1Lecture 1

TOPIC 1Introduction to management accounting: Information for

contemporary managers

Ref: LS chapters 1 & 2

2Introduction

Managers are people who are paid to make decisions and create value

Management accountants provide relevant and reliable information to managers so that they will make the right decisions

The study of management accounting yields insights into both the manager’s role and the accountant’s role in an organization.

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3 Major Purposes of Accounting Systems

1 Internal routine reporting2 Internal non-routine reporting3 External reporting

4Internal Routine Reporting

This purpose covers information provided for decisions that occur with some regularity:

Daily reports Weekly reports Performance reports

The information in these reports is needed for pricing and other short-run decisions.

5Internal Non-routine Reporting

This purpose covers information for decisions that occur irregularly or that may be without precedent, for example:

Outsourcing of components or services Implementation of a special cost control

system Accept or reject a special ‘once-off’ order

from a customer

6External Reporting

This purpose covers information provided to investors, government authorities, and other outside parties on the results of the organization’s operations.

External reporting focuses on an entity’s financial performance and position. It must comply with rules created by external bodies.

What is management accounting?

… the processes and techniques that focus on the effective and efficient use of organisational resources to support managers in their tasks of enhancing both customer value and shareholder value

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8

Management Accounting...

measures and reports financial and non-financial information that helps managers make decisions that will achieve the organization’s goals.

9Financial Accounting...

focuses on reporting to external parties.

It measures and records business transactions. It provides financial statements based on

generally accepted accounting principles. It is subject to the requirements of accounting

standards, the Corporations Act 2001 and (for listed companies) the ASX Listing Rules.

10Cost Management...

describes the activities of managers in short- run and long-run planning and controlling of costs.

It includes the continuous reduction of costs. It is a key part of general management

strategies and their implementation.

11What is Planning?

It is deciding on organization goals, predicting results under various alternative ways of achieving those goals, and then deciding how to attain the designated goals.

12What is Control?

Basically control means comparing actual performance with planned performance and then taking action to correct any unfavourable trends and/or adjust future planning processes.

Planning and Control Cycle

DecisionMaking

Formulating long-and short-term plans

(Planning)

Formulating long-and short-term plans

(Planning)

Measuringperformance (Controlling)

Measuringperformance (Controlling)

Implementing plans (Directing and Motivating)

Implementing plans (Directing and Motivating)

Comparing actualto planned

performance (Controlling)

Comparing actualto planned

performance (Controlling)

Begin

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14What are Budgets?

They are quantitative expressions of a proposed plan of action by management for a future time period and an aid to the coordination and implementation of the plan.

Budgets are like financial roadmaps that tell us where we are going and how we intend to get there.

Budgets are covered in Lecture 8

15What is a Performance Report?

This is a report that compares actual results with budgeted or planned amounts.

The performance report of the Seattle Specialty shop for the month of July shows the following:

16Performance Report

Seattle Specialty Shop, July 2010 Seattle Specialty Shop, July 2010 BudgetBudget ActualActual VarianceVariance Revenues Revenues $57,000$57,000 $60,000$60,000$3,000 F Cost of goods sold$3,000 F Cost of goods sold 40,000 40,000 43,40043,400 3,400 U 3,400 U Wages expense Wages expense 6,700 6,700 7,000 7,000 300 300 U General expensesU General expenses 1,300 1,300 900 900 400 400 F Fixed costsF Fixed costs

5,000 5,000 5,000 5,000 ------- ------- Operating Operating incomeincome $ 4,000$ 4,000 $ 3,700$ 3,700 $ 300 U$ 300 U

17Performance Report

The performance report indicates that although actual revenues exceeded the budgeted amount by $3,000, operating income was $300 less than budgeted.

The report could spur investigation and further decisions.

Did the purchasing department pay more than expected for the merchandise?

18Performance Report

Yes, actual cost of goods sold was 72% of revenues instead of the budgeted 70%.

Budget % Actual % Revenues

$57,000 100 $60,000 100 Cost of goods sold 40,000 70 43,400 72 Gross profit $17,000 30 $16,600 28

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3 Key Roles of Management Accountants

Problem-solving, scorekeeping, and attention-directing

20Problem Solving...

– involves comparative analysis for decision making.

This role requires the management accountant to consider several alternatives and then decide which one is the best?

21Scorekeeping...

– involves accumulating data and reporting reliable results to all levels of management.

This role requires the management accountant to explain how well the business is performing.

22Attention Directing...

– involves helping managers properly focus their attention.

This role involves identifying opportunities and problems and then ranking them according to their importance.

Attention directing should focus on all opportunities to add value, and not just on cost-reduction opportunities.

23Management Accountants...

– Fulfil each of these three roles in relation to both planning and control decisions.

The problem-solving role is critical for planning decisions.

The scorekeeping and attention-directing roles are most important for control decisions.

24Value Chain

The term “value chain” refers to the sequence of business functions in which usefulness is added to the products or services of an organization.

The term “value” is used because as the usefulness of the product or service is increased, so is its value to the customer.

25Value Chain

Management accountants provide decision support for managers in the following six business functions:

26Value Chain

Distribution

Management Accounting

Service

Marketing

Production

Design

R & D

27Value Chain

1 Research and development (R&D) – the process that is conducted to generate and experiment with ideas related to new products, services, or processes.

2 Design – the detailed planning and engineering of products, services, or processes.

3 Production – the acquisition, coordination, and assembly of resources to produce a product or deliver a service.

28Value Chain

4 Marketing – the manner by which companies promote and sell their products or services to customers or prospective customers.

