Introduction to Management Accounting
What is accounting?
Accounting is an information system. It exists to provide information for the end-user. It is possible to distinguish between two branches of accounting.
1 Financial accounting.
The purpose of financial accounting is to report the financial performance of the company. It’s main focus is on external reporting to a number of groups viz.
Owners ( shareholders )
Loan creditors ( banks )
Trade creditors (suppliers )
Sundry creditors ( suppliers of services )
Government agencies ( tax authorities )
Employees ( trade unions )
A set of financial statements - a profit and loss account, a balance sheet and a cash flow statement are prepared and published.
Management accounting
The main purpose of management accounting is to provide information to the management team at all levels within the organisation for the following purposes:
(a) formulating the policies - strategic planning
(b) planning the activities of the organisation - corporate planning
(c) controlling the activities of the organisation
(d) decision-making - long-term and tactical
(e) performance appraisal at strategic and operational level
Definition: Management accounting is the application of professional knowledge and skill in the preparation and presentation of accounting information in such a way as to assist management in the formulation of policies and in planning and controlling the operations of the organisation.
Let us look at a simple financial statement.
Example Financial Accounts
£ | £ | |
Sales | 30,000 | |
Cost of sales | 24,000 | |
-------- | ||
Gross profit | 6,000 | |
-------- | ||
Deduct | ||
Administration expenses | 2,000 | |
Selling and distribution expenses | 1,000 | |
-------- | 3,000 | |
-------- | ||
Net profit | 3,000 | |
-------- |
Financial accounts indicate the results of a business over a period of time. They deal with historic or past costs and are concerned with stewardship accounting.
A management accounting/ cost statement provides information to allow managers to plan, control and organise the activities of the business. The purpose of a costing/maagement accounting information system is:
1 to provide information about product costing to be used in financial
statements.
2 to provide information for planning, controlling and organising.
The information provided by the costing system should be:
relevant
reliable
timely
succinct
presented in the desired format.
A cost system should be
cost effective
appropriate for the organisation
encourage managerial action.
Example Management Accounts
Products | ||||
A | B | C | Total | |
Materials | £4,800 | £3,700 | £6,500 | £15,000 |
Wages | 1,500 | 2,500 | 3,000 | 7,000 |
Prod. overhead | 500 | 600 | 900 | 2,000 |
------- | ------- | ------- | ------- | |
Prod. cost | 6,800 | 6,800 | 10,400 | 24,000 |
Admin. costs | 700 | 800 | 500 | 2,000 |
Selling costs | 300 | 400 | 300 | 1,000 |
------- | ------- | ------- | ------- | |
Total cost | 7,800 | 8,000 | 1,200 | 27,000 |
Sales | 10,240 | 10,800 | 8,960 | 30,000 |
Profit | 2,240 | 2,800 | ---- | 3,000 |
(Loss) | ---- | ---- | (2,240) | ---- |
Net profit margin | 24% | 26% | ---- | 10% |
------- | ------- | ------- | ------- |
This performance statement is of the same business as the previous example of
financial accounts. However, it gives management much more information. It analyses the cost elements in respect to materials, labour and overheads allowing management to focus on costs which require investigation and control. It facilitates decision-making. E.g. should product C be discontinued?
Compared to the financial accounts the management accounting information which is much more comprehensive will allow management to better carry out their functions of planning, controlling organising and decision-making.
Cost classification
The management accountant will use cost information for two main reasons.
1 to ascertain the cost of a product. This information is used to value stock which is required for external reporting .
2 to assist management in the decision-making process.
Depending on the cost objective the costs will be classified into a number of categories.
(a) By nature of resource
(i) Materials
(ii) Labour
(iii) Other Expenses
(b) By type of cost
(i) Direct Costs
(ii) Indirect Costs - Overheads
(c) By function
Production, Administration, Selling and Distribution
(d) By the behaviour of costs
(i) Fixed or Periodic Costs
(ii) Variable Costs
(iii) Semi-fixed, or Semi-variable Costs
Cost Objectives
(a) Product costing
It is essential for an organisation to ascertain the cost of manufacturing a product. The information is used for two purposes:
1 to determine the value of closing stock which is required for the financial statements viz. the profit and loss account and the balance sheet.
Direct materials £X
Direct labour £X
Direct expense £X
-----
Prime cost £X
Production overheads £X
-----
Production cost £X
-----
2 Also some businesses use a cost plus pricing strategy. The product cost is calculated and a mark up percentage is added to arrive at a selling price which gives a reasonable gross profit which in turn can cover the non-production overheads and leave a satisfactory net profit.
(b) Decision making - Cost behaviour
The classification of costs into variable, fixed and semi-fixed is important in terms of decision-making and cost control, activities that comprise the fundamentals of the management accounting function.
Variable costs are those costs which increase/decrease with the level of production and sales. In a manufacturing company the variable production costs change directly with the level of production.
Fixed costs can be either committed fixed costs or discretionary fixed costs. Fixed costs are termed fixed because they do not change in response to changes in the level of activity. It should be noted that they are not fixed because they do not change because cost items like rent is often subject to revision.
Semi-fixed/semi-variable costs are costs which move in the same direction but not at the same rate as the level of activity. The semi-fixed/semi-variable cost contains a fixed and a variable element. For example, the electricity bill contains a fixed or standing charge and and the variable aspect which depends on usage.
Cost ascertainment
It is important that the management accountant can determine the variable and fixed costs and there are a number of techniques to assist in separating the fixed and variable elements of semi-fixed or semi-variable costs.
1 Analysing costs by direct observation of the resources required to convert materials into a finished product and applying costs to these activities. Direct materials, direct labour and machine time can be established quite easily.
2 By inspecting the accounts the accountant can classify costs as being variable or fixed.
3 High-low method. This method entails selecting the period of highest and lowest levels of activity and comparing the changes in costs that result from the two levels.
Example
Output 10000units £30000
15000units £40000
£40000 - £30000 = £10000/
15000units - 10000= 5000units = £2per unit.
The fixed costs therefore are £10000.
Nice post. Thanks for sharing such a valuable information among the users about management accounting. I got great information from your post. Keep doing such a posting.
ReplyDelete_____________________________________________
Sell Structured Insurance Settlement