MANAGEMENT ACCOUNTING THEORIES

Management Accounting is a growing field in a modern business organization. It is seen as that aspect of accounting which supplies valuable information to attain a given objective.

It is accounting in the perspective of the management. The Internal reporting functions of an accounting system is sometimes called Managerial Accounting and it provides management with information necessary for daily operations and also for planning in the long term.

It is also that aspect of Accounting which enables management to use accounting information for decision making, planning and control efficiently and effectively. Management Accounting uses data from accounting systems by conducting special investigation to gather required data, processes the data, for the intended purposes, depending on the goals and objectives of the 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 business enterprise. It is concerned with the control of the activities of any business enterprises.

Management may perform the following functions:

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

The functions as above could be sub-divided into planning and control 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 and giving interpretations to the results arrived at.

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

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

Internal parties i.e. management for managerial decision making and external users for investment decisions and many more other reasons.

Definitions of Management Accounting

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

Some of these definitions considered in this text are as follows:-

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

Management Accounting is the provision of information required by management for such purposes as:

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

The above involves participating in management to ensure that there is effective;

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

The above definitions lay emphasis on decision making, planning and 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, medium and short terms.
  • Controlling the activities of the organization to ensure that plans are in conformity with what obtains in order to achieve desired result,
  • Decision making.  This is the process of choosing between alternatives. The choice of alternatives should be in line with the goals and aspirations of the organization
  • Performance   Appraisal:   This   is   the   evaluation   of performance. The result of the assessment will enable management to know its score card, i.e., whether it is performing well or not.

Qualities of A Good Management Accounting Report

  1. Factual: An ideal management accounting report must be capable of being independently proven by the users, i.e., it must contain both quantitative and qualitative data.
  2. Degree of Details: A good management accounting report must be conclusive in nature i.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 be higher than the benefit to be derived from the report.
  4. Timeliness:   For a management accounting report to be considered relevant in a particular situation    it must be presented on time, i.e, prior to the 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 key aspect 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 that are capable of different interpretation and meaning because of its implications to the users.
  7. Volume of Content: A good management accounting report must be explicit yet not voluminous. It must contain adequate information and must be self-explanatory to the user.

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

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

Cost Accounting and Cost Accounting methods supply the basis of factual information on which the Management Accountant builds up his presentation 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 for the achievement of a given objective. Internal Audit as part of management control system will make for effective planning control, and appraisal of the system to ensure conformity with the desired objectives.

Management Accounting, Cost Accounting and Financial Accounting supply information in the light of a given objective: Such objectives may include:

  1. Internal reporting to managers for the purpose of planning and control of routine operations. This aspect relates to Cost Accounting as well as management Accounting.
  2. Internal reporting to managers  in  making  non-routine decisions and in formulating major plans and policies.  This aspect also relates to Management Accounting and to some extent Cost Accounting.
  3. External reporting to stockholders, government and other parties for use in investor decisions, income tax collections, wage negotiations,   performance appraisals, and a host of other reasons.

As seen from the above, the first two have to do with Internal Reporting for decision making, planning and control process while the third has to do with external reporting.

Internal Reporting relates to Financial Accounting which emphasizes the stewardship and custodial aspect of Accounting. The area is constrained by certain accounting concepts and conventions and by other regulation. However, internal reporting which focuses on management planning and control called

Management Accounting is less constrained than Financial Accounting because 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 have seen from the above definitions above, we can summarize that; The primary objective of cost and management Accounting is to assist planning and control functions of internal decision-makers (i.e. management). In control, financial or traditional accounting is primarily concerned with the information needs of external decision-makers (shareholders, loan creditors, analyst advisers, governmental authorities, the public, etc.). Reasonable accuracy, as in an audit is enough. What is reasonable depends upon the nature of industry.                                       As a rule, costing information should be collected as and when the work proceeds. This system of ascertaining costs is known as continuous costing akin to perpetual inventory the accounting records are kept perpetually up-to-date.   It will involve the task of      preparing an estimate of expenses even before a period begins. The other system, post costing, of finding out the cost after full and accurate information is available is not useful, because it is like a post-mortem; it can reveal the exact cause of loss but without the chance to take corrective action.   Post costing is useful only in ‘cost plus contracts’ which are usually awarded by the Government in an emergency on the basis that the ultimate price will depend upon 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 of steel, it is a tone, in case of cotton textiles it is a kilogram.  Other cost units are:

