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MANAGEMENT ACCOUNTING THEORIES

Management Accounting is a growing field in a modern businessorganization. It is seen as that aspect of accounting which supplies valuableinformation to attain a given objective.

It is accounting in the perspective of the management. TheInternal reporting functions of an accounting system is sometimes calledManagerial Accounting and it provides management with information necessary fordaily operations and also for planning in the long term.

It is also that aspect of Accounting which enables management touse accounting information for decision making, planning and controlefficiently and effectively. Management Accounting uses data from accountingsystems by conducting special investigation to gather required data, processesthe data, for the intended purposes, depending on the goals and objectives ofthe organization.

For a better and clearer understanding of Management Accounting,it is necessary to know what management means and also what accounting means.

Definition of Management

Managements concerned with managing an industry or a businessenterprise. It is concerned with the control of the activities of any businessenterprises.

Management mayperform the following functions:

  • Planning
  • Organizing
  • Directing
  • Staffing
  • Control
  • Communicating

The functions as above could be sub-divided into planning andcontrol elements as will be seen in the definition of management accounting.

Definition of Accounting

Accounting is the art or science of recording, utilizing,analyzing in a systematic manner, transactions which have monetary value andgiving interpretations to the results arrived at.

The underlying purpose of accounting is to provide financialinformation about an economic entity.

The financial information provided by an accounting system isneeded by both internal and external parties.

Internalparties i.e. management for managerial decision making and external users for investment decisionsand many more other reasons.

Definitions of Management Accounting

There are as many definitions of Management Accounting as thereare authorities in management accounting, committees, bodies and associations.

Some of thesedefinitions considered in this text are as follows:-

  • Management Accounting is a field of study, specifically designedfor cost gathering, analysis and cost reporting for the purpose of equippingmanagement with the requisite for decision making.
  • The Chartered Institute of Management Accountants CIMA definesManagement Accounting as the application of professional knowledge and skill inthe preparation and presentation of information so as to assist management inthe formulation of policies and in planning and control of the activities of aBusiness Enterprise.
  • The Terminology published by the Institute of Cost and ManagementAccountants gives the following definition,

ManagementAccounting is the provision of information required by management for suchpurposes as:

  • Formulation of polices.
  •  Planning and controllingthe activities of the Enterprise.
  • Decision Making on Alternative course of action.
  •  Disclosure to thoseexternal to the entity (shareholders and others).
  • Disclosure to employees.
  • Safeguarding Assets

The above involvesparticipating in management to ensure that there is effective;

  • Formulation of plans to meet objectives (long term planning),
  •   Formulation of short termoperations plans (budgeting/profit planning).
  • Recording of actual transactions (financial accounting and costaccounting, corrective action to bring future and actual transactions intoline).
  •  Obtaining and controllingof finance (treasure ship).
  • Reviewing and reporting on systems and operators (internal audit,management audit).

The above definitions lay emphasis on decision making, planningand control which are an embodiment of management accounting.

Purpose of Management Accounting

Management Accounting is concerned with gathering data and ,processing the data for the purposes of:

  • Formulating the policies of the organization.
  • Planning the activities of the organization in the long, mediumand short terms.
  • Controlling the activities of the organization to ensure thatplans are in conformity with what obtains in order to achieve desired result,
  • Decision making.  This isthe process of choosing between alternatives. The choice of alternatives shouldbe in line with the goals and aspirations of the organization
  • Performance  Appraisal:   This   is  the   evaluation   of performance. The result of the assessmentwill enable management to know its score card, i.e., whether it is performingwell or not.

