Management accounting

(1)

Management accounting

M. Mongiello

AC3097

2013

Undergraduate study in

Economics, Management,

Finance and the Social Sciences

This is an extract from a subject guide for an undergraduate course offered as part of the University of London International Programmes in Economics, Management, Finance and the Social Sciences. Materials for these programmes are developed by academics at the London School of Economics and Political Science (LSE).

(2)

Dr Marco Mongiello, Programme Director (MSc Management and MSc Innovation, Entrepreneurship and Management), Principal Teaching Fellow in Accounting, Imperial College Business School.

This is one of a series of subject guides published by the University. We regret that due to pressure of work the author is unable to enter into any correspondence relating to, or arising from, the guide. If you have any comments on this subject guide, favourable or unfavourable, please use the form at the back of this guide.

University of London International Programmes Publications Office Stewart House 32 Russell Square London WC1B 5DN United Kingdom www.londoninternational.ac.uk Published by: University of London © University of London 2013

The University of London asserts copyright over all material in this subject guide except where otherwise indicated. All rights reserved. No part of this work may be reproduced in any form, or by any means, without permission in writing from the publisher. We make every effort to respect copyright. If you think we have inadvertently used your copyright material, please let us know.

(3)

Contents

Introduction

About this edition

This edition of the subject guide builds on Thomas Ahrens’s 2005 edition and its 2006 and 2009 amendments. However, many of the elements that contribute to this subject guide have changed since the previous edition was first published. In particular, the thirteenth and fourteenth editions of the Horngren et al. textbook have a slightly different approach than the previously adopted edition. The thirteenth and fourteenth editions emphasise the importance of the role of management accounting for decision making, by introducing the ‘five-step decision-making framework’. Also, the strategic relevance of many concepts and techniques is stressed more. These aspects are highlighted throughout the subject guide. My view of managerial accounting is that traditional techniques and concepts are not surpassed or made obsolete by new and more sophisticated ones, but instead are put in different perspectives and relegated to more specific uses. However, the subject of management accounting has acquired more and more strategic relevance in the management of organisations. Hence, the chapters of this edition of the subject guide are organised in a loop, whereby in the first chapters the influence of management accounting on an organisation’s strategy is introduced. In further chapters management accounting concepts and techniques are explained and, in the final chapters, the same concepts are applied in strategic contexts.

My personal approach is to stimulate your own reflection on the topics and try to relate them to your own experience, where possible.

Nevertheless, I owe a debt of gratitude to Thomas Ahrens for his invaluable work on the previous edition of this subject guide and for allowing me to keep or rephrase substantial parts of his material for inclusion in this edition. This is particularly the case in, but not limited to, some of the ‘insights’ and activities I use throughout this edition. Where parts of the previous editions have been used, though, in many cases their gist, focus and sometimes their conclusions have been changed, contributing (I would hope) to the theoretical debate on the subject.

Aims

This course is designed to equip you with the knowledge of concepts and the ability to apply techniques of management accounting, in order to be able to contribute to the success of a firm. Management accounting has evolved from being purely concerned with the recording and measurement of costs, to supporting decision makers in their daily and strategic decisions. For this reason non-financial information is included in management accounting reports, where it is used in combination with financial information to construct information that can unveil the contribution of each division, function, activity, process and procedure to the strategic achievements of a firm.

This subject guide opens by putting management accounting in its current context, i.e. as an essential function for the implementation of a firm’s strategy. Chapters 1 and 2 give particular emphasis to the role played by management accounting in the support of strategic decision making.

(8)

Chapters 3 to 7 address various costing techniques, showing their underlying logic and demonstrating their most appropriate use. These techniques enable different analyses aimed at tracing the consumption of resources back to units of products or services. The choice among them will be seen in light of the different aims that the decision makers are willing to achieve.

Chapters 8 to 10 close the loop opened in Chapters 1 and 2 with regards to the role of management accounting in strategic management. Chapter 8 will demonstrate how the concepts and techniques presented in the previous chapters can be used for advanced management practices, such as budgeting and controlling in a strategic context. Chapter 9 will explore how management accounting can enable performance evaluation aimed at supporting daily and strategic decision making. Chapter 10 brings it all together by emphasising the use of comprehensive frameworks, such as the balanced scorecard, in strategic decision making.

Learning outcomes

At the end of this course, and having completed the Essential readings and activities, you should be able to:

• critically evaluate the uses of managerial accounting information for strategic decision making in various business contexts

• select, devise and apply different types of cost allocation and explain their different roles for supporting strategic managerial decisions • design and prepare budgets and explain their use in strategic planning

and control

• design and use variances to support feedback analysis and strategic control

• discuss various approaches to performance measurement and control in various types of organisations, and devise and evaluate simple indicators of performance

• discuss the changing role of management accounting.

