Cost Accounting as a tool of management accounting Practice, implement & Challenge in Bangladesh
History of Managerial Accounting:-
Managerial accounting has its roots in the industrial revolution of the 19th century. During this early period, most firms were tightly controlled by a few owner-managers who borrowed based on personal relationships and their personal assets.
Since there were no external shareholders and little unsecured debt, there was little need for elaborate financial reports. In contrast, managerial accounting was relatively sophisticated and provided the essential information needed to manage the early large scale production of textile, steel, and other products.
After the turn of the century, financial accounting requirements burgeoned because of new pressures placed on companies by capital markets, creditors, regulatory bodies, and federal taxation of income. Many firms needed to raise funds from increasingly widespread and detached suppliers of capital.
To tap these vast reservoirs of outside capital, firms’ managers had to supply audited financial reports. And because outside suppliers of capital relied on audited financial statements, independent accountants had a keen interest in establishing well defined procedures for corporate financial reporting.
The inventory costing procedure adopted by public accountants after the turn of the century had a profound effect on management accounting. As a consequence, for many decades, management accountants increasingly focused their efforts on ensuring that financial accounting requirements were met and financial reports were released on time. The practice of management accounting stagnated.
In the early part of the century, as product line expanded operations became more complex, forward looking companies saw a renewed need for management-oriented reports that was separate from financial reports. But in most companies, management accounting practices up through the mid-1980s were largely indistinguishable from practices that were common prior to World War I.
In recent years, however, new economic forces have led to many important innovations in management accounting.
Historical Development:-
Maher states: Management accounting has a short but exciting history: – While management accounting concepts can be traced back at least to the beginning of the Industrial Revolution, management accounting as a teaching discipline appears to have got off the ground in the late1940’s.
Parker concurs: – Management accounting has historical antecedents that stretch back longer than we might expect and certainly accounting historians have not yet concluded their investigations of its earliest genesis.
Cunagin and Stancil believe:
Management accounting with its lack of generally accepted accounting practice has not yet had the exposure afforded to financial accounting. The history of management accounting is one of innovation based on necessity. Innovation therefore continues without constraints imposed by preconceived ideas of what constitutes “proper” accounting.
The historical development of management accounting is of particular importance in answering relevancy questions in a rapidly developing technological environment.
| The Evaluation Of Management Accounting Practice | |
| Accounting for Process | 1812-1920: Prior to the matching concept. Focus on operating cost and efficiency of processes. |
| Cost Accounting | 1920-1950: Matching concept developed. Focus on cost determination and financial control. |
| Managerial Accounting | 1950-1980’s: Focus shifted to providing information for management planning & control. |
| Lean Enterprise CAM-1 Cost Management | 1980’s: Focus shifted to the reduction of waste, JIT, teamwork, ABC, target costing, quality, investment & product life cycle management. |
| Value based Management | 1990’s: Focus shifted to include the creation of customer value, strategy, Balanced scorecards, EVA, and other related concepts. |
Management accounting before the First Management Accounting Revolution:-
According to the International Federation of Accountants (IFAC), the period before the First Management Accounting Revolution is known as the “classical period” and ended in the late 1950s. Robles and Robles (2000:4) state that contributions to cost accounting during this period (especially from 1820 to 1885) were particularly barren.
After years of merely recording financial information, Johnson and Kaplan mention the emergence of hierarchical organizations that all created a new demand for accounting information. The Industrial Revolution during the 18th and 19th centuries presented new challenges to accountants. Business operations became more complex and information was needed to facilitate those operations. Manufacturing activities multiplied, and according to Wyatt (2002:4), accountants were expected to provide information to control expenditure and to price manufactured products.
The label “management accounting” was not used in the Anglo-Saxon world prior to the First Management Accounting Revolution. The term “cost accounting” was used to define processes for the computation of costs and for financial control. Although management accounting was not recognized before the 19th century when masses of financial information had to be recorded, it is quite possible that businessmen were already using management accounting concepts at the time.
In Parker’s (2002:1) address to the Chartered Institute of Management Accounting (CIMA) in March of 2002, he stated that there was strong evidence of a full range of cost management practices in the British extractive, iron and textile industries before the 1900s. Yamey, for example, stated that the records of Robert Loders’ farm accounts (1610-1620) showed evidence of calculations for business decision making (Parker 1969:15). Another example is found in the French mathematician, Augustin Cournot’s, records for 1838 in which he pointed out that a monopolist would always stop production when the increase in expenses exceeded the increase in receipts (Parker 1969:17). During this period cost accounting was evidently considered a necessary technical activity to pursue organizational objectives. Associations that were established during this period to disseminate the work performed by accountants emphasized the use of cost accounting.
