1.

The role of financial and management accounting information for investors and managers
Accounting is the means by which information about an enterprise is communicated and, thus, is sometimes called the language of business. Many different users have need for accounting information in order to make important decisions. These users include investors, creditors, management, governmental agencies, labour unions, and others. Because the primary role of accounting information is to provide useful information for decision-making purposes, it is sometimes referred to as a means to an end, with the end being the decision that is helped by the availability of accounting information. The importance of financial accounting information for external parties - primarily investors and creditors - in terms of the objectives and the characteristics of that information The primary objectives of financial accounting are to provide information that is useful in making investment and credit decisions; in assessing the amount, timing, and uncertainty of future cash flows; and in learning about the enterprise's economic resources, claims to resources, and changes in claims to resources. Some of the most important characteristics of financial accounting information are it is a means to an end, it is historical in nature, it results from inexact and approximate measures of business activity, and it is based on a general-purpose assumption.

The importance of management accounting information for internal parties - primarily management - in terms of the objectives and the characteristics of that information Management accounting information is useful to the enterprise in achieving its goals, objectives, and mission; assessing past performance and future directions; and evaluating and rewarding decision-making performance. Some of the important characteristics of management accounting information are its timeliness, its relationship to decision-making authority, its future orientation, its relationship to measuring efficiency and effectiveness, and the fact that it is a means to an end.

Elements of the system of external and internal financial reporting that create integrity in the reported information. Integrity of financial reporting is important because of the reliance that is placed on financial information by users both outside and inside the reporting organization. Important dimensions of financial reporting that work together to ensure integrity in information are institutional features (accounting principles, internal structure, and audits); professional organizations (AICPA, IMA, CIA, AAA); and the competence, judgment, and ethical behavior of individual accountants.

According to the Chartered Institute of Management Accountants (CIMA), 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 non-management groups such as shareholders, creditors, regulatory agencies and tax authorities" (CIMA Official Terminology). The American Institute of Certified Public Accountants(AICPA) states that management accounting as practice extends to the following three areas: Strategic ManagementAdvancing the role of the management accountant as a strategic partner in the organization. Performance ManagementDeveloping the practice of business decision-making and managing the performance of the organization. Risk ManagementContributing to frameworks and practices for identifying, measuring, managing and reporting risks to the achievement of the objectives of the organization. Definition of accounting Accounting is a process of identifying, measuring and communicating economical information to permit informed judgments and decisions by users of this information For whom is accounting information? EXTERNAL PARTIES Shareholders They require info about their value of investment. Creditors Require ability to cover their financial obligations. Employees Want to know the ability of the company to meet wage demand. Government Collected info is base for taxation. Suppliers Customers FINANCIAL ACCOUNTING Reporting outside the organization Respecting standards and legal requirements Emphasizing objectivity and verifiability Focusing on summarized [aggregate] data for entire organization What is and what was information respecting the prudence principle INTERNAL PARTIES Managers Require info that will assist them in their decision making and control activities. For example: info is needed on price, demand, competitive position.

MANAGERIAL ACCOUNTING Reporting inside the organization Respecting specific managers needs Emphasizing relevance, flexibility and timeliness Focusing on detailed [analytical] information Adding what is going on and what if information

MANAGEMENT ACCOUNTING MA for decision-making Making decision Cost accounting Controlling What has been and Is it OK information in the process of measuring performance, comparing actual to planned performance and providing feedback Planning What will be and What should be information in What if information in the the process of setting process of searching and assessing processes and motivating alternatives. people Ad hoc need for broad range of Periodical as well as ad information hoc need for MA information

2. The function of cost management for successful business

For a company's management to be effective overall, cost management must be an integral feature of it. It is easiest to understand this concept if it is explained in the context of a single project. For instance, before a project is started, the anticipated costs should be identified and measured. These expenses should then be approved before any purchasing occurs. During the process of completing a project, all incurred costs should be noted and kept in a record of some kind, to help ensure that the costs are controlled and kept in line with initial expectations, to the extent that this is possible. Taking this approach to cost management will help a company determine whether they accurately estimated expenses at first, and will help them more closely predict expenses in the future. Any overspending can also be monitored in this way, and either eliminated in future projects or specifically approved if the expense was necessary. Cost management cannot be used in isolation; projects must be organized and tailored with this strategy in mind. Starting a project with cost management in mind will help to avoid certain pitfalls that may be present otherwise. If the objectives of the project are not clearly defined at first, or are changed during the course of the project, cost over-runs will be more likely. If costs are not fully researched before the project, they may be underestimated, thereby inflating the expectation of the project's success unrealistically. Construction projects are subject to their own particular challenges; these can include constraints in the form of laws and regulations that must be planned around. If the project is completely and clearly defined, this will facilitate effective management of the costs it will incur. Effective cost management strategies will help a team deliver a finished project within the allocated budget, while also making it as valuable as possible to the company. There is always the possibility of unexpected costs, but preparation in the form of cost management will likely make them much easier to deal with when they occur.

