MANAGEMENT ACCOUNTING STUDY NOTES PDF

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MANAGEMENT ACCOUNTING STUDY TEXT ii MANAGEMENT ACCOUNTING Copyri ght ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior written per...

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MANAGEMENT ACCOUNTING STUDY TEXT

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MANAGEMENT ACCOUNTING

Copy r i ght ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior written permission of the

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copyright owner.

ISBN NO: 9966-760-23-7 © 2009 SUP First Published 2009

SUP P.O. Box 59857, 00200, Nairobi, Kenya. Tel: +254 (0) 20 606155

Fax: +254 (0) 20 607498

ACKNOWLEDGMENT

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We gratefully acknowledge permission to quote from the past examination papers of the following bodies: Kenya Accountants and Secretaries National Examination Board (KASNEB); Chartered Institute of Management Accountants (CIMA); Chartered Association of Certified Accountants (ACCA).

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Acknowledgment

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Table of Contents ACKNOWLEDGMENT................................................................................................................. iii TABLE OF CONTENTS................................................................................................................ v

PART A........................................................................................................................................ vii

CHAPTER ONE............................................................................................................................ 1 NATURE OF MANAGEMENT ACCOUNTING............................................................................. 3 CHAPTER TWO.......................................................................................................................... 39 COST ESTIMATION AND FORECASTING................................................................................ 41 CHAPTER THREE.................................................................................................................... 101

CHAPTER FOUR...................................................................................................................... 169 BUDGETARY CONTROL......................................................................................................... 171 CHAPTER FIVE........................................................................................................................ 221 STANDARD COSTING AND VARIANCE ANALYSIS.............................................................. 223 CHAPTER SIX.......................................................................................................................... 269 INVENTORY CONTROL........................................................................................................... 271 CHAPTER SEVEN.................................................................................................................... 317 PERFORMANCE EVALUATION DECISIONS.......................................................................... 319 CHAPTER EIGHT..................................................................................................................... 355 TRANSFER PRICING............................................................................................................... 357 CHAPTER NINE........................................................................................................................ 385 FINANCIAL AND NON FINANCIAL PERFORMANCE............................................................ 387 CHAPTER TEN......................................................................................................................... 419 INFORMATION SYSTEMS AND REPORTING TO MANAGEMENT....................................... 421 MODEL ANSWERS.................................................................................................................. 447 GLOSSARY.............................................................................................................................. 525 INDEXT..................................................................................................................................... 537 REFERENCES.......................................................................................................................... 543

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PART B....................................................................................................................................... vii

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PLANNING AND DECISION MAKING..................................................................................... 103

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PART A S T U D Y

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S T S T T SU U TD DUY YD Y T E E TX X ET TX T

CHAPTER ONE

NATURE OF MANAGEMENT ACCOUNTING

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CHAPTER ONE NATURE OF MANAGEMENT ACCOUNTING CHAPTER OBJECTIVES After this chapter the student will be able to: § Get some background on management accounting. § Explain the decision making process.

INTRODUCTION

It also explains the management process, decision making process and decision making environment.

DEFINITION OF KEY TERMS Accounting is the process of identifying measuring and communicating economic information to permit informed judgments and decisions by users of information. Management Accounting is the process of identification, measurement accumulation, analysis, preparation, interpretation and communication of financial information used by management to plan, evaluate and control within an organization and to ensure appropriate use of and accountability for is resources. Financial Accounting is the process of measuring, classifying, summarizing and reporting financial information used in making economic decisions. It’s also concerned with the preparation of financial statements to be used by the firm’s stakeholders. Cost accounting is the process of cost ascertainment and cost control. It is a formal system of accounting by means of which cost of product and services are ascertained and controlled. Information is anything that is communicated and is sometimes said to be processed data. It’s data processed in such a way as to be of meaning to the person receiving it. Management process involves planning, organizing, controlling, directing, communicating and motivating. Decision making is the process of choosing among alternatives.

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It then touches on information; explains the attributes of good information and the importance of information.

