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Introduction to

Management
Accounting
History of Management
• Accounting
Managerial accounting has its roots since the industrial revolution (19th
century). During this early period, most firms were tightly controlled by a
few owner-managers who borrowed based on personal relationships
and their personal assets. Since there were no external shareholders
and little unsecured debt, there was little need for elaborate financial
reports.
• In contrast, managerial accounting was relatively sophisticated and
provided the essential information needed to manage the early large
scale production of textile, steel, and other products. After the turn of the
century, financial accounting requirements burgeoned because of new
pressures placed on companies by capital markets, creditors, regulatory
bodies, and federal taxation of income. Johnson and Kaplan state that
"many firms needed to raise funds from increasingly widespread and
detached suppliers of capital. To tap these vast reservoirs of outside
capital, firms' managers had to supply audited financial reports. And
because outside suppliers of capital relied on audited financial
statements, independent accountants had a keen interest in establishing
well defined procedures for corporate financial reporting.
Continued……
• The inventory costing procedure adopted by public accountants after the
turn of the century had a profound effect on management accounting. As a
consequence, for many decades, management accountants increasingly
focused their efforts on ensuring that financial accounting requirements were
met and financial reports were released on time. The practice of
management accounting stagnated. In the early part of the century, as
product line expanded operations became more complex, forward looking
companies saw a renewed need for management-oriented reports that was
separate from financial reports. But in most companies, management
accounting practices up through the mid-1980s were largely
indistinguishable from practices that were common prior to world war I.

• In recent years, however, new economic forces have led to many important
innovations in management accounting.
About Management
• Accounting
Managerial accounting is concerned with providing information to managers-
that is, people inside an organization who directs and control its operation.
Managerial accounting provides the essential data with which the
organizations actually runs.

• Managerial accounting is also termed as management accounting or cost


accounting. Managerial accountants prepare a variety of reports. Some
reports focus on how well managers or business units have performed-
comparing actual results with plans and benchmarks. Some reports provide
timely, frequent updates on key indicators such as orders received, order
backlog, capacity utilization, and sales. Other analytical reports are prepared
as needed to investigate specific problems such as a decline in the
profitability of a product line. And yet other reports analyze a developing
business situation or opportunity.

• While financial accounting is concerned with providing information to


stockholders, creditors, and others who are outside an organization. It is
oriented toward producing a limited set of specific prescribed annual and
quarterly financial statements in accordance with
Generally Accepted Accounting Principles (GAAP). (Ray H. Garrison,
Eric W. Noreen 1999).
Learning Users of Accounting
Objective 1
Information
Management Financial Accounting
Accounting
External
Internal managers Users
Investors:
Stockholders
Creditors:
Day-to-day operating decisions Suppliers
Long-range strategic decisions Bankers

Government
Authorities
Decision Making

Scorekeeping: Attention Directing:


Evaluate Compare Actual
Organizational Results to Expected
Performance

Problem Solving:
Assess Possible
Courses of
Action
Influences on Accounting
Systems
Generally accepted accounting principles (GAAP)

Foreign Corrupt Practices Act

Internal controls

Internal auditors Sarbanes-Oxley Act

Management audits
Management Accounting

Relationship between Content in Management Acct.


* Accounting
As a part of • Full Cost Accounting
• Financial Accounting the • Differential Accounting
• Cost Accounting accounting
information • Responsibility
• Management system Accounting
Accounting
• Relationship between Accounting, Cost,
Financial & Management Accounting

Accounting

Cost Accounting Management


Financial Acct Accounting
Relationship Between Accounting, Financial, Cost &
Management Accounting
• Accounting – is collection, summarization, analysis &
reporting of information about a business enterprise, in
financial (monetary) terms. The business accounting
information system consists of three parts:
- Financial accounting
- Cost accounting
- Management accounting
• Financial Accounting - is involved with financial
transactions that have already happened and with the
preparation and interpretation of financial statements for
the benefit of managers, the owners and the external
stakeholders of an organization
• Cost accounting -The term cost refers to the
resources, expressed in monetary terms, which
are used to achieve some purpose. While cost
accounting records, measures & reports
information about costs. Its purpose is cost
ascertainment and its use in decision making &
performance evaluation. It provides data for both
financial & management accounting. When cost
are used by outsider for performance &
investment decision it forms the part of financial
accounting. On the other side when cost are
used for internal management to evaluate
performance of the operation it is management
accounting.
• Management accounting- is the process of identification,
measurement, accumulation, analysis, preparation,
interpretation & communication of financial information
used by management to plan, evaluate & control within
an organization & to assure appropriate use of and
accountability for its resources. Management accounting
also comprises the preparation of financial reports for
management groups such as shareholders, creditors,
regulatory agencies & tax- authorities.
The Nature of Planning &
Controlling
Management Internal Accounting
Process System
Budgets,
Budgets, Other information
Special
Special systems
Planning
Planning Reports
Reports Customer
Customer
Increase
Increase surveys
surveys
Profitability
Profitability Competitor
Accounting Competitor
Accounting analysis
analysis
System
System Advertising
Advertising
Control
Control impact
impact
––Actions
Actions Performance
Performance New
New items
items
––Evaluations
Evaluations Reports
Reports report
report
t c err o C
a s nal p
Management Accountant’s
Role as
Internal Consultant
Collects Prepares
and compiles standardized
information reports