In management accounting, cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company's costs and improve profitability. As a form of management accounting, cost accounting need not to follow standards such as GAAP, because its primary use is for internal managers, rather than outside users, and what to compute is instead decided pragmatically. Costs and revenues vary with different levels of activity, is it an important knowledge for the organization? Why? Decision-making on: -Planned level of activity -Price setting -Additional job/order -Profit analysis

Basic concepts: Cost - A monetary measure of the resources sacrificed or forgone to achieve a specific objective, such as acquiring a good or service / The monetary value of goods and services expended to obtain current or future benefits. Expense - The costs of goods or services that have expired, that is, have been used up in the process of creating goods and services. Cost object - Any activity/accounting data item for which a separate measurement of costs is desired. Direct Cost is directly attributable to the manufacture of a product (or provision of a service). Direct costs are very often variable costs and vice-versa, but the two are not synonymous. Three types: direct material, labor, and expenses. Indirect Costs are costs that are not directly accountable to a cost object (such as a particular function or product). Indirect costs may be either fixed or variable. Indirect costs include taxes, administration, personnel and security costs, and are also known as overhead. Conversion cost - Sum of direct labor and manufacturing overhead costs. It represents the cost of converting raw materials into finished products. Period cost - Those costs that are not included in valuation of inventory and as a result are treated as expenses in period in which they are incurred. Usually selling and general administrative expenses, matched against sales revenues in the same period. They are marked in Profit and Loss Statement right away.

Product costs are these costs that are identified with goods purchased or produced for resale. In a manufacturing organization, those are costs that the accountant attaches to the product and then they are included in the inventory valuation until sold, then they are recorded as expenses and matched against revenues (i.e. they go through Inventories on Balance Sheet first, when sold they are posted in Profit and Loss Statement, the rest of them (unsold) remain in Balance Sheet) Variable costs vary in direct proportion to the volume of activity, increase with increase of production and vice versa. Unit variable cost stays constant. Fixed costs remain constant over wide ranges of activity for a specified time period, and decrease in terms of unit costs. Over long time period (several years) all costs become variable. Semi-fixed (step fixed) costs - Within a given time period they stay fixed within specified activity levels, but they eventually increase or decrease by a constant amount at various critical activity levels. Semi-variable (mixed) costs include both variable and fixed component. Relevant costs and revenues - Are those future costs and revenues that will be changed by the decision. The concept of relevant costs eliminates unnecessary data that could complicate the decision-making process. Examples of when management uses relevant costs can be seen when it is determining whether to sell or keep a business unit, make or buy an item, or accept a special order. Decision specific, meaning that a relevant cost may be important in one situation but irrelevant in another. Irrelevant costs and revenues are those that will not be affected by the decision. A managerial accounting term that represents a cost, either positive or negative, that does not relate to a situation requiring management's decision. Examples of irrelevant costs are fixed overheads, notional costs, sunk costs and book values. Avoidable and unavoidable costs - Avoidable costs are those costs that can be saved by not adopting given alternative, on the other hand, unavoidable costs cannot be saved; thus, only avoidable costs are relevant for decision-making purposes. Opportunity costs - Measure the opportunity that is lost or sacrificed when the choice of one course of action requires that an alternative course of action is given up. It considers what has not happened. The term can be applied just to the use of scarce resources. It measures the loss (or sacrifice)/cost of given up activity on behalf of another one. (Wikipedia: Opportunity cost is the value of the next-best choice available to someone who has picked between several mutually exclusive choices.) Sunk costs are costs of resources already acquired where the total will not be affected by the choice between various alternatives. They have already been incurred and cannot be recovered (past/retrospective costs). Incremental (differential) costs - The increase or decrease in costs as a result of one more or one less unit of output. Incremental cost is the overall change that a company experiences by producing one additional unit of good.

Set-up costs - Costs associated with establishing a new manufacturing procedure. Setup costs include design costs, acquisition and location of machinery, and employee hiring and training. Expenses incurred each time a batch is produced. It consists of engineering cost of setting up the production runs or machines, paperwork cost of processing the work order, and ordering cost to provide raw materials for the batch.

Cost and management accounting information system should generate information to meet the following requirements: To allocate costs between costs of goods sold and inventories for internal and external profit measurement and inventory valuation To provide relevant information to help mangers make better decisions To provide information for planning, control and performance measurement

Elements of Cost Material Direct Material Indirect Material Labor Direct Labor Indirect Labor Overhead Indirect Material Indirect Labor They are grouped further based on their functions as, Production or Works Overheads Administration Overheads Selling Overheads Distribution Overheads

Classification of cost means, the grouping of costs according to their common characteristics. The important ways of classification of costs are:

By nature or element: materials, labor, expenses By functions: production, selling, distribution, administration, R&D, As direct and indirect By variability: fixed, variable, semi-variable By controllability: controllable, uncontrollable By normality: normal, abnormal

development,

Variable vs. absorption costing the way the unsoled products are evaluated (crucial for profit reporting) Variable costing = just variable manufacturing costs Absorption costing = variable + fixed manufacturing costs

3. The purpose of cost-volume-profit analysis for managerial decision-making

CVP is a systematic method of examining the relationship between changes in activity (i.e. output) and changes in total sales revenue, expenses and net profit. As a model of these relationships, CVP analysis simplifies the real- world conditions that a firm will face. It is a powerful tool for decision-making in certain situations and witnesses how management accounting information can be of assistance in providing answers to questions about the consequences of following particular courses of action. Such questions might include How many units must be sold to break- even?, What would be the effect on profits if selling price is about to be reduced and more units sold?, What sales volume is required to meet the additional fixed charges arising from an adve rtising campaign?, Should sales people be paid on the bases of salary only , or on the basis of a commission only, or by a combination of the two?. Cost-volume-profit (CVP) analysis can be used as an answer to this and other questions.