Why study management accounting?

Whether profit is or is not one of the key aims of an organisation, its decision makers will nonetheless be very much interested in using its resources in the most efficient way. Resources are, by definition, scarce and their efficient use is determinant for a fuller achievement of any organisation’s ultimate goals. Management accounting explores techniques and concepts to measure the use of resources and how they are linked with the production of services and products, with the aim of supporting decision making with regards to allocation of resources, design of activities, processes and procedures, evaluation of their effectiveness and proposals for their improvement. Hence, studying management accounting is relevant for any context where resources are used: for commercial firms and any type of business as much as for not-for-profit organisations, governments and charities.

Your position may require you to measure others’ performance in terms of results compared to the consumption of resources that they used. In this case you will be faced with the choices of how to allocate costs to one person’s actions or another’s. Your choices will have important effects on how people will behave in the firm, what decisions they will take, what priorities they will assume.

(9)

Introduction

Also, your organisation may be willing to measure your performance, in which case you will want to be able to discuss the methods of such measurement that may affect your pay or your promotion.

How to measure, what to measure, whom to feed with this information and when, constitutes management accounting or managerial accounting. Hence, whether or not you want to be a specialist in this field, you will

become involved in discussions of performance and the uses of resources. It is in this perspective that you should aim at acquiring management accounting knowledge and skills.

Organising your studies

This course builds on the knowledge and skills acquired in AC1025 Principles of accounting. Hence, before beginning this course, it is recommended that you go back to that learning material and refresh your memory.

The subject guide is intended to lead you through your learning of management accounting. Using your textbooks and their companion websites as tools to this end, the subject guide provides you with a

framework for your study; it contains aims and learning objectives for each topic, which should help you focus more clearly on what is expected of you in the assessment. In the subject guide I also point to the most important issues in each topic and provide some additional explanations and cross references, so that you can see the links between different topics and how they all are different faces of similar problems. My worked examples and activities are aimed at making your learning as active as possible.

Your use of the textbooks depends very much on whether you receive instruction from a teaching institution or whether you study by yourself. However, it is important to remember that under no circumstances is the subject guide meant to replace the textbooks. The reading relevant to each chapter of the subject guide is listed at the beginning of each chapter. When the Essential reading also includes journal articles, they are mostly available through the University of London Online Library.

If you are receiving regular instructions at a teaching institution I recommend that you read through each chapter of the subject guide prior to attending the relevant taught sessions. This will give you the opportunity to participate and contribute to the taught sessions more effectively. The introduction of each chapter should help you to reflect on what to expect in the remainder of the chapter. Try to read the whole chapter in one go even though this may result in a somewhat superficial overview. After attending the taught session, you should read the chapter again giving more attention to the details. It is paramount that you allow enough time to go through the activities proposed in each chapter. These are designed to elicit your reasoning and check whether you have merely understood or in fact learned a topic. Where possible, try to explain the topics to others (experts or non-experts alike); you will soon realise that by explaining a topic you will gain a fuller grasp of it.

As you receive instruction, the main role of the textbooks is to complement your learning during the taught sessions. The textbooks go into deeper details and you should combine this subject guide, the taught sessions and the textbooks to construct your own critical view of each topic and to obtain a deeper grasp of specific concepts and techniques. As per the subject guide, I would recommend that you read the relevant textbooks’ material prior to and after the respective taught sessions. Also, I recommend that you use the textbooks’ companion websites.

(10)

If you study by yourself, this subject guide, the textbooks, the companion websites and the other readings are your main source of knowledge. In the same way as indicated above, I recommend that you read a whole chapter of the subject guide in one go. The introduction of each chapter should help you to reflect on what to expect in the remainder of the chapter. After that, go to the textbooks and read the relevant chapters alongside the subject guide, which is intended to help you navigate through them. It is paramount that you allow enough time to go through the activities proposed in each chapter of the subject guide. These are designed to elicit your reasoning and check whether you have merely understood or in fact learned a topic. Where possible, try to explain the topics to others (experts or non-experts alike); you will soon realise that by explaining a topic you will gain a fuller grasp of it.

You should combine this subject guide, the textbooks and other suggested reading to construct your own critical view of each topic. Make sure you understand the logic of the learning objectives at the beginning of each chapter of the subject guide and those of the textbooks. From the combination of the Essential reading textbooks you will obtain a deeper grasp of specific concepts and techniques. As you read, try to relate the text to the learning objectives for each chapter. The textbooks’ companion websites are an invaluable source of interactive learning material, which I recommend you use immediately upon completing a chapter. Finally, go over the summaries in the margins again and make sure they still make sense! Attempt immediately a few exercises provided at the end of each chapter, given that practising is a very effective way of complementing your learning. Leave a few exercises for one or two days after, to consolidate your learning.