The first North American organizations that developed cost or management accounting systems were the integrated cotton textile factories that were established after 1812. They used cost accounts to ascertain the direct labor and overhead costs of converting raw material into yarn and fabric.
One of the first publications on the principles of cost accounting, namely Factory accounts, written by the electrical engineer Emile Garcke and the accountant John Manger Fells, appeared in 1887. These two writers would later be recognized as the founders of marginal costing (Parker 1969:20). Another contribution to cost accounting during the period was that of Friederich von Wieser who first formulated the concept of opportunity cost in a paper entitled On the relation of cost to value (written in 1889, but published in 1929).
Among the earliest manufacturing cost records found by American historians were those of the Boston Manufacturing Company. Company records dated as early as 1815 reveal that remarkably sophisticated sets of cost accounts were used.
Overview of Management Accounting: –
Management accounting is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis in making informed business decisions that would allow them to be better equipped in their management and control functions. Unlike financial accountancy information, management accounting information is used within an organization “typically for decision-making” and is usually confidential and its access available only to a select few.
According to The Chartered Institute of Management Accountants (CIMA) – Management Accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources. Management accounting also comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies and tax authorities.
The American Institute of Certified Public Accountants (AICPA) states that management accounting practice extends to the following three areas:
· Strategic Management— advancing the role of the management accountant as a strategic partner in the organization.
· Performance Management— developing the practice of business decision-making and managing the performance of the organization.
· Risk Management— contributing to frameworks and practices for identifying, measuring, managing and reporting risks to the achievement of the objectives of the organization.
The Institute of Certified Management Accountants (ICMA) states – “A management accountant applies his or her professional knowledge and skill in the preparation and presentation of financial and other decision oriented information in such a way as to assist management in the formulation of policies and in the planning and control of the operation of the undertaking.”
Management Accountants therefore are seen as the – “value-creators” amongst the accountants. Management accounting knowledge and experience can therefore be obtained from varied fields and functions within an organization, such as information management, treasury, efficiency auditing, marketing, valuation, pricing, logistics, etc.
· Formulating strategies;
· Planning and constructing business activities;
· Helps in making decision & Optimal use of resources;
· Supporting financial reports preparation; and Safeguarding asset
Management accounting is concerned with the provisions and use of cost accounting information to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions. From different significance – management accounting information is used within an organization, typically for decision-making. In contrast to financial accountancy information, management accounting information is:
· Designed and intended for use by managers within the organization, whereas financial accounting information is designed for use by shareholders and creditors.
· Usually confidential and used by management, instead of publicly reported;
· Forward-looking, instead of historical;
· Computed by reference to the needs of managers, often using management information systems, instead of by reference to financial accounting standards.
The distinction between ‘traditional’ and ‘innovative’ management accounting practices can be illustrated by reference to cost control techniques. Cost accounting is a central method in management accounting, and traditionally, management accountants’ principal technique was variance analysis, which is a systematic approach to the comparison of the actual and budgeted costs of the raw materials and labor used during a production period. While some form of variance analysis is still used by most manufacturing firms, it nowadays tends to be used in conjunction with innovative techniques such as life cycle cost analysis and activity-based costing, which are designed with specific aspects of the modern business environment in mind. Life-cycle costing recognizes that managers’ ability to influence the cost of manufacturing a product is at its greatest when the product is still at the design stage of its product life-cycle, since small changes to the product design may lead to significant savings in the cost of manufacturing the product. Activity-based costing recognizes that, in modern factories, most manufacturing costs are determined by the amount of ‘activities’ and that the key to effective cost control is therefore optimizing the efficiency of these activities. Activity-based accounting is also known as Cause and Effect accounting.
Both lifecycle costing and activity-based costing recognize that, in the typical modern factory, the avoidance of disruptive events reducing the costs of raw materials. Activity-based costing also deemphasizes direct labor as a cost driver and concentrates instead on activities that drive costs, such as the provision of a service or the production of a product component.
Management Accounting Principal: –
To achieve the above objectives Management Accounting employs three principal devices from cost accounting –
1. Forward looking principle: Based on the past and all other available data, forecasting, the future and recommending wherever appropriate the course of action for the future.
2. Target setting principle: Fixation of an optimum target which is variously known as standard, budget etc. and through continuous review ensuring that the target is achieved.
3. The principle of exception: Instead of concentrating on voluminous masses of data management accounting concentrates on deviations from targets and continuous and prompt analysis of the causes of these deviations on which to base management action.
