Management Accounting 1 PDF

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P. Box 342- Thika Email: [email protected] Web: mku.acDEPARTMENT OF BUSINESS ANDSOCIAL STUDIESCOURSE CODE: BBM 221COURSE TITLE: MANAGEMENTACCOUNTING IInstructional Material for BBM- Distance LearningMt Kenya UniversityiiBBM 221: MANAGEMENT ACCOUNTING I Contact Hours: 42 Pre-requisites: BBM 114, BBM 125 an...

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Mt Kenya

University

P.O. Box 342-01000 Thika Email: [email protected] Web: www.mku.ac.ke

DEPARTMENT OF BUSINESS AND

SOCI SOCIAL AL STUDIES

COURSE CODE: BBM

221

COURSE TITLE: MANAGEMENT

ACCOUNTING I

Instructional Material for BBM- Distance Learning

BBM 221: MANAGEMENT ACCOUNTING I Contact Hours: 42 Pre-requisites: BBM 114, BBM 125 and BBM 221 Purpose: To provide the student with the knowledge of important concepts and techniques needed by managers in planning, control, management and decision making in business organization Expected Learning Outcomes of the Course: By the end of the course unit the learners should be able to:i) Explain the importance of management accounting in the management of organizations ii) Apply management accounting techniques to solve various management dilemmas iii) Explain the importance of budgeting and responsibility accounting in management of organizations Course Content: Nature, Purpose and scope of Management Accounting; Decision Making environments and techniques; Cost Behavior; Cost Estimation; Relevant costing; Cost-Volume- Profit Analysis; Variable and absorption costing; Master Budget and Responsibility Accounting

Course Outline WEEK 1 Chapter: Nature, Purpose and Scope of Management Accounting Sub Topics: • Definitions- Managerial Accounting, Cost Accounting, Financial Accounting • Evolution of Management Accounting • Objectives of Management Accounting • Difference between Management and Financial Accounting • Management Accounting System • The Management Accounting Guidelines • Role of management accounting in management process Week 2 & 3 Chapter: DECISION MAKING Sub Topics: • Decision Making Process • Decision Making Conditions • Decision Making Techniques- Decision trees analysis; Maximin, Maximax, Laplace and Minimax regret criteria; Probability distributions, Expected values, standard deviation, coefficient of variation; Portfolio analysis, Grid Analysis Week 4 & 5 Chapter: COST ESTIMATION AND FORECASTING • Cost Concept • Cost Classifications- Stock valuation and profit measurement; Planning control and decision making- Cost behavior, According to the degree of traceability to the final product, Relevance • Managerial ability to avoid, According to functions of department,

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Cost Estimation Methods- Accounts analysis (Accounts inspection method), The two point method (High-Low Method), Regression analysis (least-square method), Graphical method, Conference method, Engineering methods

Week 6 & 7 Chapter: SHORT TERM PLANNING • Sub Topics: • Cost Volume Profit Analysis • Assumption of CVP analysis • The Break- Even Point • B. E. P in Graphical Form • B. E. P in Mathematical Formula • Margin of safety • C V P in Multi-product Environment • Criticisms of CVP analysis Week 8 & 9 Chapter: RELEVANT COSTS FOR NON ROUTINE DECISION Sub Topics: • The concept of cost relevance to decision making • Assumptions of Relevant Costing • Quantitative and qualitative factors in decision making • Limiting factors in decision making • Special pricing decisions • Make or buy decisions • Discontinuation decisions • Equipment replacement decisions Week 10 & 11 Chapter: ABSORPTION COSTING AND MARGINAL COSTING Sub Topics: • Absorption Costing • Overhead Cost Allocation • Overhead Cost Apportionment- Direct method, The step (elimination) method, Continuous (repeated distributed) method, Algebraic method • Overhead Absorption • Application of Overhead to Product • Marginal / Variable Costing Vs Absorption Costing • A comparison of the impact of variable costing and absorption costing on profit • Activity Based Costing (ABC) Week: 12 & 13 Chapter: BUDGETING Sub Topics: • Budgetary Control iii