Especially if you study by yourself you should benefit from the fact that both the subject guide and the textbooks, though in different ways, take a holistic approach to the subject of management accounting. Although topics must be presented in separate chapters, they are interrelated, as pointed out both in the textbooks and in the subject guide. In particular, one of the textbooks refers to a five-step decision-making framework, which brings all topics together, as they are all aimed at supporting decision making. An example in the subject guide is activity-based costing (ABC), which has its own chapter (Chapter 6), but is referred to also in Chapters 8 and 10, where the technique is applied in a more strategic context. The advantage of this holistic approach is that it explains the relevance of certain techniques in relation to different ideas within management accounting. Therefore, if you seek to find out more about a particular topic or technique, first consult the glossary and then the index. Follow up the references from the index to find out about the different ideas in relation to which a topic or technique is explained.

It is helpful to look back regularly to the earlier chapters of the subject guide, in order to refresh and reinforce your understanding of the earlier topics. Also, it is a good idea to follow up some of the references provided in the textbooks together with the suggestions for further reading which are given in this subject guide. Once you have started to study you will be able to evaluate how long it should take you to proceed further and to completion. Allow enough time to fully cover lecture preparation, organisation of lecture notes after the lecture (if you are in a taught programme), reading in the guide, the Essential reading textbooks, Further reading and exercises.

(11)

Introduction

Essential reading

Horngren, C.T., S.M. Datar and M.V. Rajan Cost accounting: a managerial

emphasis. (Harlow: Pearson Education, 2012) fourteenth edition

(international) [ISBN 9780273753971].

This textbook provides plenty of examples. In fact, it is mostly based on case studies. I recommend that you have exclusive access to this textbook’s contents (including its companion website), at least for the period of time when you are preparing for this course. You can use either the current fourteenth or the previous thirteenth edition. However, the changes introduced in the thirteenth edition are meaningful and make the previous editions obsolete.

Drury, C. Management and cost accounting. (London: Cengage, 2008) seventh edition [ISBN 9781844805662].

This textbook provides comprehensive insights into the theory behind methods and techniques. I recommend that you have exclusive access to this textbook’s contents (including its companion website), at least for the period of time when you are preparing for this course.

Mongiello, M. International financial reporting. (BookBoon.com, 2009) first edition [ISBN 9788776814243].

This text will help you to recall to your memory some concepts of financial accounting and the value of accounting information that are fundamental for your understanding of management accounting. The text is downloadable free of charge here: http://bookboon.com/uk/student/ finance/basics-of-international-financial-reporting

Detailed reading references in this subject guide refer to the editions of the set textbooks listed above. New editions of one or more of these textbooks may have been published by the time you study this course. You can use a more recent edition of any of the books; use the detailed chapter and section headings and the index to identify relevant readings. Also check the virtual learning environment (VLE) regularly for updated guidance on readings.

Online study resources

In addition to the subject guide and the Essential reading, it is crucial that you take advantage of the study resources that are available online for this course, including the VLE and the Online Library.

You can access the VLE, the Online Library and your University of London email account via the Student Portal at:

http://my.londoninternational.ac.uk

You should have received your login details for the Student Portal with your official offer, which was emailed to the address that you gave on your application form. You have probably already logged in to the Student Portal in order to register. As soon as you registered, you will automatically have been granted access to the VLE, Online Library and your fully

functional University of London email account.

If you have forgotten these login details, please click on the ‘Forgotten your password’ link on the login page.

(14)

The VLE

The VLE, which complements this subject guide, has been designed to enhance your learning experience, providing additional support and a sense of community. It forms an important part of your study experience with the University of London and you should access it regularly.

The VLE provides a range of resources for EMFSS courses:

• Self-testing activities: Doing these allows you to test your own understanding of subject material.

• Electronic study materials: The printed materials that you receive from the University of London are available to download, including updated reading lists and references.

• Past examination papers and Examiners’ commentaries: These provide advice on how each examination question might best be answered. • A student discussion forum: This is an open space for you to discuss

interests and experiences, seek support from your peers, work collaboratively to solve problems and discuss subject material. • Videos: There are recorded academic introductions to the subject,

interviews and debates and, for some courses, audio-visual tutorials and conclusions.

• Recorded lectures: For some courses, where appropriate, the sessions from previous years’ Study Weekends have been recorded and made available.

• Study skills: Expert advice on preparing for examinations and developing your digital literacy skills.

• Feedback forms.

Some of these resources are available for certain courses only, but we are expanding our provision all the time and you should check the VLE regularly for updates.