Internal
Consultant

Interprets and Is Involved


Analyzes information In decision making

Management
Similarities
Basis Cost Financial Management

Data Used Data’s are information derived from


system accounting

Measuring All transactions money or moneyworth


Units measured in terms of money are
recorded
Financial Accounting Managerial Accounting
Reports to those outside the organization Reports to those inside the organization for
owners, lenders, tax authorities and planning, directing and motivating, controlling
regulators. and performance evaluation.

Emphasis is on summaries of Emphasis is on decisions affecting the


financial consequences of past activities. future.

Objectivity and verifiability of data are Relevance of items relating to decision


emphasized. making is emphasized.

Precision of information is required. Timeliness of information is required.

Only summarized data for the entire Detailed segment reports about
organization is prepared. departments, products, customers, and
employees are prepared.

Must follow Need not follow


Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles (GA
. .

Mandatory for external reports. Not mandatory


Managerial Accounting
Management accounting consists of three types of
information & each of them is governed by different set
of principles

Content of Management Accounting

Full Cost Differential Responsibility


Accounting Accounting Accounting

Full costing is the sum of The accounting Three tools:


both the direct & indirect information that is
cost or total cost used in making (i) Budgeted/ Planned
alternative choice performance.
decision i.e make (ii) Actual
or buy decision performance
(iii) Difference b/w the
budgeted & actual
Full Cost Accounting
Full Cost accounting may be defined as a system of
management accounting that is prepared in
circumstances where the full cost of an item consisting of
the direct costs & a fair share of indirect costs is
relevant. Its relevance may be in situations where items
are shown in full costing and in fixation of selling price.

Direct Cost – are those which are conveniently, wholly &


exclusively attributable to a particular unit of production.

Indirect Cost – relates to the organization as whole and


cannot be identified with specific units of production.
Differential Accounting ( Make or Buy)
• The accounting information that is used in
making alternative choice decision is termed as
differential accounting. A situation in which there
are alternatives uses to which the resources
(cost) may be put. These alternatives are
mutually exclusive where the selection of one
alternative precludes the selection of the other.
Includes decision like make or buy, lease or buy,
capital budgeting decision and so on. Differential
costing is relevant for decision making.
Responsibility Accounting

Under responsibility accounting the accounting


information is summarized for each segment to
understand the performance and operation of
each segment in the organization. This is done
through preparation of budgets or budgeting.

Budget is a plan, expressed in financial terms,


for the activities and operation of a firm
Cost Objects & Drivers
• Cost - A sacrifice of resources. Distinguish from
“expenses”.

• Cost Object - Any or item for which a separate


measurement of costs is desired. e.g Product.

• Cost Driver - Any factor whose change “causes” a


change in the total cost of a related cost object. Cost
drivers can be factors other than volume. e.g
Processing Sales Order.
Cost Drivers Cost Object
Management Accounting Change
Drivers

Shift from a manufacturing-based


to a service-based economy

Increased global competition

Advances in technology

Changes in business processes


Types of costs
Managers may want cost data to prepare external financial reports, to prepare
planning budgets, or to make decisions therefore, costs are classified
differently according to the immediate need of management. Each different
use of cost data demands a different classification and definition of cost. For
example, the preparation of external financial reports require historical cost
data, whereas decision making may require predictions about future costs.
 Manufacturing and Non-manufacturing Costs.
 Product & Period Cost.
 The financial statements prepared by manufacturing companies.
 Mixed/Semi, Fixed & Variable Cost.
 Quality Costs
Manufacturing costs are those costs that are directly involved in
manufacturing of products and services. Eg. of manufacturing costs
include raw materials costs and salary of labor workers.
Manufacturing cost is divided into three broad categories by most
companies.
• Direct materials cost
• Direct labor cost
• Manufacturing overhead cost.

Non-manufacturing costs are those costs that are not


incurred to manufacture a product. Examples of such costs are
salary of sales person and advertising expenses. Generally
non-manufacturing costs are further classified into two
categories.
• Marketing and Selling Costs
• Administrative Costs
Product & Period Cost
Product costs include all the costs that are involved in acquiring or making
product. In the case of manufactured goods, these costs consist of direct
materials, direct labor and manufacturing overhead. Period costs are all the costs
that are not included in product costs. These costs are expensed on the income
statement in the period in which they are incurred, using the usual rules of
accrual accounting that we learn in financial accounting.

PRODUCT COSTS OR INVENTORIABLE COSTS


• Direct Materials:
Materials that can be physically and conveniently traced to a product, such as wood in a table.
• Direct Labor:
Labor costs that can be physically and conveniently traced to a product such as assembly line
workers in a plant. Direct labor is also called touch labor cost.
• Manufacturing Overhead:
All costs of manufacturing a product other than direct materials and direct labor, such as indirect
materials, indirect labor, factory utilities, and depreciation of factory equipment.