• • • • • • •

The role and rationale of budgeting- Functions of budgets, Advantages of budgets and budgetary control systems Types of budgets Mechanics of budgeting Stages in the budgeting process Steps in developing a master budget Human aspects of budgeting Alternative Budgeting Procedures- Zero-Based Budgeting (ZBB), Activity-Based Budgeting, Incremental budgeting

Course Assessment Examination - 70%; Continuous Assessment Test (CATS) - 20%; Assignments - 10%; Total - 100% Recommended Text Books: i) Horngren C.T and Foster, G: (2003), Cost Accounting: A Managerial Emphasis, (11th Edition) ii) Hansen (2008); Management Accounting; Cengage Learning ( Thompson ) Text Books for further Reading: i) Horngren C.T Sundrem G L and Stratton W. O; (1996), An introduction to Management Accounting, (10th International Edition), Prentice Hall International Inc

Note: Sit in CATs cover work up to week 7 in the course outline

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Table of Contents Page 1.0 Chapter One: Nature, Purpose and Scope of Management Accounting………1 1.1 Definitions……………………………………………………………………………...….1 1.2 Evolution of Management Accounting…………………………………………………8 1.3 Objectives of Management Accounting………………………………………………..8 1.4 Difference between Management and Financial Accounting………………………9 1.5 Management Accounting System………………………………………………………10 1.6 The Management Accounting Guidelines…………………………………………….11 1.7 Role of management accounting in management process………………………….12 1.8 Review Questions………………………………………………………………………..12 2.0 Chapter Two: Decision Making…………………………………………………13 2.1 Decision Making Process……………………………………………………………….13 2.2 Decision Making Conditions……………………………………………………………15 2.3 Decision Making Techniques…………………………………………………………...16 2.3.1 Decision trees analysis..…………………….………..……………………………….16 2.3.2 Maximin, Maximax, Laplace and Minimax regret criteria……………………….18 2.3.3 Probability distributions Expected values, standard deviation and coefficient of variation……………………………………………………………………….20 2.3.4 Portfolio analysis………………………………………………………………………22 2.3.5 Grid Analysis……………………………………………………………………………24 2.4 Review Questions…………………………………………………………………………25 3.0 Chapter Three: Cost Estimation and Forecasting……………………………..27 3.1 Cost Concept……………………………………………………………………………..28 3.2 Cost Classifications……………………………………………………………………..29 3.3 Cost Estimation Methods…………………………………………………………........33 3.3.1 Accounts analysis (Accounts inspection method)…………………………………33 3.3.2 The two point method (High-Low Method)………………………………………..34 3.3.3 Regression analysis (least-square method)………………………………………..36 3.3.4 Graphical method……………………………………………………………………..41 3.3.5 Conference method……………………………………………………………………42 3.3.6 Engineering methods ………………………………………………………………...43 3.3.7 Learning curve ……………………………………………………………………….44 3.4 Review Questions……………………………………………………………………….49 4.0 Chapter Four: Short Term Planning…………………………………………...51 4.1 Cost Volume Profit Analysis……………………………………………………………51 4.2 Assumption of CVP analysis……………………………………………………………51 4.3 The Break- Even Point………………………………………………………………….52 4.4 B. E. P in Graphical Form……………………………………………………………..52 4.5 B. E. P in Mathematical Formula……………………………………………………..54 4.6 Margin of safety………………………………………………………………………….57 4.7 C V P in Multi-product Environment…………………………………………………59 4.8 Criticisms of CVP analysis……………………………………………………………..61