Making use of the Online Library

The Online Library contains a huge array of journal articles and other resources to help you read widely and extensively.

To access the majority of resources via the Online Library you will either need to use your University of London Student Portal login details, or you will be required to register and use an Athens login: http://tinyurl.com/ollathens The easiest way to locate relevant content and journal articles in the Online Library is to use the Summon search engine.

If you are having trouble finding an article listed in a reading list, try removing any punctuation from the title, such as single quotation marks, question marks and colons.

For further advice, please see the online help pages: www.external.shl.lon.ac.uk/summon/about.php

Examination advice

Important: the information and advice given here are based on the examination structure used at the time this guide was written. Please note that subject guides may be used for several years. Because of this we strongly advise you to always check both the current Regulations for relevant information about the examination, and the VLE where you should be advised of any forthcoming changes. You should also carefully

(15)

Introduction

check the rubric/instructions on the paper you actually sit and follow those instructions.

This course is examined by a written unseen examination which lasts for three hours 15 minutes (including 15 minutes of reading time). There are two sections. Section A contains four questions which require the use of calculations to answer the questions. Section B has essay questions. There are four questions in each section. Candidates must answer at least two questions from Section A, one question from Section B and one other from either section. All questions carry equal marks, 25 in total. Where the questions require you to answer different parts, the relative weighting of marks is given. Typically, those questions which ask you to perform calculations also ask you to interpret your results in a later part. Some of the essay questions may give you a further choice of two questions. At the end of each chapter in the subject guide you will be given one or two sample questions. Note that the questions cannot usually be answered with reference to only one chapter in the subject guide, but will require you to integrate the material with other chapters, textbook and journal article reading, and also with other subjects, such as AC1025Principles

of accounting.

The Examiners’ commentaries contain valuable information about how to approach the examination and so you are strongly advised to read them carefully. Past examination papers and the associated reports are valuable resources when preparing for the examination.

Past examination papers and commentaries are available online but you should be aware that the syllabus and subject guide were revised for 2012 and bear this in mind as you look at past examination papers. You should also consult the Examination section of your Student handbook.

Remember, it is important to check the VLE for:

• up-to-date information on examination and assessment arrangements for this course

• where available, past examination papers and Examiners’ commentaries for the course which give advice on how each question might best be answered.

Changes to the syllabus

The material contained in this subject guide reflects the syllabus for the year 2013–2014. The field of accounting changes regularly, and there may be updates to the syllabus for this course that are not included in this subject guide. Any such updates will be posted on the VLE. It is essential that you check the VLE at the beginning of each academic year (September) for new material and changes to the syllabus. Any additional material posted on the VLE will be examinable.

Abbreviations

Following is a list of abbreviations that you may encounter in this subject guide and in the readings for this course.

ABC activity-based costing ABM activity-based management AVCO average cost

CVP cost-volume-profit analysis EVA® _{economic added value}

(16)

FIFO first in, first out IRR internal rate of return JIT just-in-time inventory system LIFO last in, first out

NPV net present value

R&D research and development ROI return on investment TOC theory of constraints

(17)

Chapter 1: Management accounting and its strategic context

Chapter 1: Management accounting and

its strategic context

Aim

The aim of this chapter is to clarify the importance of the management accounting function in organisations, in light of their business model and strategy. This entails exploring the role of the management accountant in organisational practice.

Learning outcomes

By the end of this chapter, and having completed the Essential readings and activity, you should be able to:

• distinguish between financial accounting, management accounting and cost accounting

• discuss the importance of the management accounting function for the strategic success of an organisation

• use the value chain framework for classifying and analysing dimensions of performance according to its functions

• discuss the challenges and role of management accountants in an organisation’s decision-making process.

Essential reading

(international) [ISBN 9780273753971] Chapter 1.

Drury, C. Management and cost accounting. (London: Cengage, 2008) seventh edition [ISBN 9781844805662] Chapter 1.

Mongiello, M. International financial reporting. (BookBoon.com, 2009) first edition [ISBN 9788776814243]. Free from: http://bookboon.com/uk/ student/finance/basics-of-international-financial-reporting

Introduction

The basic concepts and terms of management accounting have been introduced in AC1025 Principles of accounting.In particular, Chapters 8 to 14 of that subject guide should provide you with an initial framework to place management accounting into the context of the modern business environment and the provision of information. It is strongly recommend that you go back and revisit this learning material prior to proceeding with this chapter.

This chapter aims at developing the subject of management accounting by explaining in more detail how management accounting supports and contributes to the strategic achievements of an organisation. This chapter should help you to get the best out of Chapter 1 of Horngren et al. (2012), the related online learning material provided in the textbook’s companion website www.myaccountinglab.com, and Chapter 1 of Drury (2008) and the related online learning material provided in the companion website www.drury-online.com. I also recommend that the free ebook International

financial reporting is read in conjunction with this guide (see Essential

reading). This will provide you with an essential overview of the main concepts and terms of financial accounting and the interpretation of corporate accounts, which you should combine with your learning from

AC1025 Principles of accounting.