Objectives of Management Accounting:-
The base objective of management accounting is to assist the management in carrying out its duties efficiently. The objectives of Management Accounting are: –
· The computation of plans and budgets covering all aspects of the business. Example: production, selling, distribution, research and finance.
· The systematic allocation of responsibilities for implementation of plans and budgets.
· The organization for providing opportunities and facilities for performing responsibilities.
· The analysis of all transactions, financial and physical, to enable effective comparison to be made between the forecasts and actual performance.
· The presentations of up to date information, at frequent intervals, to management in the form of operating statements.
· The statistical interpretation of such statements in a manner which will be of utmost assistance to management in planning future policy and operation.
The fundamental objective of management accounting is to enable the management to maximize profits or minimize losses. The evolution of management accounting has given an approach to the function of accounting. The main objectives of management accounting are as follows:
1. Planning and policy formulation:
Planning involves forecasting on the basis of available information, setting goals; framing polices determining the alternative courses of action and deciding on the program of activities. Management accounting can help greatly in this direction. It facilitates the preparation of statements in the light of past results and gives estimation for the future.
2. Interpretation process:
Management accounting is to present financial information to the management. Financial information is technical in nature. Therefore, it must be presented in such away that it is easily understood. It presents accounting information with the help of statistical devices like charts, diagrams, graphs, etc.
3. Assists in Decision-making process:
With the help of various modern techniques management accounting makes decision-making process more scientific. Data relating to cost, price, profit and savings for each of the available alternatives are collected and analyzed and provides a base for taking sound decisions.
4. Controlling:
Management accounting is a useful for managerial control. Management accounting tools like standard costing and budgetary control are helpful in controlling performance. Cost control is affected through the use of standard costing and departmental control is made possible through the use of budgets. Performance of each and every individual is controlled with the help of management accounting.
5. Reporting:
Management accounting keeps the management fully informed about the latest position of the concern through reporting. It helps management to take proper and quick decisions. The performance of various departments is regularly reported to the top management.
6. Facilitates Organizing:
“Return on Capital Employed” is one of the tools of management accounting. Since management accounting stresses more on Responsibility Centers with a view to control costs and responsibilities, it also facilitates decentralization to a greater extent. Thus, it is helpful in setting up effective and efficiently organization framework.
7. Facilitates Coordination of Operations:
Management accounting provides tools for overall control and coordination of business operations. Budgets are important means of coordination.
Nature and Scope of Management Accounting:-
Management accounting involves furnishing of accounting data to the management for basing its decisions. It helps in improving efficiency and achieving the organizational goals. The following paragraphs discuss about the nature of management accounting.
1. Provides accounting information:
Management accounting is based on accounting information. Management accounting is a service function and it provides necessary information to different levels of management. Management accounting involves the presentation of information in away it suits managerial needs. The accounting data collected by accounting department is used for reviewing various policy decisions.
2. Cause and effect analysis:
The role of financial accounting is limited to find out the ultimate result, i.e., profit and loss; management accounting goes a step further. Management accounting discusses the cause and effect relationship. The reasons for the loss are probed and the factors directly influencing the profitability are also studied. Profits are compared to sales, different expenditures, current assets, interest payables, share capital etc.
3. Use of special techniques and concepts:
Management accounting uses special techniques and concepts according to necessity to make accounting data more useful. The techniques usually used include financial planning and analyses, standard costing, budgetary control, marginal costing, project appraisal, control accounting ,etc.
4. Taking important decisions:
It supplies necessary information to the management which may be useful for its decisions. The historical data is studied to see its possible impact on future decisions. The implications of various decisions are also taken in to account.
5. Achieving of objectives:
Management accounting uses the accounting information in such away that it helps in formatting plans and setting up objectives. Comparing actual performance with targeted figures will give an idea to the management about the performance of various departments. When there are deviations, corrective measures can be taken at once with the help of budgetary control and standard costing.
6. No fixed norms:
No specific rules are followed in management accounting as that of financial accounting. Though the tools are the same, their use differs from concern to concern. The deriving of conclusions also depends upon the intelligence of the management accountant. The presentation will be in the way which suits the concern most.
7. Increase in efficiency:
The purpose of using accounting information is to increase efficiency of the concern. The performance appraisal will enable the management top in-point efficient and inefficient spots. Effort is made to take corrective measures so that efficiency is improved. The constant review will make the staff cost–conscious.
8. Supplies information and not decision:
Management accountant is only to guide and not to supply decisions. The data is to be used by the management for taking various decisions. ‘How is the data to be utilized’ will depend upon the caliber and efficiency of the management.
