CHAPTER 1 MANAGEMENT ACCOUNTING: AN OVERVIEW Management Accounting Definition Management Accounting involves the application of appropriate techniques and concepts to economic data so as to assist management in establishing plans for reasonable economic objectives and in the making of rational decisions with a view toward achieving these objectives. It is the process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of financial information, which is used by management to plan, evaluate and control activities within an organization. It also comprises the preparation of financial reports for nonmanagement groups such as shareholders, creditors, regulatory agencies and tax authorities. Objective and Scope Objective Management accountants are concerned with providing information to managers, ete inside an organization who direct and control the operations. ee ae of reports. Some reports focus on how well managers Feit undetes ie hve performed while other reports provide timely and aad, n key indicators, analysis of business situation or opportunity ‘4’ reports that are needed to investigate specific problems. Manageme process of maneay nas at appropriate levels are involved actively in the and operating, eee entity. The process includes making strategic, tactical organization, ‘The ns and helping to coordinate the efforts of the entire : ‘anagement accountant participates, as part of management, in assuring that the mn . intermediate any OrBsnization operates as a unified whole in its long-run d short-run best interests.4 Chapter! Scope cone is concerned primarily with providing information to eee are charged with planning and controlling the operations irm and making a variety of management decisions. Generally, management accountants do the following tasks: (a) Scorekeeping or data accumulation which enables both internal and external parties to evaluate organizational performance and position. (b) Interpreting and reporting of information that helps manager to focus on operating problems, opportunities as well as inefficiencies. This is commonly associated with current planning and control and the analysis and investigations of recurring routine internal accounting reports to signal situations in which management action may be required. (c) Problem-solving or quantification of the relative merits of possible courses of action as well as recommendations as to the best procedure. This is commonly associated with non-recurring decisions. Specifically, the management accountant provides a system which allows management to receive the necessary information used in performing its administrative functions of: (a) planning which involves setting of goals for the firm, evaluating the various ways to meet the goals and picking out what appears to be the best way to meet the goals; (b) controlling which involves the evaluation of whether actual performance conforms with planned goals; and (c) decision making which involves determination of predictive information (e.g. relevant costs) for making important business decisions PLANNING A key activity for all companies is planning. Planning involves identifying alternatives and selecting a course of action and specifying how the action will be implemented to further the organization's objectives. The plan communicates a company’s goals to employees and specifies the resources needed to achieve them. The plans of management are often expressed formally in budgets. Cash budgets, capital budgets, and projected statements of financial position are examples of contributions whichManagement Accounting: An Overview 5 anting can make in resource planning while break-even analysis, projected F come statements are examples of useful tools in profit planning. CONTROL Control of organizations is achieved by evaluating the performance of vogers and the operations for which they are responsible. ‘The distinetion between evaluating managers and evaluating the operations they control is important. Managers are evaluated to determine how their performance Should be rewarded or punished, which in turn motivates them to perform at a high level. Based on an evaluation indicating good performance, a manager might receive substantial bonus compensation. An evaluation indicating a manager performed poorly might lead to the manager being fired. In part because evaluations of managers are typically tied to compensation and promotion opportunities, managers work hard to ensure that they will receive favorable evaluations. Cost variance analysis, financial statements analysis, gross profit variance analysis are some of the accounting control reports used to inform managers when activities which are part of their responsibility are deviating from the plan, The reports used evaluate the performance of managers and the operations they control are referred to as performance reports. Although there is no generally accepted method of preparing a performance report, such reports frequently involve a comparison of current period performance with performance in a prior period or with planned (budgeted) performance. Performance reports may not provide definitive answers, but they are still extremely useful. Managers can use them to “flag” areas that need closer attention and to avoid areas that are under control. It would not seem necessary, for example, to investigate labor, rent, depreciation, or other Sie because these costs are either equal to or relatively close to the eee ate e cost. Typically, managers follow. the principle of anges iveetion when using performance reports. This means that they'do not ee departures from the plan that appear to be exceptional; gate minor departures from the plan. Operations are eval ; uld be change; An eval aie the man; uated to provide information as to whether or not they (.e., expanded, contracted, or modified in some way). luatioy i i n Of an operation can be negative even when the evaluation of : . Ber responsible for the operation is basically positive.6 Chapter 1 Company plans often play an important role in the control process. Managers can compare actual results with planned results and decide if Corrective action is necessary. If actual results differ from the