5 Distribution – the delivery of products or services to the customer.

6 Customer service – the after-sales support activities provided to customers.

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The R & D, Design and Supply functions are sometimes referred to as upstream activities

The Marketing, Distribution and Service functions are sometimes referred to as downstream activities

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Four key themes that are important to managers attaining

success in their planning and control decisions

31Key Themes in Management Accounting

Customer FocusCustomer Focus Success FactorsTime, Quality,

Cost, Innovation

Success FactorsTime, Quality,

Cost, Innovation

ContinuousImprovement

ContinuousImprovement

Value-Chain andSupply-Chain

Analysis

Value-Chain andSupply-Chain

Analysis

32Customer Focus

The challenge facing managers is to continue investing sufficient (but not excessive) resources in customer satisfaction such that profitable customers are attracted and retained.

The key question: “How can I add value for the customer?”

33Success Factors...

– are operational factors that directly affect the economic viability of the organization.

The key question: What are the things that we need to manage well in order to prosper and grow?

Cost – organizations are under continuous pressure to reduce costs.

Quality – customers are expecting higher levels of quality.

34Key Success Factors

Time – organizations are under pressure to complete activities faster and to meet promised delivery dates more reliably.

Innovation – there is now heightened recognition that a continuing flow of innovative products or services is a prerequisite to the ongoing success of most organizations.

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Continuous Improvement

Continuous improvement by competitors creates a never-ending search for higher levels of performance within many organizations.

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Three guidelines that assist management accountants to

increase their value to managers

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1. A Cost-Benefit Approach

A cost-benefit approach should be used in order to promote decision making that better attains organisational goals in relation to the costs of the resources consumed.

382. Behavioural and Technical Considerations

A management accountant should have two simultaneous aims when providing information:

1 To help managers make wise economic decisions

2 To help managers and other employees aim for and achieve the goals of the organisation

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3. Different Costs for Different Purposes

Management accountants should identify which costs are relevant for a particular decision. A cost concept used for external reporting purposes may not be the appropriate concept for the purpose of internal reporting to managers.

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Cost concepts and terms

Different cost concepts and terms are often used in accounting reports.

Managers who appreciate these concepts and terms are able to...

– best use the information provided, and– avoid misuse of that information.

41Costs and Cost Terminology A cost is a resource sacrificed or forgone in

order to achieve a specific objective. It is usually measured as the monetary amount

that must be paid to acquire goods and services. An actual cost is the amount that was paid (an

historical cost) as distinguished from a budgeted cost which is a predicted or future cost.

An opportunity cost is the value of what is given up when one alternative is chosen instead of another

Sunk Costs Sunk costs cannot be changed by any decision. They are the same

for all possible alternatives and should be ignored when making decisions.

Example: You bought a motor car that cost $10,000 two years ago. The $10,000 you paid is a sunk cost because whether you drive the car, park it, trade it, or sell it, you cannot change the $10,000 cost.

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43Costs and Cost Terminology

A cost object is anything for which a separate measurement of costs is desired.

44Costs and Cost Terminology

There are two basic stages of accounting for costs:

1 Cost accumulation2 Cost assignment to various cost objects

45Costs and Cost Terminology

Cost accumulation is the collection of cost data in some organized way by means of an accounting system.

Cost assignment is a general term that encompasses both...

– tracing direct costs to a cost object, and– allocating indirect costs to a cost object.

46Direct Costs

Direct costs are those that are related to a given cost object (e.g. a product or a department) and can be traced to it in an economically feasible way.

47Indirect Costs...

– may be related to a particular cost object but cannot be traced to it in an economically feasible way.

– indirect manufacturing costs are grouped under the heading of Manufacturing Overhead

The ProductThe Product

Direct Materials Direct Materials

Direct Labour Direct Labour

ManufacturingOverhead

ManufacturingOverhead

Manufacturing Costs48

Direct Materials

Those materials that become an integral part of a product and that can be conveniently traced

directly to it.

Example: A radio installed in a motor vehicleExample: A radio installed in a motor vehicle

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Direct Labour

Those labour costs that can be easily traced to individual units of a product.

Example: Wages paid to vehicle assembly workersExample: Wages paid to vehicle assembly workers

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Includes all manufacturing costs that cannot be traced directly to specific units produced.

Manufacturing Overhead

Examples: Indirect labour and indirect materialsExamples: Indirect labour and indirect materials

Wages paid to employees who are not directly involved in production work. e.g. maintenance workers, cleaners and security guards.

Materials used to support the production process. e.g. the lubricants and cleaning supplies used in a vehicle assembly plant.

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Classifications of Costs

DirectMaterialDirect

MaterialDirect

LabourDirect

LabourManufacturing

OverheadManufacturing

Overhead

PrimeCost

ConversionCost

Manufacturing costs are oftenclassified as follows:

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53Indirect Costs

Cost allocation describes the assigning of indirect costs to the particular cost object.

Pendal Ltd. has two production departments, Assembly and Finishing, and two service departments, Maintenance and Personnel.

54Direct and Indirect Costs

Direct Costs:

Maintenance Department $30,000

Personnel Department $24,600

Assembly Department $70,000

Finishing Department $50,000 Assume that Maintenance Department costs are

allocated equally among the production departments. How much is allocated to each department?

55Direct and Indirect Costs

Allocated $15,000 $15,000

Maintenance$30,000

AssemblyDirect Costs

$70,000

FinishingDirect Costs

$50,000

56Direct and Indirect Costs

Several factors affect the classification of a cost as direct or indirect:

– The materiality of the cost in question– Available information-gathering technology– Design of operations– Contractual arrangements The direct/indirect classification can depend

on the choice of the cost object.

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For longer-term decisions, product costs may include upstream, manufacturing and downstream costs

For short-term decisions, only manufacturing and downstream costs may be considered

Product costs for decision making

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End of Lecture 1