The objective of CVP analysis is to establish what will happen to the financial results if a specified level of activity or volume fluctuates. Cost volume profit analysis (CVP analysis) is one of the most powerful tools that managers have at their command. It helps them understand the interrelationship between cost, volume, and profit in an organization by focusing on interactions among the following five elements: 1.Prices of products

2.Volume or level of activity 3.Per unit variable cost 4.Total fixed cost 5.Mix of product sold The break-even point (BEP) for a company is the sales volume, which will give the company a profit of zero. If sales exceed BEP point, company will make a profit. Because cost-volume-profit (CVP) analysis helps managers understand the interrelationships among cost, volume, and profit it is a vital tool in many business decisions. These decisions include, for example, what products to manufacture or sell, what pricing policy to follow, what marketing strategy to employ, and what type of productive facilities to acquire. Contribution margin: is the amount remaining from sales revenue after variable expenses have been deducted. Thus it is the amount available to cover fixed expenses and then to provide profits for the period. So it is the selling price variable costs per unit. CVP analysis can be used to help find the most profitable combination of variable costs, fixed costs, selling price, and sales volume. Profits can sometimes be improved by reducing the contribution margin if fixed costs can be reduced by a greater amount. Break- even point in units = Fixed expenses / Unit contribution margin. Target profit is the amount of net operating income or profit that management desires to achieve at the end of a business period. Management needs to know the required level of business activities to get target profits. Cost volume profit (CVP) equations and formulas can be used to determine the sales volume needed to achieve a target profit. Unit sales to attain target profit = (Fixed expenses + Target Profit) Unit contribution margin. Margin of safety (MOS) is the excess of budgeted or actual sales over the break-even volume of sales. It stats the amount by which sales can drop before losses begin to be incurred. The higher the margin of safety, the lower the risk of not breaking even is. Margin of Safety (units) = Total budgeted or actual sales - Break even sales. CVP shows that profit increases if sales volume increases and fixed costs remain constant. Sale mix--Definition and Explanation of the Concept:

The term sale mix refers to the relative proportion in which a company's products are sold. The concept is to achieve the combination, that will yield the greatest amount of profits. Most companies have many products, and often these products are not equally profitable. Hence, profits will depend to some extent on the company's sales mix. Profits will be greater if high margin rather than low margin items make up a relatively large proportion of total sales. Changes in sales mix can cause interesting variation in profits. A shift in sales mix from high margin items to low margin items can cause profits to decrease even though total sales may increase. Conversely, a shift in sales mix from low margin items to high margin items can cause reverse effect-total profit may increase even though total sales decrease. It is one thing to achieve a particular sales volume; it is quite a different thing to sell most profitable mix of products. Assumptions of CVP: CVP is a useful technique for managers as it provides quick and simple estimates. It does have some limitations: All other variables remain constant Volume is the only factor that will change cost and revenue. Structuring to variable/fixed does not mean relevant/irrelevant for decision-making and management control automatically Single product or constant sales mix

Either single product or a range of products are assumed to be sold. In some industries/companies has to be interpreted very carefully Using a linear functions (TC and TR are linear functions)

Unit variable costs and selling price are constant (within the relevant range of production.). Simple and easy but limited potential for prediction Analysis applies to relevant range only

CVP is appropriate only for decisions taken within the relevant production range. Sometime hard to identify for future Accurate separation fixed and variable costs items

Many costs items are semi-variable/fixed Application to short-term horizon

In short terms, costs of providing firms operating capacity are fixed in relation to changes in activity (property taxes, salaries or seignior managers). Usually misleading in strategic decision-making Complexity-related fixed costs do not change (range of items produced)

Not only volume but also the range of items may influence costs. If a change of volume doesnt not alter the range of products, than it is likely that complexity related fixed costs wont alter. But if volume stays constant and the rage of item s produced changes -support department FC will change.

4. Cost assignment as the way to relevant information for managers

Cost assignment is the process that identifies costs with cost objects, such as activities, products, or services. Cost assignment should be performed by the following methods, listed in the recommended order: Direct assignment: Costs should be assigned by direct assignment where they can be directly identified with a single cost object, which is the case for the salary cost of an employee who is fully employed in a cost object.

Assignment of costs on a cause-and-effect basis: Costs should be assigned on a cause-and-effect basis where costs are identified with two or more cost objects, which is the case for the salary cost of a manager who supervises a number of activities. Here the costs are assigned on a causal basis, such as time spent on each activity. Depending on the volume and circumstances, cost pools may be advisable. Allocation of costs on a reasonable and consistent basis : Costs should be allocated on an otherwise reasonable and consistent basis in cases where a causal relationship cannot be identified, or where it is not feasible to assign costs based on an identifiable causal relationship. For example, corporate human resource costs may be allocated to activities on the basis of the number of FTEs assigned to each activity. Depending on the volume and circumstances of the costs, cost pools may be advisable.