As a starting point it is worth reflecting on the fact that management accounting builds on financial accounting information, as it requires measurements and records of business transactions from diverse sources, such as creditor and debtor records, the payroll, the fixed asset inventory and other records. In addition, management accountants can create additional ad-hoc and ‘notional’ (or ‘figurative’) accounting information; for example, by calculating opportunity costs for the use of capital. Imagine two companies which belong to the same group and provide similar services to two different geographical areas. Assume that they provide similar output levels, with one company using twice as much working capital (debtors, inventory, cash) as the other. In terms of reported profit, based on financial accounting records, these two

companies are very similar. However, the company that produces its results using less working capital is more efficient and most likely more profitable, too. Management accountants may therefore decide to include a notional

(19)

or figurative interest charge on working capital when calculating the financial contribution of the companies. This incentivises the CEO of each company to be economic with working capital; for example, by seeking to minimise the cash operating cycle.

Accounting and organisational strategy

Management accounting produces information for internal decision makers, as opposed to the aim of financial accounting, which is to satisfy the informational needs of external stakeholders. Hence, management accounting information must mirror the strategic relevance of the decisions it is aimed at supporting. It must reach the decision makers to facilitate the decision-making process, and it must contain adequate detail to allow an informed decision. Therefore, while the production of management accounting information should not cause damaging delays to the decision-making process, the decision makers should also be confident in their ability to evaluate alternative scenarios and all foreseeable

consequences of their decisions, before making them.

Management accounting and its importance to the decision-making process is well addressed in Horngren et al. (2012), with reference to the ‘five-step decision-making process’ introduced on p.35 and used throughout the other chapters; the idea is that managerial accounting is aimed at producing and communicating information that is relevant to managerial decision making.

Management accounting is therefore much more detailed and potentially much more varied than financial accounting because it is supposed to respond to specific information requests rather than follow the general reporting standards that are valid for different types of organisations. Refer to Exhibit 1-1 of Horngren et al. (2012) for a summary of these aspects. This is not to say that all management accounting reporting is ad hoc. However, this information is usually tailored around the specific strategic priorities of an organisation. For a better understanding of this concept, refer to the value chain framework and the Coca-Cola supply chain analysis example (Exhibits 1-2 and 1-3, Horngren et al., 2012). In both cases reflect on how the management of each part of the value chain and the supply chain can benefit from ad hoc information. For example, when managing ‘research and development’ it is probably useful to know the amount of resources that have been allocated to each research project, and how these resources should be conveniently split between human resources (e.g. scientists, skilled workers, unskilled workers, consultants, etc.), raw materials and other rights (e.g. licences to use others’ intellectual property). Look at the ‘design of products, services or processes’ and reflect on how the same categories of costs are likely to change in proportion to each other. For example, at the design stage it is likely that less scientists and more skilled workforce will be used than at the stage of ‘research and development’. What about raw materials? How will this change again to consider the next stage of ‘production’?

Refer now to Drury (2008, pp.5–21) to consolidate your knowledge. Activity 1.1

Apply the concept of a value chain to any familiar production process and reflect on what categories of costs would apply to each phase (or ‘part’ in Horngren et al.’s terminology) of the value chain. Repeat the same exercise with another familiar production process and compare the two, phase by phase. It should be possible to draw some conclusions based on the strategic relevance of each phase in different contexts. The exercise is particularly

(20)

interesting when reflecting on firms that are operating in similar conditions but clearly have different strategic goals, for example, one firm’s main key success factor is being innovative, whereas the other firm’s main key success factor may be increasing efficiency to facilitate lower prices. Refer to Insight 1.1 for supporting information about different strategies. This activity can be enhanced by obtaining the annual reports of the firms previously considered and discovering some information about the firms’ respective focus in the allocation of their resources.

Upon completing this activity, refer to pp.33–34 of Horngren et al. (2012) for a list and explanation of typical key success factors.

Insight 1.1

A useful digression on strategies

(adapted from the 2011 subject guide)

The relevance of managerial accounting information for strategic decisions depends on the firms’ different strategies.

Two ‘generic’ strategies that are frequently distinguished are ‘price leadership’ and ‘differentiation’. ‘Price leadership’ implies low prices combined with a standardised offering. The strategic effort goes into developing a customer proposition that appeals to large numbers of customers and can be provided at low cost. Product variation or even tailoring products to individual customers’ wishes is then not usually part of the product offering. Budget airlines are an extreme example of this strategy.