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4.9 Review Questions……………………………………………………………………….62 5.0 Chapter Five: Relevant Costs for Non Routine Decision 5.1 The concept of cost relevance to decision making…………………………………63 5.2 Assumptions of Relevant Costing…………………………………………………….64 5.3 Quantitative and qualitative factors in decision making………………………….64 5.4 Limiting factors in decision making…………………………………………………65 5.5 Special pricing decisions……………………………………………………………...66 5.6 Make or buy decisions…………………………………………………………………67 5.7 Discontinuation decisions…………………………………………………………….68 5.8 Equipment replacement decisions……………………………………………………69 5.9 Review Questions………………………………………………………………………72 6.0 Chapter Six: Absorption Costing and Marginal Costing……………………73 6.1 Absorption Costing…………………………………………………………………….73 6.2 Overhead Cost Allocation…………………………………………………………….74 6.3 Overhead Cost Apportionment……………………………………………………….74 6.4 Overhead Absorption…………………………………………………………………..78 6.5 Application of Overhead to Product…………………………………………………82 6.6 Marginal / Variable Costing Vs Absorption Costing……………………………...84 6.7 Activity Based Costing (ABC)………………………………………………………..94 6.7 Review Questions………………………………………………………………………97 7.0 Chapter Seven: Budgeting……………………………………………………..99 7.1 Budgetary Control……………………………………………………………………..99 7.2 The role and rationale of budgeting………………………………………………..100 7.3 Types of budgets………………………………………………………………………101 7.4 Mechanics of budgeting……………………………………………………………...101 7.5 Steps in developing a master budget……………………………………………….103 7.6 Human aspects of budgeting………………………………………………………..114 7.7Alternative Budgeting Procedures………………………………………………….115 7.8 Review Questions…………………………………………………………………….119 Sample Exam Papers……………………………………………………………………..121

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1.0 CHAPTER ONE: NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING Learning Objectives By the end of this chapter the learner should be able to: i) Distinguish between managerial accounting, cost accounting and financial accounting ii) State objectives of management accounting iii) Describe the management accounting system iv) Explain the role of management accounting in management process 1.1 Definitions Managerial Accounting Management accounting is the application of the professional knowledge and skills in preparation and presentation of accounting information in such a way as to assist management in formulation of policies and planning and control of the operations of undertakings. It measures and reports financial and non-financial information that helps managers make decision to fulfill the goals of an organization. It is focused on internal reporting. It is concerned with the provision of information to people within the organization so as to help them make decision and improve efficiency and effectiveness of existing operations. Management accounting provides information required by management for such purposes as:1. Formulation of policies 2. Planning and controlling activities of the enterprises 3. Decision making on alternative causes of action. 4. Disclosure to those external to the entity 5. Disclosure to employees 6. Safeguarding assets The above involves participative management to ensure that there is effective:1. Formulation of long tern plans to meet objectives 2. Formulation of short term operation plans 3. Recording of actual transactions

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4. Corrective actions required to bring future actual transactions into line. 5. Obtaining and controlling finance 6. Reviewing and reporting on systems and operations Cost Accounting Cost accounting measures and reports financial and non-financial information that relates to the cost of acquiring or consuming resources by an organization, it includes those parts of management and financial accounting where information cost is collected or analyzed. It provides information both managerial accounting and financial accounting. Financial Accounting It focuses on reporting to external parties. It measures and records business transactions and provides financial statements that are based on generally accepted accounting principles. It is defines as that part of accounting which covers the classification and recording actual transactions of an entity in monetary terms in accordance with established concepts, principles, accounting standards and legal requirements and present as accurate view as possible of the effect of those transactions over a period of time and at the end of that time. Note: - All the above three branches of the accounting should be integrated into the company’s reporting system where: Financial accounting maintains records of each transaction and helps control the firm’s assets and liabilities e.g. plant, equipment, stock, debtors and creditors. It satisfies the legal and taxation requirements and also provides input into the costing system. Cost accounting analyses the financial data into more detail and provides a lot of other information used for control It also provides key data such as stock valuation and cost of sale which are fed back into the financial accounting system so that accounts can be finalized. Managerial accounting gets information from financial and cost accounting system and uses this and other available information in order to advice management on matters such as cost control, pricing, investment decisions and planning.

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1.2 Evolution of Management Accounting Financial accounting used to be considered adequate for making information needs of the management for the control of the business operations. The annual financial statements which comprised of a balance sheet and profit and loss account are still prepared and presented to management by the financial accountant. However the management needs much more detailed information than those supplied by this financial statement. Management accounting compared to financial accounting is a young discipline and so management accounting concept and tools are still evolving as new ways are found to provide information that assists management. Management accounting evolved as a result of rapidly changing business environment. Several changes that are especially pertinent to management accounting are:Globalization, deregulation, emergency of new industries, just in time inventory management, continuous improvement, computer integrated manufacturing, product quality etc. 1.3 Objectives of Management Accounting 1. Planning All organization should plan a head in order that they can set objectives and decide how they can meet them. Management accounting uses past data to predict the future 2. Control The production of the company internal accounts enable the firm to concentrate on achieving its objectives by identifying which areas are performing and which are not. The use of management by exception reports enables control to be exercised where it is most useful. 3. Organization There is a direct relationship between the organizational structure and the management accounting system. Management accounting system should therefore produce the right information at the right cost, at the right time. 4. Communication The existence of budgetary and management accounting system is an important part of communication process. Plans are outlined to managers so that they are fully aware of