Qualities of A Good Management Accounting Report

  1. Factual: An ideal management accounting report must be capable of being independentlyproven by the users, i.e., it must contain both quantitative and qualitativedata.
  2. Degree of Details: A good management accounting report must be conclusive in naturei.e it must be adequate for the purpose of taking a particular decision.
  3. Cost Benefit Analysis: The cost of generating management accounting report must not behigher than the benefit to be derived from the report.
  4. Timeliness:   For a managementaccounting report to be considered relevant in a particular situation    it must be presented on time, i.e, prior tothe decision at stake, information    will not serve the appropriate objective of the Organization.
  5. Method of Presentation: An ideal management accounting report must highlight the keyaspect of the report in such a way that it will be accessible to the users.This may be done through appropriate headings on paragraph method.
  6. Ambiguity: An ideal management accounting report must not include words thatare capable of different interpretation and meaning because of its implicationsto the users.
  7. Volume of Content: A good management accounting report must be explicit yet notvoluminous. It must contain adequate information and must be self-explanatoryto the user.

MANAGEMNT ACCOUNTING AS IT RELATES TO COST ACCOUNTING, FINANCIAL ACCOUNTING AND INTERNAL AUDIT

The role of Management Accounting, Cost Accounting and FinancialAccounting are related and may overlap. This has to do with the accountants’roles and the managers’ role in the organization. There are close links betweenthese two functions.

Cost Accounting and Cost Accounting methods supply the basis offactual information on which the Management Accountant builds up hispresentation of planning and control.

By the use of financial accounting techniques, data are gathered,refined and processed into necessary information for the use of management forthe achievement of a given objective. Internal Audit as part of managementcontrol system will make for effective planning control, and appraisal of thesystem to ensure conformity with the desired objectives.

Management Accounting, Cost Accounting and Financial Accountingsupply information in the light of a given objective: Such objectives mayinclude:

  1. Internal reporting to managers for the purpose of planning andcontrol of routine operations. This aspect relates to Cost Accounting as wellas management Accounting.
  2. Internal reporting to managers in  making  non-routine decisions and in formulatingmajor plans and policies.  This aspectalso relates to Management Accounting and to some extent Cost Accounting.
  3. External reporting to stockholders, government and other partiesfor use in investor decisions, income tax collections, wage negotiations,   performance appraisals, and a host of otherreasons.

As seen from the above, the first twohave to do with Internal Reporting for decision making, planning and controlprocess while the third has to do with external reporting.

Internal Reporting relates to Financial Accounting whichemphasizes the stewardship and custodial aspect of Accounting. The area isconstrained by certain accounting concepts and conventions and by otherregulation. However, internal reporting which focuses on management planningand control called

Management Accounting is less constrained than Financial Accountingbecause information provided is mostly used for internal planning and control.

DIFFERENCE BETWEEN MANAGEMENT ACCOUNTING AND FINANCIAL ACCOUNTING

ITEM OF DIFFERENCES MANAGEMENT ACCOUNTING FINANCIAL ACCOUNTING
Legal Requirements There is no legal requirement to produce and present report at the annual general meeting There is a statutory requirement for public ltd companies to produce annual financial accounts at least once in a year to be presented at the annual general meeting
Focus a. Management Accounting reports focus on individual parts or segments of the business. b. Management accounting report is futuristic a. Financial Accounting reports will describe all aspects of the business. b. Financial accounting reports focus on the present by the use of present and past information.
General accepted accounting principles Management accounting does not adhere to generally accepted  accounting principles. Financial accounting statements must be prepared in line with the  regulations of regulatory bodies such of the NASB, financial accounting Standard Board in the U.S e.t.c.
Report frequency Reports are prepared and presented to management as and when required      Annually as required by           CAMP 1990.
Regulatory Framework No regulatory framework Regulated by SAS, SSAP, FAS e.t.c.
Users of information Mainly internally by management Internally and externally by equity investor group, loan creditor group, employees group, business contact group, research analyst group, government group and the general group.

