. Diploma in Business Management MANAGERIAL ACCOUNTING Contents Unit Title Page 1 Management Accounting and Information 1 Introduction 2 Management Accounting 2 Information 4 Collection and Measurement of Information 6 Information for Strategic, Operational and Management Control 11 Information for Decision Making 14 2 Cost Categorisation and Classification 17 Introduction 19 Accounting Concepts and Classifications 20 Categorising Cost to Aid Decision Making and Control 23 Management Responsibility Levels 32 Cost Units 33 Cost Codes 34 Patterns of Cost Behaviour 35 Influences on Activity Levels 39 Numerical Example of Cost Behaviour 39 3 Direct and Indirect Costs 41 Introduction 42 Material Costs 42 Labour Costs 45 Decision Making and Direct Costs 50 Overhead and Overhead C 51 4 Absorption Costing 53 Introduction 54 Definition and Mechanics of Absorption Costing 54 Cost Allocation 55 Cost Apportionment 56 Overhead Absorption 60 Under and Over Absorption of Overheads 65 Treatment of Administration and Selling and Distribution Overhead 67 Uses of Absorption Costing 69 5 Marginal Costing 75 Introduction 76 Definitions of Marginal Costing and Contribution 76 Marginal Versus Absorption Costing 79 Limitation of Absorption Costing 82 Application of Marginal and Absorption Costing 85 Unit Title Page 6 Activity-Based and Other Modern Costing Methods 99 Introduction 100 Activity-Based Costing (ABC) 100 Just-in-Time (JIT) Manufacturing 114 7 Product Costing 119 Introduction 121 Costing Techniques and Costing Methods 121 Job Costing 122 Batch Costing 126 Contract Costing 127 Process Costing 129 Treatment of Process Losses 132 Work-In-Progress Valuation 135 Joint Products and By-Products 138 Other Process Costing Considerations 142 8 Cost-Volume-Profit Analysis 143 Introduction 144 The Concept of Break-Even Analysis 144 Break-Even Charts (Cost-Volume-Profit Charts) 149 The Profit/Volume Graph (or Profit Graph) 157 Sensitivity Analysis 160 9 Planning and Decision Making 167 Introduction 168 The Principles of Decision Making 168 Decision-Making Criteria 173 Costing and Decision Making 175 10 Pricing Policies 183 Introduction 184 Fixing the Price 184 Pricing Decisions 184 Practical Pricing Strategies 187 Further Aspects of Pricing Policy 195 11 Budgetary Control 199 Introduction 201 Definitions and Principles 201 The Budgetary Process 205 Budgetary Procedure 210 Changes to the Budget 221 Flexible Budgets 222 Budgeting With Uncertainty 226 Budget Problems and Methods to Overcome Them 229 Unit Title Page 12 Standard Costing 235 Introduction 236 Principles of Standard Costing 236 Setting Standards 238 The Standard Hour 245 Measures of Capacity 246 13 Standard Costing Basic Variance Analysis 249 Introduction 250 Purpose of Variance Analysis 250 Types of Variance 253 Investigation of Variances 257 Variance Interpretation 263 Interdependence between Variances 264 14 Management of Working Capital 267 Principles of Working Capital 268 Management of Working Capital Components 269 Dangers of Overtrading 272 Preparation of Cash Budgets 272 Cash Operating Cycle 273 Practical Examples 276 15 Capital Investment Appraisal 281 Introduction – The Investment Decision 282 Payback Method 283 Return on Investment Method 284 Introduction to Discounted Cash Flow Methods 285 The Two Basic DCF Methods 288 Appendix: Present Values Tables 296 16 Presentation of Management Information 301 Introduction 302 Information for Management – General Principles 302 Using Diagrams and Charts 306 Using Ratios 310 1 Study Unit 1 Management Accounting and Information Contents Page Introduction 2 A. Management Accounting 2 Some Introductory Definitions 2 Objectives of Management Accounting 3 Setting Up a Management Accounting System 4 The Effect of Management Style and Structure 4 B. Information 4 Information and Data 4 Users of Information 5 Characteristics of Useful Information 5 C.
Collection and Measurement of Information 6 Sources of Information 6 Relevancy 7 Measuring Information 7 Communicating Information 8 Value of Information 9 Quantitative and Qualitative Information 10 Accuracy of Information 10 Financial and Non-Financial Information 10 D. Information for Strategic, Operational and Management Control 11 Elements of Control 11 Feedback 12 Control Information 12 E. Information for Decision Making 14 © ABE and RRC 2 Management Accounting and Information INTRODUCTION We begin our study of this module with some definitions which will make clear what managerial or management accounting is, what it involves and what its objectives are. A number of factors must be considered when setting up a management accounting system and the management style and structure of an organisation will affect the system which it creates.