In all cases, the assumptions, methodologies, and source data used must be credible and documented. Allocating costs - Allocating is the action taken to apportion a cost when it benefits two or more objects. The term "allocating costs" is often used interchangeably with "cost assignment."

When a cost cannot be directly identified with a single cost object, it must be allocated to the two or more objects it benefits on a basis that is as fair and accurate as possible based on the relative share that each cost object has consumed. If an engineer is engaged in three different activities, his or her salary cost would need to be "allocated" to each of these activities on some reasonable basis, such as the estimated time spent engaged in each activity. Wherever feasible, costs should be allocated on a causal basis (e.g. time spent). In cases where this is not feasible or practical, another reasonable basis for allocation should be used, such as the number of FTEs or percentage of budget. In choosing a cost allocation method, a balance should be maintained between the level of effort invested in the method and the usefulness of the information produced. In other words, a more precise allocation method may not be worthwhile for a cost that is not material. Information for managers: All managers need to understand what causes the consumption of resources; i.e. costs and what it costs to produce their services or products. Whether departments use sophisticated costing software or more basic cost-finding methods is not important; the choice will depend on what is feasible and cost-effective. What is important is an understanding of fundamental costing principles and concepts and how to apply them consistently in decision making, performance comparison, and planning, managing, and reporting results and resources. More accurate and better-justified costing information will benefit decision makers in departments. It will also make improved information available to stakeholders. Managers may also use the cost information to develop, for example, cost-benefit analyses, risk assessments, or cost-recovery strategies. Whether departments use sophisticated costing software or more basic cost-finding methods is not important. The choice of method depends on what is feasible and costeffective in light of their operations. What is important is an understanding of fundamental costing principles and concepts and how to apply them consistently in decision making, performance comparison, and planning, managing, and reporting results and resources. Costing is a business management function that needs to be understood and used effectively by financial officers and managers at all levels. Consultation between the program managers and the department's DCFO (Deputy Chief Financial Officer) organization is essential to the production of quality costing information.

DCFOs and their financial officers provide functional direction, guidance, and support to managers on the most appropriate costing methods and practices to meet their needs. Given their expertise, a department's financial officers, under the ultimate direction of the DCFO, should normally take the lead in most costing exercises. Judgment is a critical element in this business management function because costing is not an exact science. Costing is needed because questions about costs arise virtually every day, such as the following: What is the appropriate budget for Program X? What does it cost to deliver this service? What did it cost to improve the timeliness of this service? What will the department's costs be in a joint undertaking? What will the additional cost be if client demand increases by 10 per cent? What is the difference in cost between providing this function in-house and outsourcing it? What are the relevant costs associated with a proposed cost-recoverable arrangement? What are the environmental costs associated with this project?

Cost is the value of the resources consumed for something such as an activity, output, or outcome. A question on costs is answered through effective costing, which involves the production of cost information specifically for the purposes intended. What are the best ways to assign costs to cost objects?

Responsibiliy It is the responsibility of the DCFO organization to determine and apply the appropriate methodology for allocating program support and IS costs to the cost object. Determining the most appropriate allocation processes to meet a department's particular requirements,

however, requires consultation with program and IS managers, because they are in the best position to understand the factors that drive their costs. A model for allocating costs to a targeted cost object from a cost base that is relevant to several cost objects appears on the page following.

5. Management control systems with the emphasis on management accounting and financial control systems

Management Control Systems (MCS) is a system which gathers and uses information to evaluate the performance of different organizational resources like human, physical, financial and also the organization as a whole considering the organizational strategies. Finally, MCS influences the behaviour of organizational resources to implement organizational strategies. MCS might be formal or informal. Management control as the process by which managers influence other members of the organization to implement the organizations strategies. Management control systems are tools to aid management for steering an organization toward its strategic objectives. Management controls are only one of the tools which managers use in implementing desired strategies. However strategies get implemented through management controls, organizational structure, human resources management and culture. Management control system is an integrated technique for collecting and using information to motivate employee behaviour and to evaluate performance. Chenhall (2003) mentioned that the terms management accounting (MA), management accounting systems (MAS), management control systems (MCS), and organizational controls (OC) are sometimes used interchangeably. In this case, MA refers to a collection of practices such as budgeting or product costing. But MAS refers to the systematic use of MA to achieve some goal and MCS is a broader term that encompasses MAS and also includes other controls such as personal or clan controls. Finally OC is sometimes used to refer to controls built into activities and processes such as statistical quality control, just-in-time management. Management control is concerned with coordination, resource allocation, motivation, and performance measurement. The practice of management control and the design of management control systems draw upon a number of academic disciplines. Management control involves extensive measurement and it is therefore related to and requires contributions from accounting especially management accounting. Second, it involves resource allocation decisions and is therefore related to and requires contribution from economics especially managerial economics. Third, it involves communication, and motivation which means it is related to and must draw contributions from social psychology especially MC is a must in any organization that practices decentralization. MCS must fit the firms strategy.