By contrast, ‘differentiation’ emphasises the satisfaction of individual customers’ wishes as closely as possible, be it with respect to quality of manufacture, ease of use, flexibility of application or delivery, product variety, reliability, pre-sale and after-sale assistance or any combination of these. An example would be luxury motor vehicle manufacturers. Product cost is also a concern for organisations that pursue this strategy, but not to the same extent as for those that pursue price leadership.

Even though the academic literature on strategy often portrays price leadership and differentiation as strategic opposites, in practice there is usually a combination of both; for example, in the various markets for electronic consumer goods. There are different reasons for this. In large organisations some divisions may tend towards one strategy and some towards the other. During their life cycle, certain products may start out as differentiated products that are tailored towards the high price segment (perhaps because they are innovative), and later they may be marketed to compete mainly on price (perhaps because many competitors have entered this market, production volumes have increased and high quality is no longer a differentiating factor).

Accounting information and decision making

All the managerial accounting information reviewed by reading these first pages, and by completing Activity 1.1, should be useful for decision making, i.e. for (i) identifying problems and uncertainties, (ii) obtaining information, (iii) making a prediction about the future, (iv) making a decision by choosing among alternatives and (v) implementing the decision, evaluating the performance and learning. These steps make the ‘five-step decision-making process’ as introduced in Horngren et al. (2012, p.35) and Drury (2008, p.8). I recommend you refer to both framework explanations as this will elicit your critical view of the concept.

Also, the managerial accountant is bound to make decisions with regards to what accounting information to produce and how to do so. During this process three main guidelines should be followed. The first one is the cost-benefit approach, which requires that the information’s added value must be compared with the cost of producing that information prior to deciding to produce it. For example, acquiring and installing certain information

(21)

management systems, such as SAP,1_{may provide an enormous wealth of}

information. However, the required amount of data that must be traced, recorded and inputted to feed these systems may be disproportionate in comparison with the benefits of the information returned.

Behavioural and technical considerations make the second

guideline. Accountants should consider who is going to supply the accounting system and use its information. Consideration must be given to the corporate culture and to the culture of the region where the firm is based and operates. For example, regional attitudes to recording can differ, similarly the concept of how much tolerance should be allowed for approximation may differ. Moreover, different people may present various degrees of technical preparation and reliability; hence, different training efforts and control procedures must be put in place in order to ensure that data are recorded to the required specifications.

Finally, managerial accountants must always be aware that different

costs should be produced for different purposes. An example

of this is how information is aggregated in different categories according to the type of decision that it sought to be supported. Products’ revenues and related costs can be segmented geographically, when the decision maker is evaluating the allocation of regional marketing. However, when the decision maker is considering re-engineering the production of a pool of products, then revenues and costs will be segmented according to the production lines or the firm’s functions instead. We will address this matter more closely in various chapters of this subject guide: in Chapter 3 costs will be allocated according to their behaviour; in Chapter 4 costs will be allocated according to their contribution to the overall life of the products; in Chapters 5 and 6 the cost per unit of product or service will be calculated using different methods; finally in Chapters 7 and 8 those costs per unit will be used for different purposes.

In this subject guide the assumption has been made that managerial accounting is of strategic relevance for the reasons highlighted above, which will also be more widely explored later. However, it is noteworthy that management accounting, as a subject and in practice, has reached this point as the result of many years of development. To this end Insight 1.2 and Drury (2008, p.20) provide a short compendium of the developments of managerial accounting in the last three decades.

Insight 1.2

Strategic management accounting

(adapted from the 2011 subject guide)

In the 1980s management accounting and accountants were criticised for their failure to recognise organisations’ new strategic priorities (Johnson and Kaplan, 1987), and this decade produced many of the initiatives that make management accounting more strategically relevant today. The reproach was that management accounting was in fact dominated by financial reporting requirements and took no account of what decision makers wanted to know. For example, standard costing systems allocated overhead costs to products that were not causing them, and standard costs were updated so infrequently that the changes in the design and manufacture of these products quickly made them obsolete. One of the attempts to correct the shortcomings of traditional standard costing systems (see Chapter 5) was activity-based costing (ABC), which sought to allocate manufacturing overheads depending on the manufacturing activities that were caused by a product, and which is the subject of Chapter 6. A more general suggestion to enhance the managerial relevance of management accounting was Simmonds’ (1981) concept of strategic management accounting. It focused on the incorporation of marketing

1_{Refer to www.sap.com}

for details about this product.

(22)

knowledge into management accountants’ roles. A study by Roslender and Hart (2003) suggested that even though the term ‘strategic management accounting’ itself was not common in practice, on the whole, the management accountants whom they studied could be said to hold more strategic roles then, than they had in the past.