Information is an important part of any such system and the study unit will go on to examine its various types and sources. MANAGEMENT ACCOUNTING Some Introductory Definitions The Chartered Institute of Management Accountants (CIMA) in its Official Terminology describes accounts as follows: The classification and recording of actual transactions in monetary terms, and The presentation and interpretation of these transactions in order to assess performance over a period and the financial position at a given date. The American Accounting Association (AAA) supplies a slightly more succinct definition of accounting: ".the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of information." Another way of saying this is that accounting provides information for managers to help them make good decisions. Cost accounting is referred to in the CIMA Terminology as: "That part of management accounting which establishes budgets and standard costs and actual costs of operations, processes, departments or products and the analysis of variances, profitability or social use of funds.
The use of the term costing is not recommended." Management accounting is defined as: "The provision of information required by management for such purposes as: (1) formulation of policies; (2) planning and controlling the activities of the enterprise; (3) decision taking on alternative courses of action; (4) disclosure to those external to the entity (shareholders and others); (5) disclosure to employees; (6) safeguarding assets. The above involves participation in management to ensure that there is effective: (a) formulation of plans to meet objectives (long-term planning); (b) formulation of short-term operation plans (budgeting/profit planning); © ABE and RRC Management Accounting and Information 3 (c) recording of actual transactions (financial accounting and cost accounting); (d) corrective action to bring future actual transactions into line (financial control); (e) obtaining and controlling finance (treasurership); (f) reviewing and reporting on systems and operations (internal audit, management audit)." Financial accounting is referred to as: "That part of accounting which covers the classification and recording of actual transactions of an entity in monetary terms in accordance with established concepts, principles, accounting standards and legal requirements and presents as accurate a view as possible of the effect of those transactions over a period of time and at the end of that time." All three branches of accounting should be integrated into the company's reporting system. Financial accounting maintains a record of each transaction and helps control the company's assets and liabilities such as plant, equipment, stock, debtors and creditors. It satisfies the legal and taxation requirements and also provides a direct input into the costing systems.
Cost accounting analyses the financial data into more detail and provides a lot of the information used for control. It also provides key data such as stock valuations and cost of sales which are fed back into the financial accounting system so that accounts can be finalised. Management accounting draws from the financial and cost accounting systems. It uses all available information in order to advise management on matters such as cost control, pricing, investment decisions and planning.
Users of financial accounting are usually external – shareholders, the tax authorities etc. Management Accounting users are internal – the managers at different levels. Objectives of Management Accounting (a) Planning: all organisations should plan ahead in order that they can set objectives and decide how they should meet them. Planning can be short- or long-term and it is the role of the management accounting system to provide the information for what to sell, where and at what price.
Management accounting is also central to the budgetary process which we shall look at in more detail later. (b) Control: production of the company's internal accounts, its management accounts, enables the firm to concentrate on achieving its objectives by identifying which areas are performing and which are not. The use of management by exception reports enables control to be exercised where it is most useful. (c) Organisation: there is a direct relationship between the organisational structure and the management accounting system.
It is often difficult to determine which has the greater effect on the other, but it is necessary that the management accounting system should produce the right information at the right cost at the right time, and the organisational structure should be such that immediate use is made of it. (d) Communication: the existence of a budgetary and management accounting system is an important part of the communication process; plans are outlined to managers so that they are fully aware of what is required of them and the management accounts tell them whether or not the desired results are being achieved. © ABE and RRC 4 Management Accounting and Information (e) Motivation: more will be said about the motivational aspects of budgeting later, but suffice to say here that the targets included in any system should be set at such a level that managers and the people who work for them are motivated to achieve them. (f) Decision Making: all businesses have to make decisions, may of which are short term like whether a component should be made or bought from an outside supplier, pricing and eliminating loss making activities.
Setting Up a Management Accounting System There are several factors which should be borne in mind when a system is being set up: What information is required? Who requires it? How often is it required? Further thought will need to be given to such matters as: What data is required to produce the information? What are the sources of this data? How should it be converted? How often should it be converted? Finally, factors such as organisational structure, management style, cost and accuracy (and the trade-off between them) should also be taken into account. The Effect of Management Style and Structure Theories of management style range from the autocratic at one end of the spectrum to the democratic at the other. Which style a particular organisation uses very much affects the management accounts system. With a democratic style for instance, it is likely that decision making is devolved further down the management structure and information provided will need to reflect this.
An autocratic style, by contrast, means that decision making is exercised at a higher level and therefore the necessary information to enable the function to be carried out will similarly be provided at this level also. In addition, the management structure will also have an impact, a flat management structure will mean that a particular manager will need to be provided with a greater range of reports (e. on sales, marketing, production matters, etc.) than in a company with a functional structure where reports are only required by a manager for his or her own function, such as sales. Note that management structure is much more formalised than management style; it is possible for instance to have both democratic and autocratic managers within a particular management structure.
INFORMATION Information and Data You need to read the following as background information to inform your study. This section is not Management Accounting as such, but will give you a context for it's study.