Elements of a Control System: 1. A detector or sensor a device that measures what is actually happening in the process being controlled. 2. An assessor a device that determines the significance of what is actually happening by comparing it with some standard or expectation of what should happen. 3. An effector a device (feedback) that alters behavior if the assessor indicates the need to do so. 4. A communication network devices that transmit information between the detector and the assessor and vise-versa. The management control process is the process by which managers at all levels ensure that the people they supervise implement their intended strategies. The control process used by managers consists of the same elements as those in simpler control system described above: detectors, assessors, effectors, and a communications system. Detectors report about what happening throughout the organization; assessors compare this information with the desired state; effectors take corrective action if there are difference between actual state and the desired state; and communication system tells managers what is happening and how that compares to the desired state. However, there are significant differences between the MC process and the simpler control process: 1 MC the standard is not present 2 MC is not automatic 3 MC requires coordination among individual 4 MC is self-control. Management control system require both planning and control: ST and TC and fits between strategy formulation and task control in several aspects. ST focuses long-run, task control on a short-run activities and MC is in between. ST uses rough approximations of the future, TC uses current accurate data and MC between. Each activity involves both planning and control. But in SF planning process is much more important, in TC is more important control process and both are approximately important in MC. MC is the process by which managers influence other members of the organization to implement the organizational strategies. MC activities: 1. 2. 3. 4. 5. 6. planning what organization should to do coordinating the activities of several parts of the organization communicating information evaluating information deciding what, if any action should be taken influencing people to change their behavior

Strategy formulation - is the process of deciding on the goals of the organization and the strategies for attaining these goals. Complete responsibility for strategy formulation should never be assigned to a particular person or organizational unit. Goals are timeless. Strategies

are big and important plans. They state in general way the direction in which senior manager wants the organization to move. Strategy formulation arises in response to a perceived threat or opportunity Strategy Formulation vs. Management Control SF

Process of deciding on new strategies Essentially unsystematic Judgment and rough estimates Involves sponsor of idea, headquarters staff, senior manager

MC Process of implementing those strategies More or less fixed timetable and reliable estimates Involves managers and their staff at all levels Task control - is the process or assuring that specified tasks are carried out effectively and efficiently. TC

TC systems are scientific Human beings are not involved at all The focus on specific tasks performed by these units Related to specified tasks

MC MC systems can never be reduce to a science Managers in MC interact with other managers The focus is on organization units Is concerned with the broadly defined activities Benefits of Internet: Instant access Multi-targeted communication Costless communication Ability to display images Shifting power and control to the individual Changed the rules in B2I consumer sector Changed B2B commerce

6. Budgeting process setting-up, control and feedback

Budgets can be prepared for and used by anyone and anything. That is, we can prepare and use personal budgets and organizations, ministries and non-profit making organizations can all use them.

Budgets, by definition, have to be prepared in advance; and for this reason, they are often referred to in terms of their being part of a feed forward system. Feedback is a term frequently heard both in accounting and ordinary use. Feed forward, on the other hand tends to be less frequently heard, yet this word incorporates the most important aspect of budgeting: looking at situations in advance, thinking about the impact and implications of things in advance and attempting to take control of situations in advance. A budget is a plan expressed in quantitative and money terms. Budgets need to be prepared and approved in advance of the period in which they are to be used. Budgets can include some or all of income, expenditure, and the capital to be employed. Moreover, a budget can be drawn up for an entire organization, any segment of the organization such as a department or sales territory or division, or for a significant activity such as the production and sale of a specific product. Budgets are simply exercises in calculation unless they are used. When we use a budget, we do so as part of a system of budgetary control. That is, we have some basic ideas of what we want to do, we prepare budgets to help us achieve those ideas; and then once we have done whatever it is that we wanted to do, we check to see if we kept to our budget. Budgetary control relates to the establishment of budgets relating the responsibilities of budget holders the needs of a policy. Budgetary control also relates to the continuous comparison of actual with budgeted results: it does this to try to ensure that the objectives of that policy are achieved; or to provide a basis for the change of those objectives. In summary, a budget is a statement setting out the monetary, numerical or nonquantitative aspects of an organizations plans for the coming week or month or year. Budgetary control is the analysis of what happened when those plans came to be put into practice, and what the organization did or did not do to correct for any variations from these plans. The annual budget should be set within the context of longer-term plans, which are likely to exist even if they have not been made explicit. A long-term plan is a statement of the preliminary targets and activities required by an organization to achieve its strategic plans together with a broad estimate for each year of the resources required. Because long-term planning involves looking into the future for several years, the plans tend to be uncertain, general in nature, imprecise and subject to change. Annual budgeting is concerned with the detailed implementation of the long-term plan for the year ahead. As the year progresses the control process involves comparing planned and actual outcomes and responding to any deviations by taking appropriate remedial action to ensure that future results will conform to the annual budget. Alternatively, the annual budget may have to be changed if remedial action cannot be taken. Budgeting is therefore a continuous and dynamic process, and should not end once the annual budget has been prepared.