9. Concerned with forecasting:
The management accounting is concerned with the future. It helps the management in planning and forecasting. The historical information is used to plan future course of action. The information is supplied with the object to guide management for taking future decisions.
Advantages of Management Accounting:-
One of the most significant steps to improve managerial performance is the development of the new discipline. Management accounting it is still very much in a state of evolution. However, the following advantages are claimed for it:-
1. The main contribution of management accounting is the elimination of initiative management. With the help management accounting, the business activities are regulated systematically by means of efficient planning and organization thereby avoiding over working in busy periods and slackness in slump periods.
2. It enables the business to get the maximum return on capital by helping it in planning, distribution and controlling activities.
3. It helps the management to improve its service to its customers by resorting to a continuous method of comparing the results with the standards.
4. It helps in improving the relations between the management and labor by avoiding unreasonable standard of work which is the main cause of labor unrest.
Limitations of Management Accounting:
Management Accounting is in the process of development. Hence, it suffers form all the limitations of a new discipline. Some of these limitations are:
1. Limitations of Accounting Records:
Management accounting derives its information from financial accounting, cost accounting and other records. It is concerned with the rearrangement or modification of data. The correctness or other wise of the management accounting depends upon the correctness of these basic records. The limitations of these records are also the limitations of management accounting.
2. It is only a Tool:
Management accounting is not an alternate or substitute for management. It is a mere tool for management. Ultimate decisions are being taken by management and not by management accounting.
3. Heavy Cost of Installation
The installation of management accounting system needs a very elaborate organization. This results in heavy investment which can be afforded only by big concerns.
4. Personal Bias:
The interpretation of financial information depends upon the capacity of interpreter as one has to make a personal judgment. Personal prejudices and bias affect the objectivity of decisions.
4. Psychological Resistance
The installation of management accounting involves basic change in organization setup. New rules and regulations are also required to be framed which affect a number of personnel and hence there is a possibility of resistance form some or the other.
5. Evolutionary stage:
Management accounting is only in a developmental stage. Its concepts and conventions are not as exact and established as that of other branches of accounting. Therefore, its results depend to a very great extent upon the intelligent interpretation of the data of managerial use.
7. Provide soonly Data:
Management accounting provides data and not decisions. It only informs, not prescribes. This limitation should also be kept in mind while using the techniques of management accounting.
8. Broad-based Scope:
The scope of management accounting is wide and this creates many difficulties in the implementations process. Management requires information from both accounting as well as non-accounting sources. It leads to in exactness and subjectivity in the conclusion obtained through it.
Management Accounting Tasks: –
Management accounting may be said to include all activities connected with collecting, processing, interpreting and presenting information to management. The management accounting satisfies the various needs of management for arriving of appropriate business decisions. They may be described as modification of data, analysis and interpretation of data, facilitating management control, formulation of business budgets, use of qualitative information, and satisfaction of informational needs of management.
Listed below are the primary tasks performed by management accountants generated by different cost accounting tools. The degree of complexity relative to these activities is dependent on the experience level and abilities –
· Variance Analysis
· Rate & Volume Analysis
· Product Profitability
· Cost Analysis & Cost Benefit Analysis
· Cost-Volume-Profit Analysis
· Life cycle cost analysis
· Capital Budgeting
· Strategic Planning Strategic Management Advise
· Internal Financial Presentation and Communication
· Sales and Financial Forecasting & Annual Budgeting
· Cost Allocation
· Resource Allocation and Utilization
Emerging Themes of Management Accounting: –
· Customer Orientation
· Cross-functional Perspective
· Global Competition
· Total Quality Management
· Time as a Competitive Element
· Advances in Information Technology
· Advances in the Manufacturing Environment
· Deregulation and Growth in the Service Industry
· Activity-based Management
Code of Conduct for Management Accountants: –
Practitioners of management accounting and financial management have an obligation to the public, their profession, the organization they serve, and themselves, to maintain the highest standards of ethical conduct. In recognition of this obligation, the Institute of management Accountants has promulgated the following standards of ethical conduct for practitioners of management accounting and financial management. Adherence to these standards internationally is integral to achieving objective of management accounting. Standards of Ethical Conduct for Management Accountants are:-
· Competence
· Confidentiality
· Integrity
· Objectivity
Competence:
Practitioners of management accounting and financial management have a responsibility to:
· Maintain an appropriate level of professional competence by ongoing development of their knowledge and skills.
· Perform their professional duties in accordance with relevant laws, regulations and technical standards.