OBJECTIVES AND CONCEPTS OF COST AND MANAGEMENT ACCOUNTING

From what we haveseen from the above definitions above, we can summarize that; Theprimary objective of cost and managementAccounting is to assist planning and control functions of internal decision-makers (i.e. management).In control, financial or traditional accounting is primarily concerned with theinformation needs of external decision-makers (shareholders, loan creditors,analyst advisers, governmental authorities, the public, etc.). Reasonableaccuracy, as in an audit is enough. What is reasonable depends upon the natureof industry.                                       As arule, costing information should be collected as and when the work proceeds.This system of ascertaining costs is known as continuous costing akin toperpetual inventory the accounting records are kept perpetuallyup-to-date.   It will involve the task of     preparing an estimate of expenseseven before a period begins. The other system, post costing, of finding out thecost after full and accurate information is available is not useful, because itis like a post-mortem; it can reveal the exact cause of loss but without thechance to take corrective action.   Postcosting is useful only in ‘cost plus contracts’ which are usually awarded bythe Government in an emergency on the basis that the ultimate price will dependupon actual cost of production plus a reasonable margin of profit.

 A proper unit of cost should be determined.Unit of cost is the quantity about which cost will be ascertained. In case ofsteel, it is a tone, in case of cotton textiles it is a kilogram.  Other cost units are:

Hospital                       Patient/day

Operations

Out-patientvisit

Accounting firm         Auditperformed

Chargeablehour

Restaurant                    Mealserved

Passenger                     Transport

Organization                Passenger/kilometeror mile

THEORY QUESTIONS AND SUGGESTED ANSWERS

(1) In the broadestsense, all accounting is management accounting. All financial and costinformation generated by accountants is of some interest to management. But inpractice management accounting differs from financial accounting.

In  the light of the above  statement you are required to:

(a)  Provide a brief definition of managementaccounting

(b)   discuss the major differences betweenmanagement and financial accounting.

ICAN

ANSWER

(a)        CIMA’s  Official   Terminology   defines  Management   Accounting   as  the   application of professionalknowledge and skill in the preparation and presentation of accountinginformation so as to assist management in the formulation of policies, and inplanning and controlling of the activities of a business enterprise.

(b)        The major differences between ManagementAccounting and Financial Accounting are discussed under the followingsub-headings:

(i)       Users of information

Financial accounting reports have multi-various users e.g. theequity investors, government, shareholders, employees, creditors, trade unions,investment analysts, etc. while management is the only user of managementaccounting reports.

(ii)      Rules and regulations

Financial accounting reports must be prepared in accordance withstatutory requirements, rules, regulations and pronouncements of-AccountancyBodies. Management accounting reports need not adhere to any of theseconstraints.

(iii)   Report frequency

        Focus

        Regulatoryframe  work  etc. Refer to the Table above for thedifferences

QUESTION  2

One of thefundamental innovations in the Accountancy Profession has been the introductionof Management Accounting techniques in the presentation of accountinginformation.

You are required tobriefly mention three respects in which this new field of Management Accountingdiffers from the “traditional” financial accounting procedures.                                                 

I CAN

ANSWER

Areas of difference  between Management and Financial Accounting.

i)          Management Accounting is a more recentintroduction whereas Financial Accounting has     beenin use since the time of  Pacioli.

ii)         The focus of Management Accounting isfor internal decision – making – planning and          controlwhile Financial Accounting focuses more on score – keeping and performance       measurement.

iii)        The target   audience of Management Accounting is internalmanagement, whereas though Financial Accounting is also of importance tomanagement, external third parties, e.g. government, creditors prospective andexisting investors also use its product.

iv)       Arising from (iii) above, FinancialAccounting is subject to legal and professional standards

whereas ManagementAccounting is devoid of such controls.                                    

QUESTION 3

The ManagementAccountant must inform Management and Supervisors about vital facts known tohim which affect the running of a business using suitably drafted reports andstatements which                 etimessupported by charts, diagrams and statistical aids.

(a)   Explain briefly the following basic forms ofreports

(i)   Routine report

(ii)Special report

(b)   State briefly at least four fundamentalprinciples of report preparation and presentation.

ICAN

ANSWER

(a) (i) RoutineReports.: Are routine information about the business produced at intervals whichmay be daily, weekly, monthly, quarterly report. They highlightcompliance/deviation from plans e.g. Weekly Sales Report, Daily Bank Balances,Daily Production report etc.

(ii) Special Report: unusual or special information prepared toovercome a special  problem. They arereports produced on demand by management e.g. low sales    volume, material wastages, etc.