Budgets serve a number of useful purposes. They include: Planning annual operations

The budgeting process ensure that managers do plan for future operations, and that they consider how conditions in the next year might change and what steps they should take now to respond to these changed conditions. This process encourages managers to anticipate problems before they arise, and hasty decisions that are made on the spur of the moment, based on expediency rather than reasoned judgments, will be minimized. Coordinating the activities of the various parts of the organization and ensuring that the parts are in harmony with each other

Without any guidance, managers may each make their own decisions, believing that they are working in the best interest of organization. It is the aim of budgeting to reconcile these differences for the good of the organization as a whole, rather then for the benefit of any individual area. Budgeting therefore compels managers to examine relationship between their own operations and those of other departments, and, in the process, to identify and resolve conflicts. Communicating the plans to the managers of the various responsibility centers

Through the budget, top management communicates its expectations to lower level management, so that all members of the organization may understand these expectations and can coordinate their activities to attain them. Motivating managers to strive to achieve organizational goals

The budget may be a useful device for influencing managerial behavior and motivating managers to perform in line with the organizational objectives. A budget provides a standard that under certain circumstances, a manager may be motivated to strive to achieve. Controlling activities

A budget assists managers in managing and controlling for which they are responsible. By comparing the actual results with the budgeted amounts for different categories of expenses, managers can ascertain which costs do not conform to the original plan and thus require their attention. This process enables management to operate a system of management by exception which means that a managers attention and effort can be concentrated on significant deviations from the expected results. By investigating the reasons for the deviations, managers may be able to identify inefficiencies such as the purchase of inferior quality materials. When the reasons for the inefficiencies have been found, appropriate control action should be taken to remedy the situation. Evaluating the performance of managers

A managers performance is often evaluated by measuring his or her success in meeting the budgets.

It would be easy to dismiss the budgeting process as beginning when the first budget is prepared, and as being complete when the master budget is finalized. In reality, the budgeting process begins for many organizations a long time before the budget period begins; and the process ends once the budget period has ended. This means the budgeting process is a very lengthy process: typically, for a large organization, the pre budgeting phase can begin up to a year before the budget period starts. The important stages in the budget process are: 1. Communicating details of the budget policy: the long range planning is the starting point for the preparation of the annual budget. Top management must communicate the policy effects of the long term plan to those responsible for preparing the current years budgets. All the managers should be aware of the policy of top managers. Important to communicate from the top managers: guidelines that that are to govern the preparation of the budget the allowance for price and wage increases and the expected changes in productivity, any expected changes in industry demand and output and how to respond to any expected environmental changes. 2. Determining the factor that restricts the performance: in many companies there is at least one factor that restricts the performance in a given period: in most of the companies this is the sales demand. Prior to prepare the budget, it is essential for the top management to define this factor, because is this factor determine the point at which the budgeting should begin. 3. Preparation of the sales budget: the volume of sales and the sales mix determine the companys volume of operation thats why the sales budget is the most important plan in the annual budgeting process. On the other side it is the most difficult plan, because the total sales revenue depends on the actions of customer, or sales demand can be influenced by the state economy or competitors actions. 4. Initial preparation of the budget: A bottom- up process means the budget should originate at the lowest level of the company and after coordinated at higher levels. This enables managers to participate in the preparation of their budget for those areas they are responsible. There is no single way in which the appropriate quantity for a particular budget is determined past day may be used, a useful guidance but do not forget that budgeting is not based on the assumption that what has happened in the past will occur in the future. In additional they can look at the guidance provided by the top managers permitted changes that can be in price of purchases of material and services. 5. Negotiation of budgets: budget should be originated at lowest level of management participative approach of budgeting. The superiors should then incorporate this

budget with other budget which she is responsible for and then submit this budget for approval to his/her superior. The lower management is 1-8 where manager 1 and manager 2 will prepare their budget in accordance with guidelines and budget policy. They will send their budgets to their supervisor of who is in charge for the whole department A. Once their budget have been approved manager of dep. A budget will be combined by him and will be sent to his supervisor Manager of P1 for approval. The manager of P1 is responsible for B and will combine the agreed budgets for A and B and will present to it supervisor. Than the production manager will merge the budget of P1 and 2 and this will present the budget production which will be presented at budget committee for approval. It is necessary that the budgeters that the budget will not present easily attainable target. 6. Coordination and review of the budgets: budgets must be examined in relation with each other and this means that some budgets are out of balance with other budgets and needs to be modified so they will be compatible with other conditions, constraints and plans that are beyond a managers knowledge or control. During a coordination process, a budgeted profit and loss account, a balance sheet and cash flow statement should be prepared to ensure that all the parts combine to produce an acceptable whole. 7. The final acceptance of the budgets: when all the budgets are in harmony with each other they are summarized into a master budget consisting of a budgeted (P/L, Balance and CF statement). After budgets are approved they pass down again to the appropriate responsibility centers. 8. Budget Review Feedback: periodically actual results should be compared with the budgeted results. Normally this should be in monthly basis and a report should be sent to the appropriate budgeters in the first week of the following month. This will enable to find items which are not corresponding with according to the plan and investigate the reasons. If there are any changes, the budget should be revised for the remaining portion of budget period. Important to note her is that the budgetary process does not end for the current year once the budget has begun; budgeting should be seen as a continuous and dynamic process.