plan, the plan may not have been followed properly, the plan may have not been well thought out, or changing circumstances may have made the plan out of date. Figure 1.1 presents the major steps in the planning and control process. Once a plan has been made, actions are taken to implement it. These actions lead to results, which are compared with the original plan. Based on this evaluation, managers are rewarded (e.g., given substantial bonuses or promoted if performance is judged to be good) or punished (e.g., given only a small bonus, given no bonus, or even fired if performance is judged to be poor). Also, based on the evaluation process. operations may be changed. Changes may consist of expanding (¢.g., adding a second shift), contracting (e.g., closing a production plant), or improving operations (e.g., training employees to do a better job answering customer product inquiries). Changes may also consist of revising an unrealistic plan. Figure 1.1. Planning and Control Process Cr» > Decisions to change Action taken to [>] operations or revise plans implement plan Results ¥ Decisions to reward or Comparison of planned : punish managers and actual resultsKe Management Accountil vung serves management at all stages of the management nee objectives and so on up to the feedback of the formulation 0} ‘ formation which in turn helps in the reformulation of Thus, accou! rocess. from performance in objectives: DECISION MAKING As indicated in Figure 1-1, decision, making is an integral part of the planning and control process ~ decisions are made to reward or punish managers, and decisions are made to change operations or revise plans. Should a firm add a new product? Should it drop an existing product? Should it manufacture @ component used in assembling its major product or contract with another company to produce the component? What price should a firm charge for a new product? These questions indicate just a few of the key decisions that confront companies. And how well they make these decisions will determine future profitability and, possibly, the survival of the company. Recognizing the importance of making good decisions, we will devote all of Chapter 19 to the topic. In summary, the management accountant develops cost management information for the Chief Financial Officer, other managers and employee teams to use to manage the firm and make the firm more competitive and successful. Comparison of Financial Accounting and Management Accounting Financial accounting involves the systematic recording of business transactions, governed by a body of international finaicial reporting standards (IFRS) leading to the preparation of finan te cial statements for the use of various i i internal as well as external. oe Management accounti iccounting is i ‘ areas persons within the orens concerned with providing financial information to effective devicens panieation to enable them to make informed judgments and which further the organization's goals : Figure 1.2 summarizes the signi | Managers the significant differences between Financial Accounting paragraphs unting. ‘These differences are discussed in the followingL ._compter 1 _— eae differences between Financial Accounting (FA) and Managemen c dil scifi Te in (MA) are as follows: 1, Asto objective FA: To provi users (@-2- © MA: To provide data for organization. oth internal (management) and. external de data for b overnment, etc.). editors, Owners, 8 internal users within the busi business is aimed primarily at external users accounting information, whereas managerial accounting is oa primarily at internal users. External users include investo, creditors, and government agencies, which need information to sh investment, lending and regulation decisions. Their informati e needs differ from those of internal managers, who need ingens for planning, control, and decision making. ton Financial accounting 2. As to compliance with International Financial Reporti (ERS) porting Standards FA: Financial data should be recorded i ae and presented in accordance MA: Reports need not be presented i i in conformity with I able to present more useful data to ee ee mu ole Anancia accounting information is required. The ne seaihcaae Commission (SEC) requires large, publicly ae Never reports in accordance with intemational eee (hae: andards (IFRS). Even companies that are not fens ate zon Ae the SEC prepare financial accounting heeatates cordance with IFRS to satisfy creditors stresses itformation the on the other hand, is completely optional. !t sonol aid denice He . useful to internal managers for planning that deviating Ase ee Ifa managerial accountant believes fice ene will provide more useful information © gers, IFRS need not be followed. 3A S ' emphasis on the future A: Thi i S primarily i i “ reer provides summaries of past finat MA: Thi . 1) Shas a strong future orientation.‘Management Accounting: An Overview 9. ing is pri i ting the es ounting is primarily concerned with presen Fane vast transactions. Managerial accounting, on the other nil ies considerable emphasis on the future. As indicated, ee iy one of the primary purposes of managerial accounting is Pye iets. managerial accounting information often involves Pate of the costs and benefits of future transactions. e 4, Asto the relevance and flexibility of data FA: All-purpose reports with historical data are prepared for use of different parties. MA: Special reports containing both historical and projected data : are prepared to meet the needs of specific users. They contain information, quantitative and qualitative, that are relevant for a particular decision. Both managerial and financial accounting reports generally contain monetary information (information expressed in pesos such as revenue and expense). But, managerial accounting reports can also contain a substantial amount of nonmonetary information. The quantity of material consumed in production, the number of hours worked by the office staff, and the number of product defects are examples of important nonmonetary data that appear in managerial accounting reports. Also, financial accounting presents information in a_ highly summarized form. Net income, for example, is presented for the company as a whole. To run a company, however, managers need more detailed information — for example, information about the cost of operating individual departments in addition to the cost of operating the company as a whole. 