Studies of the role of the management accountant in organisational management in different countries have found that commercially aware and active management accountants distinguish commercial involvement from the old ‘bean counter’ mentality (e.g. Friedman and Lyne, 1997). By ‘bean counting’ they meant an overriding concern with administration, record keeping and elementary financial reporting work. In terms of the classic distinction between the roles of the management accountant – namely, record keeping, attention directing and problem solving – this implies a shift in emphasis from the first to the last two.

If the calls for greater strategic relevance have been an important criticism that led to conceptual changes within management accounting, an important facilitator of those changes has been the technical advances in information technology. Contemporary accounting and information systems are significantly more powerful and easier to operate than they were only a few years ago.

Generally speaking, it is now easier to extract information from the systems that are used in organisations. Management accountants can offer information that is better tailored to answer the questions of managers. In some cases, managers can now directly access information. As a consequence, less effort is needed on the part of management accountants to administer information systems and serve simply as mediators between an organisation’s management and its information systems. There is now the potential for management accountants to become much more actively involved in management decision making.

Management accountants in their organisations

A management accountant may cover a number of different technical or strategic positions. Technical positions span from more basic positions (main responsibilities would include inputting data in order to produce relevant management accounting information) to more advanced positions (main responsibilities would include determining what data to input, how to elaborate upon it and deciding what information is relevant for whom, and for what purpose).

The responsibilities may be wider at a more strategic position, such as finance director (also called chief financial officer – CFO) or controller (also called chief accounting officer – CAO). These are executive positions where management accountants are expected to deploy their technical and strategic skills to the extent that they have a significant input in determining their firms’ major decisions.

Most commonly, management accountants are expected to contribute to planning, controlling and performance evaluation. Senior management accountants, who are involved in any of those three roles, need an extensive knowledge of the operations of the organisation they work for. In this way they will be able to recommend to the top management courses of action that fulfil their strategic goals. Gaining experience in various roles within the organisation or in other organisations will be essential for you to be able to convincingly discuss strategic decisions with the top management.

More specifically, the greater proximity the role has to the CFO, the more responsibility and influence it will have on treasury, risk management, tax planning, investor relations, internal audit and overall control.

The strategic relevance of management accounting is represented by its ability to support the management in taking strategic decisions, which include the definition of the organisational strategy. Management accountants collaborate with the organisation’s managers in preparing

(23)

alternative scenarios and evaluating different possible courses of actions. For example, the management accountants can calculate the cost implications of design choices and factor in the revenue that can be expected from new product attributes (e.g. style, durability, multi-functionality, etc.). With a similar perspective, using ABC and management, the management accountant can provide valuable information with respect to each activity’s added value. A strategic view will be required to evaluate the activities’ respective added value, provided that an activity can be equally valuable or wasteful according to its contribution to the firm’s fulfilment of its strategic goals. For example, an activity aimed at improving the quality of service above and beyond the minimum necessary may be wasteful in a budget airline and highly valuable in a luxury airline.

Management accountants must reflect on the ethical implications of their job, which implies also addressing the question of to whom they respond with their actions and decisions. Management accountants respond to the owners along with many other organisational stakeholders. The social environment of an organisation is much wider than just its owners, employees and customers. Creditors, competitors, other organisations, neighbours and suppliers may be equally affected by the decisions taken in an organisation. For example, manufacturing firms are accountable to the wider community for their contribution to the external environment pollution and safety. All firms are accountable for spreading good commercial practices and providing sound advice to clients in a way that contributes to the overall economic system’s stability. Universities can be held accountable by students, parents and the wider scientific, business and social communities. Hospitals are subject to the concerns of patients, their relatives, the professional associations of doctors, the government’s drug regulators, etc. Overall, these concerns go under the name of corporate social responsibility and constitute a pillar of contemporary firms’ strategies for survival and success.

Typically, production engineers and marketing managers tend to have different views of where the priorities are and what solutions are most appropriate. Both groups have incentives to depict particular organisational problems in ways that emphasise certain aspects rather than others and will more or less consciously bias the information that they provide to management accountant.

If you reflect on the meaning of the term ‘organisational goals’ you will realise that these are in fact the aggregate of the goals of individual organisational members, which may well be conflicting goals. The implications for the role of management accounting in decision making are profound. When producing management accounting information, should the management accountant factor in that their choices may favour the view of one or another member of the organisation? The management accountant will have to invoke not only their technical abilities but also their ethical principles.

A reminder of your learning outcomes

Having completed this chapter, and the Essential readings and activity, you should be able to:

• distinguish between financial accounting, management accounting and cost accounting

• discuss the importance of the management accounting function for the strategic success of an organisation

• use the value chain framework for classifying and analysing dimensions of performance according to its functions

• discuss the challenges and role of management accountants in an organisation’s decision-making process.