· Prepare complete and clear reports and recommendations after appropriate analysis of relevant and reliable information
Confidentiality:
Practitioners of management accounting and financial management have a responsibility to:
· Refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally obligated to do so.
· Inform subordinates as appropriate regarding the confidentiality of information acquired in the course of their work and monitor their activities to assure the maintenance of that confidentiality
· Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage either personally or through third parties.
Integrity:
Practitioners of management accounting and financial management have a responsibility to:
- Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict.
- Refrain from engaging in any activity that would prejudice their ability to carry out their duties ethically.
- Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions.
- Refrain from either activity or passively subverting the attainment of the organization’s legitimate and ethical objectives.
- Recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity.
- Communicate unfavorable as well as favorable information and professional judgment or opinion.
- Refrain from engaging or supporting any activity that would discredit the profession.
Objectivity:
Practitioners of management accounting and financial management have a responsibility to:
- Communicate information fairly and objectively
- Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented.
Resolution of Ethical Conflicts:
In applying the standard of ethical conduct, practitioners of management accounting and financial management may encounter problems in identifying unethical behavior or in resolving an ethical conflict.
When faced with significant ethical issues practitioners of management accounting and financial management should follow the established policies of the organization bearing on the resolution of such conflict. If these policies do not resolve the ethical conflict, such practitioner should consider the following course of action.
· Discuss such problems with immediate superior except when it appears that superior is involved, in which case the problem should be presented to the next higher managerial level. If a satisfactory resolution cannot be achieved when the problem is initially presented, submit the issue to the next higher managerial level.
· If the immediate superior is the chief executive officer or equivalent, the acceptable reviewing authority may be a group such as the audit committee, executive committee, board of directors, board of trustees, or owners. Contact with a level above the immediate superior should be initiated only with the superior’s knowledge. Assuming the superior is not involved. Except where legally prescribed, communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate.
· Clarify relevant ethical issues by confidential discussion with an objective adviser to obtain a better understanding of possible course of action
· Consult your own attorney as to legal obligations and rights concerning the ethical conflict.
· If the ethical conflict still exists after exhausting all levels of internal review, there may be no other recourse on significant matters than to resign from the organization and to submit an informative memorandum to an appropriate representative of the organization. After resignation, depending on the nature of the ethical conflict, it may also be appropriate to notify other parties.
Ethics & the Management Accountant:-
When management accounting information is used for control, management accountants may find themselves in complex situations, fraught with conflict.
· Especially when it is used for performance evaluation
Pressure may be exerted to influence the numbers to make a favored product, customer, or line of business appear more profitable than it actually is. Department managers may distort information so that unfavorable factors are not revealed in a management accounting report.
· The cost of inefficient processes
· The existence of substantial amounts of excess capacity
Senior executives whose incentive compensation is based on the reported financial numbers may put pressure on accountants.
· To recognize revenue from a customer early
· To defer until subsequent periods the recognition of an expense
In some circumstances, to recognize certain expenses early so that much higher earnings may be reported in future periods.
All of these behaviors were evident in the frauds dominating the financial news in recent years. Organizational leadership plays a critical role in fostering a culture of high ethical standards.
The way an individual responds to pressure derives from inner values and beliefs, but individuals are strongly influenced by their view of organizational standards. If individuals see unethical or illegal behavior practiced by the organization’s leaders and superiors or coworkers, they may feel that such behavior is accepted and sanctioned. An individual without a strong set of personal beliefs and values may find it difficult to withstand the pressure to “go along with the flow” and participate in this behavior when a difficult or conflicting situation arises.
- Such as being asked to misrepresent an organization unit’s performance potential when the unit is being offered for sale.
Beyond the example set by senior executives, companies may use two types of control systems to foster high ethical standards among their employees.
· Beliefs systems
· Boundary systems
A beliefs system is the explicit set of statements, communicated to employees, of the basic values, purpose, and direction of the organization:
· Credos
· Mission statements
· Vision statements
· Statements of purpose or values
The statements in a beliefs system are intended to inspire and promote commitment to the organization’s core values and its purpose for being in business.
When conflicting situations arise, however, the lofty rhetoric in the statements will only have true meaning and serve as guides to actions if employees observe senior managers acting according to the statements. In this way, employees learn that the company’s stated beliefs represent deeply rooted and actionable values. Articulate and actionable beliefs systems may inspire people to higher values and aim at higher missions but they may not communicate clearly what behavior and actions are unacceptable.
Companies also need boundary systems that communicate what actions must never be taken. Boundary systems are stated in negative terms, or in minimal standards of behavior
- Intended to constrain the range of acceptable behavior.