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what is required of them and the management accountant tells them whether or not the desired results are achieved. 5 Motivation The use of budget and achievable targets motivates the employees to work hard so as to achieve these targets. 1.4 Difference between Management and Financial Accounting 1. Legal requirements It is a legal requirement for a public limited company to produce annual financial accounts regardless of whether or not management regards this information as useful. However it is optional for management accounting to prepare this statement. 2. Financial accounts Financial accounts must be prepared to conform to legal requirements and generally accepted accounting principles established by regulatory bodies. These requirements are essential to ensure consistency and formality that is needed for external financial statement. In contrast management accountings are not required to adhere to generally accepted accounting principles when providing managerial information for internal purposes. 3. Time dimensions Financial accounting reports what has happened in the past in an organization where as management accounting is concerned with both past and future information. Management requires details of expected future cost and revenues. 4. Reporting frequency Financial accounting is published annually while management accounting requires information frequently so as to make decisions. 5. Focus on individual parts or segments of the business Financial accounting report focuses on all parts of the business whereas management accounting focuses on a small part of the business. 6. Type of information Management accounting includes non monetary and monetary information while financial accounting includes monetary information only. Management accounting includes quantities of materials as well as monetary cost of material, number of

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employees as well as Labor cost etc. Financial accounting records this information in monetary terms only. 1.5 Management Accounting System Accounting system is the system of procedures, personnel and computers used to accumulate and store financial data in the organization. Managerial accounting constitutes one of several system used by managers in running an organization. A system consists of a set of inputs, process and outputs. Those are known as elements. The design of management accounting system should be guided by the challenges facing managers. There are several factors which should be borne in mind when a system is being set up. 1. What information is required? i)

What data is required to produce the information?

ii)

What are the sources of this data?

iii)

How should it be converted?

iv)

How often should it be converted?

2 Who requires it? 3 How often is it required? The following factors should also be considered 1. What data is required to produce the information? 2. What are the sources of this data? 3. How should it be converted? 4. How often should it be converted? The organizational structure, cost and accuracy should be taken into account. The following steps should be followed while setting management accounting system. 1. The organizational manual should be drafted which gives communication line within the organization. 2. All the systems should be integrated. 3. Setting up of the cost centre, profit centre, investment centre etc 4. Introduction of budget and budgetary control. 5. Standards should be set up and standard costing should be put in place. 6. The system should be introduced gradually

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7. The staff should be recruited and trained on the system 8. There should effective internal control system 9. Monitoring and evaluation after implementation. Attributes of a Good Management Accounting Information i)

Timely

ii)

Relevant

iii)

Accurate

iv)

Inspires users confidence

v)

Appropriately communicated

1.7 The Management Accounting Guidelines Management accounting is still evolving and therefore the guidelines available are not generally accepted as those of financial accounting. However, some of the guidelines include:1. Cost benefit approach As management accounting continually face resource allocation decisions, cost benefit approach should be used. They should weigh the cost and the benefits expected from any spending. The benefits should make the organization to attain its goals. 2. Give full recognition to behavioral as well as technical considerations Management accounting system should have two simultaneous missions for providing information namely:i. To help managers make wise economic decisions ii. To motivate managers and other employees to aim and strive for goals of the organization. 3. Responsibility accounting principles. This seeks to assign each employee some authority and responsibility where by the said employee is responsible for success or failure of his sections. Responsibility accounting is a system that measures the plans and actions of each responsibility centers. There are four major types of responsibility centre are:i)

Cost centre where manager is accountable for cost duly

ii)

Revenue centre – where manager is accountable for revenue only.

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iii)

Profit centre where manager is accountable for profit only.

iv)

Investment centre – where managers is accountable for investments, revenue and costs.

4. Management by exceptional principle This is a principle where management gives more attention to critical areas unusual or exceptional ...