PERIOD COSTS OR NON-MANUFACTURING COSTS


Marketing or selling costs:
All costs necessary to secure customer orders and get the finished product or service into the
hands of the customer, such as sales commission, advertising, and depreciation of delivery
equipment and finished goods warehouse.
Administrative Costs:
All costs associated with the general management of the company as a whole, such as executive
compensation, executive travel costs, secretarial salaries, and depreciation of office building and
equipment.
Financial statements prepared by
Manufacturing Companies
• The financial statements prepared by manufacturing companies are more
complex than the statements prepared by a merchandising company.
Manufacturing companies are more complex organizations than merchandising
companies because the manufacturing companies must produce its goods as
well as market them. The production process gives rise to many costs that do
not exist in a merchandising company, and some how these costs must be
accounted for on the manufacturing company's financial statements.

• Balance Sheet
The balance sheet or statement of financial position of a manufacturing
company is similar to that of a merchandising company. However, the inventory
accounts differ between two types of companies. A merchandising company has
only one type of inventory-goods purchased from suppliers that are awaiting
resale to customers. In contrast manufacturing companies have three classes of
inventories-raw materials, work-in-process, and finished goods.

Income statements
The only apparent difference is in the labels of some of the entries in the
computation of cost of goods sold. In this example, the computation of cost of
goods sold relies on the following basic equation for the inventory accounts
Cost of Goods Sold in a Merchandising Company:
Cost of goods sold = Beginning merchandising inventory +
Purchases − Ending merchandising inventory

Cost of Goods Sold in a Manufacturing Company:


Cost of goods sold = Beginning finished goods inventory +
Cost of goods manufactured − Ending finished goods
inventory
Mixed/Semi, Fixed & Variable Cost
• Quite frequently, it is necessary to predict how a certain cost
will behave in response to a change in activity. Cost behavior
refers to how a cost will react or respond to changes in the
level of business activity. As the level of activity rises and
falls, a particular cost may rise and fall as well--or it may
remain constant. For planning purposes, a manager must be
able to anticipate which of these will happen; and if a cost can
be expected to change, the manager must know by how much
it will change. To help make such distinctions, costs are often
characterized as variable or fixed.

Mixed cost is also known as semi-variable cost. A mixed/semi


variable cost is one that contains both variable and fixed cost
elements. The relationship between mixed cost and level of
activity can be expressed by the equation y = a + bX.
Cost classification for Assigning Costs to Cost Objects (Direct and Indirect Cost)
• A direct cost is a cost that can be easily and conveniently traced to the particular cost object under
consideration. A cost object is any thing for which cost data is required including products, customers jobs
and organizational subunits. An indirect cost is a cost that cannot be easily and conveniently traced to the
particular cost object under consideration.

Decision making costs--cost classification for decision making


• Costs can be classified for decision making purposes. Costs are important feature of many business
decisions. For decision making purposes cost is usually classified as differential cost, opportunity cost, and
sunk cost. It is essential to have a firm grasp of these cost concepts.

Differential cost
Any cost that differs between alternatives in a decision-making situation. In managerial accounting, this term
is synonymous with avoidable cost and relevant cost. Also see Incremental cost.
Cost of first alternative = 5000; Cost of second alternative = 4000; Differential cost = 5000 – 4000 = 1000.

Opportunity Cost

Sunk cost
Any cost that has already been incurred and that cannot be changed by any decision made now or in the
future.

Quality Costs:
Quality cost can be defined as a cost that is incurred to avoid defaults before the products are shipped to the
customers or to satisfy the customers by removing the faults if defaulted products have been shipped to
customers to secure the good will of the company. Quality costs can be broken down into four broad groups.
Two of these groups are known as prevention costs and appraisal costs. These are incurred in an effort to
keep defective products from falling into the hands of customers. The other two groups of costs are known as
internal failure costs and external failure costs. These are incurred because defects are produced despite
efforts to prevent them. These are also known as costs of poor quality.

Further Classification of Labor Costs


• Idle time overtime, and fringe benefits associated with direct labor workers pose particular problems in
accounting for labor costs. Are these costs are a part of the costs of direct labor or are they something else?
Learning Career Opportunities in Management
Objective 7
Accounting

The Certified Management Accountant (CMA)

CMAs must pass a four-part examination:


1. Business Analysis
2. Management accounting and reporting
3. Strategic Management, and
4. Business Applications.
Major Influences on
Management Accounting
Advances in technology:
E-commerce
Enterprise resource planning (ERP)

Business process reengineering:


Just-in-time (JIT) philosophy
Lean manufacturing
Computer-integrated manufacturing
Six sigma
Major Influences on
Management Accounting
Advances in technology:
E-commerce
Enterprise resource planning (ERP)

Business process reengineering:


Just-in-time (JIT) philosophy
Lean manufacturing
Computer-integrated manufacturing
Six sigma