Hospital                       Patient/day

Operations

Out-patient visit

Accounting firm         Audit performed

Chargeable hour

Restaurant                    Meal served

Passenger                     Transport

Organization                Passenger/kilometer or mile

THEORY QUESTIONS AND SUGGESTED ANSWERS

(1) In the broadest sense, all accounting is management accounting. All financial and cost information generated by accountants is of some interest to management. But in practice management accounting differs from financial accounting.

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

(a)  Provide a brief definition of management accounting

(b)   discuss the major differences between management and financial accounting.

ICAN

ANSWER

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

(b)        The major differences between Management Accounting and Financial Accounting are discussed under the following sub-headings:

(i)       Users of information

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

(ii)      Rules and regulations

Financial accounting reports must be prepared in accordance with statutory requirements, rules, regulations and pronouncements of-Accountancy Bodies. Management accounting reports need not adhere to any of these constraints.

(iii)   Report frequency

        Focus

        Regulatory frame  work  etc. Refer to the Table above for the differences

QUESTION  2

One of the fundamental innovations in the Accountancy Profession has been the introduction of Management Accounting techniques in the presentation of accounting information.

You are required to briefly mention three respects in which this new field of Management Accounting differs from the “traditional” financial accounting procedures.                                                 

I CAN

ANSWER

Areas of difference  between Management and Financial Accounting.

i)          Management Accounting is a more recent introduction whereas Financial Accounting has     been in use since the time of  Pacioli.

ii)         The focus of Management Accounting is for internal decision – making – planning and          control while Financial Accounting focuses more on score – keeping and performance       measurement.

iii)        The target   audience of Management Accounting is internal management, whereas though Financial Accounting is also of importance to management, external third parties, e.g. government, creditors prospective and existing investors also use its product.

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

whereas Management Accounting is devoid of such controls.                                    

QUESTION 3

The Management Accountant must inform Management and Supervisors about vital facts known to him which affect the running of a business using suitably drafted reports and statements which                 etimes supported by charts, diagrams and statistical aids.

(a)   Explain briefly the following basic forms of reports

(i)   Routine report

(ii) Special report

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

ICAN

ANSWER

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

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

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

(ii) Reports should be free from personal bias as much as possible

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

(iv) Reports should be tailored to the problem and brief. It should exclude contingencies which may not be directly relevant.

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

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

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

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

QUESTION 4

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

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

ACCA

ANSWER

(a) The primary characteristic of any management information report is that the benefits to be derived from its production and use should outweigh the costs of its production. However, the measurements required to carry out such a cost-benefit analysis for each report are difficult to ascertain. Nevertheless, a review of all regularly produced reports should be carried out in order to find out whether their continued production is justified.

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

There are many attributes of management information reports and each of them, apart from the cost attributes mentioned above, concern the effective provision of information on 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 and extractions 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 a reaction by the recipient which although justified by his perception drawn from the report, is not the correct action to take given the actual position.

(iii)       Factual Where possible the report should be based on fact. When factual information is not available, or when the report requires subjective estimations for it to be relevant, then the factual and estimation content should be clearly distinguished.

(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 so voluminous that that recipient suffers an information overload.

(v)        Volume of Detail

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

(vi)       Timeliness

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

Computers assist the practice of Management Accounting in the following ways:

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

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

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

(iv)       They can carry out calculations that would 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 or budgeting
  • Complete financial modeling to predict the financial effects of plans or proposals
  • Updating of standards under a standard costing systems, or budget undera system of rolling budgets.

(f)     Responsibility Classification:

(i)     Cost centers

(ii)    Profit centers

(iii)  Investment centers.

(g)    Economic Characteristic Classification:

(i)    Opportunity cost

(ii)   Separable cost

(iii)  Incremental cost

(iv)  Avoidable cost. Etc.

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

(a)     Accounting analysis method

(b)     High and Low method

(c)     Scattered graph method

(d)     Least squares or Linear regression analysis method.