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This chapter begins by distinguishing between accounting, management accounting, financial accounting and cost accounting.

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EXAM CONTEXT In past examinations, the examiner has tested the students’ knowledge of Value of information severally. Students should therefore understand this topic.

INDUSTRY CONTEXT Decision making process is applied by organizations in making decisions so as to arrive at the best alternative. Decision making environment helps organizations to keep in mind changes that could affect decisions made in the organization such as risk and competition. This will enable the organization to make the right decision regardless of the circumstances.

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1.1 FINANCIAL ACCOUNTING, MANAGEMENT



ACCOUNTING AND COST ACCOUNTING

Accounting Accounting is the process of identifying measuring and communicating economic information to permit informed judgments and decisions by users of information. It is therefore concerned with providing information that will help decision makers make good decisions. To understand accounting one must understand: • • • • •

The attributes of good information Process of measuring and communicating information The decision-making process Users of information The above points are briefly discussed below:

Users of information The users of information can be divided into two: • •

Internal users who are parties within the organization e.g. the management or the employees. External users who on the other hand, are parties outside the organisation e.g. the shareholder, creditors, government, customers, etc

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From the users point of view accounting can be divided into two:

Management Accounting What is Management Accounting? It is the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of financial information used by management to plan, evaluate and control within an organization and to ensure appropriate use of and accountability for is resources. Management Accounting also comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies and tax authorities. (Robert E. Malcolm) Of course this definition will be difficult to swallow and regurgitation of it in an exam will only prove that you had time to cram a paragraph. Have you gotten the underlying concept? With relevance to a CIMA definition, the above is broken down to facilitate its understanding.

Formulating strategy Planning and controlling activities Decision making Optimizing use of resources Disclosure to shareholders and others external to the entity Disclosure to employees Safeguarding assets

Therefore for the above to work, management needs to: • • • • • •

Formulate plans to meet objectives (Strategy planning) Formulate short term operation plans (Budgeting/profit planning) Acquire and use finance (financial management) and record transactions (Financial Accounting and Cost Accounting) Communicate financial and operating information Take corrective action to bring plans and results into line (Financial control) Reviewing and reporting on systems and operation (Internal audit)

Management Accounting is concerned with getting data (internal and external sources), analysing, processing, interpreting and communicating resulting information for use within the organization so that management can more effectively plan, make decision and control operations.. Providing information that is relevant for the intended purpose is a key aspect of the management. It’s what he’s there for. To do this he will, to get data, - - - -

use appropriate techniques use appropriate techniques from statistics and operations research take into account human element in all activities be aware of economic logic in all transactions and activities

A clear distinction must be brought out, at this point, between management accounting and other forms of accounting.

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Management is concerned with identifying, presenting and interpretation of information used for:

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Financial Accounting It’s the discipline concerned with the provision of information to external parties outside the organization. It’s the process of measuring, classifying, summarizing and reporting financial information used in making economic decisions. It’s also concerned with the preparation of financial statements to be used by the firm’s stakeholders. Key differences between Management Accounting (MA) and Financial Accounting (FA)

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MA

FA

Users

Internal

External

Nature

Future

Historical

Details

More detailed

Summarized

Legality

Not legal

Legal

Format

Not standard

Standard

It is important to define cost accounting at this point.

Cost accounting It’s the process of cost ascertainment and cost control. It is a formal system of accounting by means of which cost of product and services are ascertained and controlled.



1.2 ATTRIBUTES OF GOOD INFORMATION

FAST FORWARD: Information produced for decision making must be of good quality. Information is anything that is communicated and is sometimes said to be processed data. It’s data processed in such a way as to be of meaning to the person receiving it. A lot of costs go into the production of information. Therefore if information is judged as being poor and ignored by management because of its unworthiness, we experience some waste of resources (time and money). To ensure this does not happen, the following should be considered.

i. Economic reality The information should correctly reflect the underlying economic realities. This is the prime requirement and may mean adjusting conventionally prepared accounting information to show

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more effectively the economic consequences.

ii. Accuracy of information As stated in the introduction to management accountant, information should always be sufficiently accurate for its intended purpose. Accuracy will be determine e.g. by collection and processing technique. However, there’s no such thing as absolute accuracy. This may mean that a realistic, speedily prepared estimate may be more useful than a more precise answer produced some time later.