For example, the organization might tell employees in the Purchasing Department that accepting any gifts under any circumstances from suppliers will result in immediate termination. Boundary systems also include clear communication of the laws under which the company operates.
- Examples include antitrust laws; zero tolerance for sexual, racial, and gender discrimination and harassment; environmental, health, and safety laws; and foreign corrupt practices regulations.
Management accountants, like all employees, must be aware of and be deeply committed to act in ways that do not violate their organization’s code of conduct and societal laws governing organizational behavior and actions.
As designers and custodians of the organization’s reporting and control systems, they have an additional obligation to ensure that such boundary systems exist in their organization, and that the boundary systems are clearly communicated throughout the organization.
They should also monitor that senior executives act quickly and decisively when behavior in violation of these standards is detected.
- If violations are detected but not acted upon, management accountants can communicate with the audit committee of the board of directors, who are the shareholders and society’s representatives in the organization.
Management accountants, as members of a profession, also operate with an additional boundary system: the code of behavior promoted or advocated by their industry and professional association.
· ICAB
· ICMA
Professional organizations usually establish ethical norms and codes of professional conduct for their members.
The professional association can monitor and police its norms and codes through peer reviews
- They have procedures for disciplinary action when violations are detected.
Many of the guidelines are phrased in terms of what management accountants should not do, consistent with how boundary systems operate.
Evaluation of management Accounting Technique
Chapter Covers By Following Topic:-
| Need for Managerial Accounting Information |
| Various Costing Technique Use by Management for Making Decision |
| The Role of Cost Accounting in Managerial Decision Making |
| Tools for Management Support |
| Cost Accounting- A Tool for Managerial Accounting |
Need for Managerial Accounting Information:-
Every organization-large and small-has managers. Someone must be responsible for making plans, organizing resources, directing personnel, and controlling operations. Every where, mangers carry out three major activities-planning, directing and motivating, and controlling.
Planning:
Planning involves selecting a course of action and specifying how the action will be implemented. The first step in planning is to identify the alternatives and then to select from among the alternatives the one that does the best job of furthering the organization’s objectives. While making choices, management must balance the opportunity against the demands made on the company’s resources.
The plans of management are often expressed formally in budgets, and the term budgeting is applied to generally describe the planning process. Budgets are usually prepared under the direction of controller, who is the manager in charge of the accounting department. Typically, budgets are prepared annually and represent management’s plans in specific, quantitative terms.
Directing and Motivating:
In addition to planning for the future, managers must oversee day-to-day activities and keep the organization functioning smoothly. This requires the ability to motivate and affectively direct people. Managers assign tasks to employees, arbitrate disputes, answer questions, solve on-the-spot problems, and make many small decisions that affect customers and employees. In effect, directing is that part of the manager’s work that deals with the routine and the here and now. Managerial accounting data, such as daily sales reports are often used in this type of day-to-day decision making.
Controlling:
In carrying out the control function, managers seek to ensure that the plan is being followed. Feedback, which signals operations are on track, is the key to effective control. In sophisticated organizations, this feedback is provided by detailed reports of various types. One of these reports, which compares budgeted to actual results, is called a performance report. Performance report suggests where operations are not proceeding as planned and where some parts of the organization may require additional attention.
The Planning and Control Cycle:
The work of management can be summarized in a model. The model, which depicts the planning and control cycle, illustrates the smooth flow of management activities from planning through directing and motivating, controlling, and then back to planning again. All of these activities involve decision making. So it is depicted as the hub around which the activities revolve.
Management Accounting As a Profession:-
An understanding of the professional status of the management accountant will clarify the ongoing need to re-evaluate the important role that management accountants fulfill in business. The professional status of the management accountant has always been in dispute. Understanding the different approaches to the study of professionalism and professions would help to determine whether management accounting is a profession or not. According to McMillan, professions survive through the ages despite changes in the environment whereas skills do not. In terms of the statement by McMillan above, it is evident that if management accountants enjoyed professional status, they would have a better chance of survival in the long term. Studies on professionalism utilize a number of theoretical and sociological perspectives, and the Marxist, Weber and Trait approaches are the most prominent. The above approaches endeavor to understand the notion of professionalism within a specific frame of reference.
Various Costing Technique Use By Management For Making Decision: –
Costing- A strong manager must understand how costs are captured and assigned to goods and services. This is more complex than most people realize. Costing is such an extensive part of the management accounting function that many people refer to management accountants as “cost accountants.” But, cost accounting is only a subset of managerial accounting applications. With that in mind, we focus on cost accounting –
Cost accounting–can be defined as the collection, assignment, and interpretation of cost. It is important to know what products and services cost to produce. The ideal approach to capturing costs is dependent on what is being produced. Some companies produce homogenous products in continuous processes.