(b.)       (i) Reports should be prepared depictingexpected achievements before current levels attained.

(ii) Reports shouldbe free from personal bias as much as possible

(iii) Reports shouldbe focused on the purpose it is to serve

(iv) Reports shouldbe tailored to the problem and brief. It should exclude contingencies which maynot be directly relevant.

(v) Management byexception principle should be used in preparing and presenting reports,

(vi) Scientific andtechnical language should be avoided as much as possible.

(vii)The events thatoccurred and what should have happened should be highlighted in the report.

(viii)A schedule ofthe dates should be prepared when routine reports are concerned.

QUESTION 4

(a)   What are the desirable characteristics ofeffective management information statements or reports?

(b)   Explain how the increasing use ofinformation technology can assist the practice of management.

ACCA

ANSWER

(a) The primarycharacteristic of any management information report is that the benefits to bederived from its production and use should outweigh the costs of itsproduction. However, the measurements required to carry out such a cost-benefitanalysis for each report are difficult to ascertain. Nevertheless, a review ofall regularly produced reports should be carried out in order to find out whethertheir continued production is justified.

It should be notedthat the benefits to be derived from regularly produced reports are frequentlyof a contingency nature. A control report9 showing that activity is proceedingaccording to plan will require no action and its production will have producedno change in activities from which incremental benefit can be derived. If thereport were to show that activities were not proceeding according to plan, thenthe resulting action taken could prove extremely useful.

There are manyattributes of management information reports and each of them, apart from thecost attributes mentioned above, concern the effective provision of informationon which the recipient can act. Among the detailed attributes are;

(i)         Relevance for Intended Purpose

Each statement should be produced to fulfill a specific need andextractions matters should be omitted. For performance and control reporting,only activities within the responsibility of the recipient should be shown.

(ii)        Accuracy

Each report should be accurate. Inaccurate reports can result in areaction by the recipient which although justified by his perception drawn fromthe report, is not the correct action to take given the actual position.

(iii)       FactualWherepossible the report should be based on fact. When factual information is notavailable, or when the report requires subjective estimations for it to berelevant, then the factual and estimation content should be clearlydistinguished.

(iv)       Volume of  information

The volume of information should be sufficient to give a full,clear description of the subject matter of the report but not to be sovoluminous that that recipient suffers an information overload.

(v)        Volumeof Detail

The amount of detail incorporated into the report will depend uponthe position of the recipient within the organization. A manager needs far lessdetail shown in his control reports than does a foreman.

(vi)       Timeliness

A report must be produced at a relevant time if it is be touseful. There is little point in producing a report which complies with all thefeatures listed above but is produced so long after the time when it wasrequired that it is too late to act upon it.

Computersassist the practice of Management Accounting in the following ways:

(i)         They ensureaccuracy of processing once data have been fed into the system.

(ii)        They provide rapid retrieval ofinformation. For example the status of a supplier’s account could be viewed onthe computer screen.

(iii)       They enable individual managers to obtainaccess 10 information at the time they need it.                                                                              

(iv)       They can carry out calculations thatwould be time-consuming or practically impossible by   other means. Examples relating to planning and budgetary control

  • Linear programming to establish optimum production level.
  • Trend calculation for sales forecasting
  • Marginal cost and revenue calculations for profit maximization
  • Probability calculations related to investment evaluation orbudgeting
  • Complete financial modeling to predict the financial effects ofplans or proposals
  • Updating of standards under a standard costing systems, or budgetundera system of rolling budgets.

(f)     ResponsibilityClassification:

(i)     Cost centers

(ii)    Profit centers

(iii)  Investment centers.

(g)    EconomicCharacteristic Classification:

(i)    Opportunity cost

(ii)   Separable cost

(iii)  Incremental cost

(iv)  Avoidable cost. Etc.

However, for the purpose of decision making, a mixed cost shouldbe properly sub-divided into its variable and fixed cost element through any ofthe following cost estimation techniques:

(a)     Accounting analysismethod

(b)     High and Low method

(c)     Scattered graphmethod

(d)     Least squares orLinear regression analysis method.

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