Systematic bias - Inaccuracy due to a feature of the system used for collection and processing data.



Collection bias - it distorts by withholding some information. This could mean that the system had either been deliberately or accidentally designed in such a way to fail to collect relevant data.



Presentation bias - when data is presented in such a way that it only presents one point of view.



Error - usually occurs as a result of the inherent variability in the system used to record data. Other sources include incorrect methods of data collection and measurement, loss of data and failure to process some data.

iii. Relevance The information must be relevant for the person and purpose intended. Relevance is the attribute of data which amongst other things is meaningful. In designing the system, planners will define informational requirements and from this, relevant data can be identified.

iv. Timing The information must be produced in time for it to be used effectively. The age of data is the time that has elapsed since the data was collected.

v. Understandability The information must be capable of being understood by the recipient. To increase comprehension one can: • • •

avoid the use of jargon use charts and diagrams exception reporting and comparative figures

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Inaccuracy can occur as a result of systematic bias or error.

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vi. Detail The amount of detail should be that which is sufficient for the intended purpose. The amount of detail will depend on the recipients’ level in the organization as explained earlier.

Note: Controlling accuracy -

Source reliability

Data may be collected from sources internal and external. Internal sources can be verified e.g. comparison between sales data and finished goods stock records. However other sources e.g. employees’ time sheet can’t be easily verified because there’s no cross references -

Data capture techniques

All information is incomplete and to some extent inaccurate. Much management information is now produced by computer. This has many advantages e.g. speed, accuracy, statistical methods etc. However care should be taken to ensure that information produced is relevant for the purpose intended. Speediness and volume of information are no substitute for relevance.

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How data is introduced into the system really determines a lot. Therefore controls should be put in place to ensure integrity of the information being used in the organization.



1.3 ROLE OF THE MANAGEMENT ACCOUNTANT IN THE MANAGEMENT PROCESS

The management accountant has several key areas of work in an organization. They are fully involved the management process.

i. Planning It is deciding what to do, and who, where, when, why and how to do it. (Robert Malcolm) Here managers decide what goals to be accomplished, how they will be accomplished. It gives the manager some warning of crises that might occur in the future. The management accountant’s role in assisting in formulation of future plans is by providing information to e.g. decide what to sell, in what markets and at what prices. In budgeting the management accountant provides historical data of past performance to be used as a benchmark.

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Control

This process involves a comparison of actual performance with the plan so that deviations from the plans can be identified and corrective action taken. The management accountant here provides performance reports that compare actual performance with plans for each responsibility centre Responsibility centre: A unit of the firm where an individual manager is held responsible for the unit’s performance (Drury) Management by exception is applied here where the management accountant draws to the attention of managers any significant deviations of actual performance from the plan.

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Organizing

Motivation

This involves influencing the human behaviour so that participants can identify with the organizational goals and make decisions that are in harmony with these objectives. It involves, for example, setting goals that are challenging but attainable.

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Communication

The communication process involves perceiving of information by the sender, encoding it in a form that is most suitable; sending it to a recipient who will decode it to aid in his understanding of the message. The next stage would be for him to give feedback to the sender containing his reaction to the message. The management accountant aids the communication process by installing and maintaining an effective communication system e.g. Management Accounting Information System such as the budgetary system.

Information systems in management accounting One major purpose of the management accountant is his use of various techniques, financial accounting, budgeting, statistical and operational research) to provide information to people within the organization to help them make better decisions. It is concerned with the provision and interpretation of the information required by management at all level. Before we go any further, we will go over some issues concerning information generally then move on further. Data >>> In technical terms, is bits and pieces of non-random symbols which represent

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It is the establishment of a framework within which the required activities are to be performed and the designation of who should perform these activities i.e. coming up with the different departments. Each with goals that is congruent to the overall goals of the organization.

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