For example:- considering the costing issues face by the companies that produce the lumber, paint, bricks or other such homogenous components used in building a home. These types of items are produced in continuous processes where costs are pooled together during production, and output is measured in aggregate quantities. It is difficult to see specific costs attaching to each unit. To deal with these types of situations, accountants might utilize “Process Costing Methods.”
Profit is the yard-stick for evaluating performance of any business concern. Since ultimate profit depends upon plan and control, cost accounting plays a vital role for this ground. Cost accounting was mostly engaged in ascertaining costs of products or service on the basis of time-series analysis. Due to competition and technological development, the role has shifted under the managerial accounting to cost reduction which depends upon availability of relevant information well in time. No such restriction is imposed in case of costing accounting since it is used internally for decision making under managerial accounting.
Uses of different techniques: – Absorption, variable and throughput costing are alternative product-costing methods. The difference is treatment of certain cost elements-
Under absorption or full cost method, all manufacturing costs are treated as product costs.
Variable costing covers only variable costs while all fixed costs are treated as period costs. This type is more suitable for operational decisions as fixed cost, being committed, is irrelevant for most decisions.
In present high tech, environment, direct labor has disappeared. The only throughput costs vary with the change in production. This would reduce the incentive to over produce to cut down cost per unit. The only common feature among the various methods is the focus or stress on providing information for decision-making, since some techniques are used only internally.
The Role of Cost Accounting in Managerial Decision Making: –
There are various types of costing tools like – Contract costing, marginal costing/variable costing & how this tool helps in managerial decision making, it helps the business to know its BEP means help the business knowing the minimum output required to carry on the business to earn the profits.
· Cost accounting is the process of tracking, recording and analyzing costs associated with the products or activities of an organization.
Managers use cost accounting tools o support decision making to reduce a company’s costs and improve its profitability. As a form of management accounting, cost accounting need not follow standards such as GAAP, because its primary use is for internal managers, rather than external auditors, and what to compute is instead decided pragmatically.
Costs are measured in units of nominal currency by convention. Cost accounting can be viewed as translating the Supply Chain into financial values.There are at least four approaches:
· Standardized Cost Accounting
· Activity-based Costing
· Throughput Accounting
· Marginal Costing – as a management accounting tool
Cost accounting has long been used to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution, when the complexities of running a large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions. In the early industrial age, most of the costs incurred by a business were what modern accountants call “variable costs” because they varied directly with the amount of production. Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes.
Some costs tend to remain the same even during busy periods, unlike variable costs which rise and fall with volume of work. Over time, the importance of these “fixed costs” has become more important to managers. Examples of fixed costs include the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production control, purchasing, quality control, storage and handling, plant supervision and engineering. In the early twentieth century, these costs were of little importance to most businesses. However, in the twenty-first century, these costs are often more important than the variable cost of a product, and allocating them to a broad range of products can lead to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing.
Standard Costing:-
In modern cost accounting, the concept of recording historical costs was taken further, by allocating the company’s fixed costs over a given period of time to the items produced during that period, and recording the result as the total cost of production. This allowed the full cost of products that were not sold in the period they were produced to be recorded in inventory using a variety of complex accounting methods, which was consistent with the principles of GAAP. It also essentially enabled managers to ignore the fixed costs, and look at the results of each period in relation to the “standard cost” for any given product.
For example: If a supplies company normally produced 40 calculator per month, and the fixed costs were still Tk.1000/month, then each calculator could be said to incur an overhead of Tk.25 (Tk.1000/40). Adding this to the variable costs of Tk.300 per calculator produced a full cost of Tk.325 per coach. This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor.
For example: if the supplies company made 100 calculator one month, then the unit cost would become Tk 310 per calculator (Tk 300 + (Tk 1000/100)). If the next month the company made 50 calculator, then the unit cost = Tk 320 per calculator (Tk 300 + (Tk 1000/50)), a relatively minor difference.
An important part of standard cost accounting is a variance analysis which breaks down the variation between actual cost and standard costs into various components (volume variation, material cost variation, labor cost variation, etc). So managers can understand why costs were different from what was planned and take appropriate action to correct the situation.
Development of Throughput Accounting: –
As business became more complex and began producing a greater variety of products; the use of cost accounting to make decisions to maximize profitability came under question. Management circles became increasingly aware of the Theory of Constraints, and began to understand that “every production process has a limiting factor” somewhere in the chain of production. Under Managerial accounting – as business management learned to identify the constraints, they increasingly adopted throughput accounting to manage them and “maximize the throughput return” from each unit of constrained resource.