Sample examination question

Explain what differences you would expect to find in the management accounting information of two pharmaceutical firms, of which one (My Drugs Plc) has a strong focus on innovation driven by internal research and the other’s (Their Drugs Plc) business model is to widely distribute drugs invented by other firms. My Drugs Plc invents and produces highly specific drugs for use in hospitals and clinics. Their Drugs Plc searches the market for small producers of generic drugs with high market potential to be distributed to the wide market. Both My Drugs Plc and Their Drugs Plc package the drugs that they sell using their own brands. My Drugs Plc also delivers the drugs to its clients, whereas Their Drugs Plc outsources all deliveries.

(25)

Chapter 2: Decision making

Aim

The aim of this chapter is to lay the foundations of management accounting theory and practice. In particular, this chapter will link management accounting concepts and tools to the ‘five-step decision-making process’ presented in Horngren et al. (2012) and the decision-making planning and control process presented in Drury (2008), showing their strategic use in practice.

Learning outcomes

By the end of this chapter, and having completed the Essential readings and activities, you should be able to:

• apply an effective decision-making process to make decisions

• distinguish relevant from irrelevant information for decisions, including sunk costs and opportunity costs

• solve resource allocation problems in situations of capacity constraint and choices between products

• discuss the effects of performance evaluation for managerial control purposes.

Essential reading

(international) [ISBN 9780273753971] Chapter 11, pp.412–28.

Drury, C. Management and cost accounting. (London: Cengage, 2008) seventh edition [ISBN 9781844805662] Chapters 2 (pp.34–37), 9, 12 and 25 .

Introduction

Managerial accounting was derived for the purpose of supporting managers in making decisions. Decision-making processes have been introduced in Chapter 1, and in this chapter we will explore the concepts of relevance of both costs and revenues in a decision-making context and how different types of information influence the process.

Managers take decisions at all levels of an organisation. At the highest level, managers define the strategy of their organisation by identifying its ultimate goals and developing long-term plans to achieve them. Implementing such strategies requires managerial control, i.e. the translation of long-term plans into detailed short-term action plans. At an even more detailed level managers must take operational decisions, which entail putting procedures and controls in place. These go under the name of operational control

(26)

Decisions taken at any level may often have strategic relevance. This is more obvious when an organisation is defining strategy, and less obvious when implementing operational procedures. However, the consequences of implementing the wrong procedure may have serious implications for the realisation of an organisation’s strategy. For example, a systematic mistake in the production process may damage the customer’s satisfaction, and may consequently compromise loyalty and damage the entire customer relationship. Alienating customers may well act as an obstruction to the realisation of an organisation’s strategy. As a consequence, a lack of managerial control at an operational level could have a direct impact at a strategic level.

Activity 2.1

Reflect on the various roles that you have assumed or you expect to assume when working for an organisation. How do you define the progress in your expected career? Most likely you will refer to the breadth and scope of the decisions that you will be expected to take and how they will affect the organisation.

Now reflect on the amount of information that you will require in order to take informed decisions throughout your career and on the increasing importance for this information to be useable for your decision purposes.

It is important that managers are supported with useable information whether they are defining strategic goals, performing managerial control or setting operational procedures and controls. Management accounting is aimed at providing managers with information that is relevant to their decisions across all these levels. This entails avoiding information deluge (overloading the managers with redundant information) and instead providing meaningful results from the analysis of data. For example, at the highest level of decision making, when managers are considering whether to concentrate the organisation’s presence in a market segment or to abandon it, managerial accounting should provide them with reliable estimates of the current profitability of that segment and a range of its possible variations in the future. More detailed information about every single product, customer or distribution channel may prove redundant. Furthermore, at the managerial control level, when managers are considering outsourcing the production of a component, management accounting will have to provide them with the actual and opportunity costs, as well as the potential savings which would emerge from such a choice. More details about the variable costs and contribution margin of each product may prove overwhelming and confusing. With another example, managerial control implies checking that each department performs the required activities within their respective budgeted costs and achieving the forecasted revenues; management accounting must provide the managers with the overall costs and revenues per department. The specific cost of each component or the exact number of hours spent in the provision of a service may be redundant.

Finally, at the operational level, information needs to be very specific and match the budget guidelines; for example, when deciding if it is worth purchasing a larger amount of a certain component in order to be entitled to a certain trade discount, or if it is worth making a payment ahead of the negotiated term, in order to be entitled to a cash discount, the manager taking these decisions should be provided with the threshold cost of capital calculated for the organisation. Providing them with a wider wealth of information may render the decision-making process more costly than beneficial.

Management accounting