5. As asis i Sto emphasis on precision and timeliness of report FA: Reports are still useful even Summaries of financial activities Where precision i if submitted late and show consequences of actual and past s required. MA: imeline: fi pI n to managers. less is often more import i ant than precisio1 anag Prompt submission s of the report is necessary to preserve its ry st Usefulness and good estimates may be enough to make good gh te goo10 Chapter 1 6. As to reporting requirements of an organization FA: This is primarily concerned with reporting for the company as a whole. MA: This focuses reporting on the parts or segments (i.¢., product line, sales, territories, divisions, departments) of the company. 7. As to requirement for compliance with law FA: This is required by law as exemplified by the report requirements of the BIR, SEC and other governmental entities. MA: This is not mandatory Similarities Between Financial and Managerial Accounting The differences between financial accounting and managerial accounting in terms of their respective user groups should not be overemphasized. Financial accounting reports are aimed primarily at external users, and managerial accounting reports are aimed primarily at internal users. However, managers also make significant use of financial accounting reports, and external users occasionally request financial information that is generally considered appropriate for internal users. For example, creditors may ask management to provide them with detailed cash-flow projections. A comparison of financial and management accounting is shown in Figure 1.2. Relationship between Management Accounting and Cost Accounting Cost accounting is a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in detail. It includes methods for recognizing, classifying, allocating, aggregating and reporting such costs and comparing them with standard costs. Management accounting is a newer interest of cost accounting. Its purpose is to provide managers with information which aids decision. There are no generally accepted principles which specify how management accounting information is to be reported. While systems such as direct costing and standard costing exist in management accounting, each accounting report should be tailored to the needs of the decision and the decision maker. The most effective systems result when the manager-decision maker and the accountant work together until the accountant understands the decision to be made-and the manager understands the source of information that the accountant will report.ee Fi gure 1.2. Financial Management Accounting: An Overview Accounting Financial Accounting Reports to various interested parties (external and internal): Owners Lenders Tax authorities Regulators Managers external ——» internal Emphasis is on summaries of financial consequences of past activities. Objectivity and verifiability of data are emphasized. Precision of information is required. Only summarized data for the entire organization are prepared. Must follow IFRS, Mandatory for external reports, Recording + Organizing © Summarizing Reporting il 1 Accounting and Management Accounting Compared Financial and Operational Data Management Accounting Reports to managers within the organization for: Planning Directing and motivating Controlling Performance evaluation Emphasis is on future-oriented data needed in decision-making. Relevance is emphasized. Timeliness of information is required. Detailed segment reports about departments, products, customers, and employees are prepared. Need not follow IFRS. Not mandatory,12 Chapter | BNA eee Lh et ee Activiti tivities of Management Accountants Managers of li Of line functi the organization ‘functions are concerned with the primary operating activities of performing a servi manufacturing (or buying) and selling a physical product or departments. For A staff manager manages a department that serves other operations Func ee eee manage obtain the cash to keen managers regai ee The manager of the legal department advises other garding the legal ramifications of actions. Rea J a st function, with management accountants providing tax problene er managers. Information can relate to financial statements, Problems, dealings with governmental authorities, and other matters. The management accountant, like other staff managers, often recommends courses of action to those using the information. But neither the management accountant, nor any other staff manager, can/impose recommendations on line managers. Nevertheless, because of their expertise, staff managers can influence decisions. Staff managers, like all managers, also manage their own departments. Management accountants discharge their responsibilities and achieve their objectives by organizing and implementing activities in the following categories 1. Planning — This involves quantifying and interpreting the effects on the organization of planned transactions and other economic events. The planning responsibility, which includes strategic, tactical and operating aspects, requires that the accountant provide quantitative historical and prospective information to facilitate planning. {It includes participation in developing the planning system, setting obtainable goals, and choosing appropriate means of monitoring the progress toward the goals. 2. Reporting — Reporting relates to both internal and external needs for information about past or future events and circumstances. Management accountants make available to managers timely reports that provide information and perspective necessary for them to make decisions 10 & goal- congruent manner. The reports may concern financial, physical, and human resources and the markets and regulatory environments In which entities operate. In addition to reporting internally, management accountants make appropriate information available to shareholde creditors, and governmental regulatory agencies and tax authorities.