Activity-based costing:-
Activity-based costing (ABC) is a system for assigning costs to products based on the activities they require. In this case, activities are those regular actions performed inside a company. “Talking with customer regarding invoice questions” is an example of an activity performed inside most companies. Accountants assign 100% of each employee’s time to the different activities performed inside a company. The accountant then can determine the total cost spent on each activity by summing up the percentage of each worker’s salary spent on that activity. A company can use the resulting activity cost data to determine where to focus their operational improvement efforts.
For example, a job based manufacturer may find that a high percentage of their workers are spending their time trying to figure out a hastily written customer order. Via ABC, the accountants now have a currency amount that will be associated with the activity of “Researching Customer Work Order Specifications”. Senior management can now decide how much focus or money to budget for the resolutions of this process deficiency. Activity-based management includes the use of activity-based costing to manage a business.
Marginal Costing/ Variable costing:-
“Marginal costing as a management accounting tool”
The current state of standard costing focuses on the methodology of Marginal Costing. Marginal Costing is a type of flexible standard costing that separates fixed costs from proportional costs in relation to the output quantity of the objects. In particular, Marginal Costing is a comprehensive and sophisticated method of planning and monitoring costs based on resource drivers. Selecting the resource drivers and separating the costs into fixed and proportional components ensures that cost fluctuations caused by changes in operating levels, as defined by marginal analysis, are accurately predicted as changes in authorized costs and incorporated into variance analysis.
This form of internal management accounting has become widely accepted in business practice. However, the demands placed on costing systems by cost management requirements have changed radically. For this reason, we focus on the cost accounting tool- Marginal Costing is currently integrated into management accounting. This method is used particularly for short-term decision-making. Its principal tenets are:-
Revenue (per product) – Variable Costs (per product) = Contribution (per product)
Total Contribution – Total Fixed Costs = Total Profit or (Total Loss)
Thus it does not attempt to allocate fixed costs in an arbitrary manner to different products. The short-term objective is to maximize contribution per unit. If constraints exist on resources, then Managerial Accounting dictates that marginal cost analysis be employed to maximize contribution per unit of the constrained resource.
Tools for Management Support: –
A wide variety of accounting tools address that “why” and “how” of entity success or failure. Many tools are proactive, helping us make sound decisions, and some are predictive, peering into the future. When one develop an understanding of cost and revenue structure, the interaction of encounters with revenue and expenses, and the amount and rate of change from volume changes.
Cost-Volume-Profit:-
The single most important concept for management is cost-volume-profit. Understanding the cost structure of an organization allows proper management decisions. Standard financial statements do not provide the proper cost separation, that is – variable costs versus fixed costs.
Variable cost: a cost that moves up or down as volume of service changes
Fixed cost: a cost that remains the same despite volume (within a relevant range)
A typical fixed cost is space rental. Whether five patients a day or 50 a day for lease is probably the same amount. A typical variable cost is medical supplies. The more patients cause the more supplies use. In real life some of these costs are considered “mixed” but for most management purposes we consider only two cost behaviors.
Break-even point:-
Break-even point becomes a key benchmark; being defined as the point at which fixed and variable costs equal revenue, or the point at which profit is zero. The break-even formula is as follows: (Revenue – variable cost) = fixed costs
Contribution margin = fixed costs
As volume grows we get to leverage the fixed costs, revenue climbs but variable costs climb little and fixed costs not at all.
CVP is critical for decision making, for example adding a new service. Usually the only relevant numbers are the new revenue versus the new expenses, assuming adequate capacity. Understanding which numbers are relevant is the key to a sound decision. With a relatively low variable cost line, additional services require very little incremental spending.
Cost-Benefit Issues:-
There are plenty of accounting tools at for one’s disposal, but those tools should only used when there is a positive cost-benefit relationship. Modern systems and one’s own creativity allow us plenty of information options, but not all options are worth the work involved. The ideal is to create enough information to improve management, without spending so much as to wipe out the benefit.
Cash Flows:-
Any business organization exists for one reason, to generate positive cash flow for the owners. The devil of business is in the details. Effective cash flow management is a key task for senior management, and anticipating cash flow ups and downs is critical.
Budgeting:-
A budget is a management plan expressed in numbers. Decisions are more important than calculations. Spreadsheets have made budgeting much easier and more flexible. Once a budget model is developed, numerous options can be calculated very quickly. Budgets should be flexible rather than static. If one budget for 10,000 patient visits and you reach 15,000 patient visits, his static budget is worthless.