Introduction to Management Accounting

 

We begins by distinguishing between accounting, management accounting, financial accounting and cost accounting.

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

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.

FINANCIAL ACCOUNTING, MANAGEMENT ACCOUNTING AND COST 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

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.

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

•             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.

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)

	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.

ATTRIBUTES OF GOOD INFORMATION

 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 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.

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

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

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.

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.

ii.          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

iii.          Organizing

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.

iv.          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.

v.            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.