7. The role of standard costing method and variance analysis for management by exceptions
Standard costing is most suited to an organization whose activities consist of a series of common or repetitive operations and the input required to produce each unit of output can be specified. It is therefore relevant in manufacturing companies, since the processes involved are often of a repetitive nature. Standard costing procedures can also be applied in service industries such as units within banks, where output can be measured in terms of the number of cheques or the number of loan applications processed, and there are also welldefined input-output relationships. Standard costing cannot, however, be applied to

activities of a non-repetitive nature, since there is no basis for observing repetitive operations and consequently standards cannot be set. Standard costing system Control over costs is best effected through action at the point where the costs are incurred. Hence the standards should be set for the quantities of material, labor and services to be consumed in performing an operation, rather than complete product cost standards. Variances from these standards should be reported to show causes and responsibilities for deviations from standard. Product cost standards are derived by listing and adding the standard cost of operations required to produce a particular product. There are two approaches that can be used to set standard costs. First, past historical records can be used to estimate labor and material usage. Secondly, standards can be set based on engineering studies. With engineering studies a detailed study of each operation is undertaken based on careful specifications of materials, labor and equipment and on controlled observations of operations. If historical records are used to set standards, there is a danger than the latter will include part inefficiencies. With this approach, standards are set based on average past performance for the same or similar operations. Known excess usage of labor or materials should be eliminated or the standards may be tightened by an arbitrary percentage reduction in the quantity of resources required. The disadvantage of this method is that, unlike the engineering method, it does not focus attention on finding the best combination of resources, production methods and product quality. Nevertheless, standards derived from average historical usage do appear to be widely used in practice. Direct Material standards These are based on product specifications derived from an intensive study of the input quantity necessary for each operation. This study should establish the most suitable materials for each product, based on product design and quality policy, and also optimal quantity that should be used after taking into account any wastage or loss that is considered inevitable in the production process. Material quantity standards are usually recorded on a bill of materials. This describes and states the required quantity of materials for each operation to complete the product. The standard material product cost is obtained by multiplying the standard quantities by the appropriate standard price. The standard prices are obtained from the purchasing department. The standard material prices are based on the assumption that the purchasing department has carried out a suitable search of alternative suppliers and has selected suppliers who can provide the required quantity of sound materials at the most competitive price. Direct Labor standards To set labor standards, activities should be analyzed by the different operations. Each operation is studied and an allowed time computed, usually after carrying out a time and motion study. The normal procedure for such a study is to analyze each operation to eliminate any unnecessary elements and to determine the most efficient production method. The most efficient methods of production, equipment and operating conditions are then standardized. This is followed by time managements that are made to determine the number or standard hours required by an average worker to complete the job. Unavoidable

delays such as machine breakdown and routine maintenance are included in the standard time. The agreed wage rates are applied to the standard time allowed to determine the standard labor cost for each operation. Overhead standards Normally the standard overhead rate will be based on a rate per direct labor or machine hour of input. Fixed overheads are largely independent of changes in activity, and remain constant over wide range of activity in the short time. It is therefore inappropriate for short-term cost control purposes to unitize fixed overheads to derive fixed overhead rate per unit of activity. However, in order to meet the external financial reporting stock valuation requirements, fixed manufacturing overheads must be traced to products. The main difference with the treatment of overheads under a standard costing system as opposed to a non-standard costing system is that the product overhead cost is based on the hourly overhead rates multiplied by the standard hour (that is, hours which should have been used) rather than the actual hours used. Types of cost standards Basic standards (represent constant standards that are left unchanged over long periods) Ideal standards (represent perfect performance; minimum costs that are possible under the most efficient operating conditions) Currently attainable standards (represent costs that should be incurred under efficient operating conditions). Purpose of standard costing Standard costing systems are widely used because they provide cost information for many different purposes such as following: Providing a prediction of future costs that can be used for decision-making purposes. Standard costs can be derived either from traditional or activity-based costing systems. Because standard costs represent future target costs based on the elimination of avoidable inefficiencies, they are preferable to be estimated based on adjusted past costs which may incorporate inefficiencies. Providing a challenging target which individuals are motivated to achieve. For example research evidence suggest that the existence of a defined quantitative goal or target is likely to motivate higher levels of performance that would be achieved if no such target is set. Assisting in setting budgets and evaluating managerial performance. Standard costs are particularly valuable for budgeting because reliable and convenient source of data is provided for converting budgeted production into physical and monetary resource requirements. Budgetary preparation time is considerably reduced if standard costs are available because the standard costs of operations and products can be readily built up into total of any budgeted volume and product mix.

 Acting as a control device by highlighting those activities which do not conform to plan and thus alerting managers to those situations that may be out of control and in need of corrective action. With a standard costing system variances are analyzed in great detail such as by element of cost, and price and quantity elements. Useful feedback is therefore provided in pinpointing the areas where variances have arisen. Simplifying the task of tracing costs to products for profit measurement and inventory valuation purposes. Besides preparing annual accounting profit statements most organizations also prepare monthly internal profit statements. If actual costs are used a considerable amount of time is required in tracking costs so that monthly costs can be allocated between cost of sales and inventories. A data processing is required which can track monthly costs in a resource efficient manner. Standard costing systems meet this requirement. Product costs are maintained at standard cost. Inventories and cost of goods of goods sold are recorded at standard cost and a conversion to actual cost is made by writing off all variances arising during the period as a period cost. A standard cost is the predetermined cost of manufacturing a single unit or a number of product units during a specific period in the immediate future. It is the planned cost of a product under current and / or anticipated operating conditions. A standard is a "benchmark" or "norm" for measuring performance. Standards are found everywhere your doctor, for example, evaluates your weight using standards that have been set for individuals of your age, height and gender. the food we eat in restaurants must be prepared under specified standards of cleanliness. The buildings we live in must conform to standards set in building codes. Standards are also widely used in managerial accounting where they relate to the quantity and cost of inputs used in manufacturing goods and producing services. Engineers and accountants assist managers to set quantity and cost standards for each major input such as raw materials and direct labor time. Quantity standards specify how much of an input should be used to make a product or provide a service. Cost or price standards specify how much should be paid for each unit of input. Actual quantities and actual costs are then compared with these standards. In case of significant deviations managers investigate the discrepancies. The purpose is to find the problem and eliminate it so that it does not recur. This process is called management by exception. In our daily lives, we operate in a management by exception mode most of the time. Consider what happens when you sit down in the driver's seat of your car. You put the key in the ignition, your turn the key, and your car starts. Your exception (standard) that the car will start is met; you do not have to open the car hood and check the battery, the connecting cables, the fuel lines, and so on. If you turn the key and the car does not start, then you have a discrepancy (variance). Your exceptions are not met, and you need to investigate why. Note that even if the car is started after a second try, it would be wise to investigate anyway. The fact that exception was not met should be viewed as an opportunity to uncover the cause of the problem rather than as simply an annoyance. If the underlying cause is not discovered and corrected, the problem may recur and become much worse.

This basic approach to identifying and solving problems is exploited in the variance analysis cycle. The cycle begins with the preparation of standard cost performance reports in the accounting department. These reports highlight the variances, which are the differences between actual results and what should have occurred according to the standards. The variances raise questions. Why did this variance occur? Why is this variance larger than it was last period? The significant variances are investigated to discover their root causes. Corrective actions are taken. And then next period's operations are carried out. The cycle then begins again with the preparation of a new standard cost performance for the latest period. The emphasis should be on flagging problems for attention, finding their root causes, and then taking corrective actions. The goal is to improve operations - not to find blame. Variance Analysis and Management By Exception: Variance analysis and performance reports are important elements of management by exception. Simply put, management by exception means that the manager's attention should be directed toward those parts of the organization where plans are not working out for reason or another. Time and effort should not be wasted focusing on those parts of the organization where things are going smoothly. The budgets and standards explained in this section reflect management's plans. If all goes according to plans, there will be little difference between actual results and the results that would be expected according to the budgets and standards. If this happens, managers can concentrate on other issues. However, if actual results do not conform to the budget and to standards, the performance reporting system sends a signal to the management that an "exception" has occurred. This signal is in the form of a variance from the budget or standards. However, are all variances worth investigating? The answer is no. Differences between actual results and what was expected will almost always occur. If every variance were investigated, management would waste a great deal of time tracking down nickel-and-dime differences. Variances may occur for any of a variety of reasons - only some of which are significant and warrant management attention. For example, hotter than normal weather in the summer may result in higher than expected electrical bills for air conditioning. Or, workers may work slightly faster or slower on a particular day. Because of unpredictable random factors, one can expect that virtually every cost category will produce a variance of some kind. How should managers decide which variances are worth investigating? One clue is the size of the variance. A variance of $5 is probably not big enough to warrant attention, whereas a

variance of $5000 might well be worth tracking down. Another clue is the size of the variance relative to the amount of spending involved. A variance that is only 0.1% of spending on an item is likely to be well within the bounds one would normally expect due to random factors. On the other hand, a variance of 10% of spending is much more likely to be a signal that something is basically wrong. A more dependable approach is to plot variance data on a statistical control chart, The basic idea underlying a statistical control chart is that some random fluctuations in variances from period to period are normal and to be expected even when costs are well under control. A variance should only be investigated when it is unusual relative to that normal level of random fluctuation. Typically the standard deviation of the variance is used as the measure of the normal level of fluctuations. A rule of thumb is adopted such as "investigate all variances that are more than X standard deviations from zero." In the control chart in example below, X is 1.0. That is the rule of thumb in this company is to investigate all variances that are more than one standard deviation in either direction (favourable or unfavourable) from zero. This means that the variances in weeks 7, 11, and 17 would have been investigated, but none of others. . . . . . . . . . . +1 Standard deviation

Fav.

Var. 0 --------------------------------------------------------------------------------------------------------------Unfav. . . 1 2 3 4 5 6 7 8 9 10 Week What value of X (standard deviation) should be chosen? The bigger the value of X, the wider the band of acceptable variances that would not be investigated. Thus the bigger the value of X, the less time will be spent tracking down variances, but the more likely it is that a real out of control situation would be overlooked. Ordinarily, if X is selected to be 1.0, roughly 30% of all variances will trigger an investigation even when there is no real problem. If X is set at 105, the figure drops to about 13%. If X is set at 2.0, the figure drops all the way to about 5%. Don't forget, however, that selecting a big value of X will result not only in fewer investigations but also a higher probability that a real problem will be overlooked. In addition to watching for unusually large variances, the pattern of the variances should be monitored. For example, a run of steadily mounting variances should trigger an investigation even though none of the variances is large enough by itself to warrant investigation. 11 12 13 14 15 16 17 18 19 . . . . . . 1 Standard deviation