INSCAE

MANAGEMENT
ACCOUNTING
Master 1 Finance

Hery-Zo TSIRAFESY
January 2020
 MANAGEMENT ACCOUNTING M1 Finance

Chapter I

INTRODUCTION

1. Management accounting

A useful starting point is to acknowledge the general role of accounting, which is to help
people make informed business decisions. All forms of accounting, including management

accounting, are concerned with collecting and analysing financial information and then
communicating this information to those making decisions.

One simple definition of management accounting is the provision of financial and non-
financial decision-making information to managers1.

Management Accounting is also known as Managerial Accounting.

1.1. Three areas of management accounting

The American Institute of Certified Public Accountants (AICPA) states that management

accounting as 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.

1
Burns, Quinn, Warren & Oliveira, Management Accounting, McGraw-Hill, London, 2013

Hery-Zo Tsirafesy – January 2020 1

  Risk management

Contributing to frameworks and practices for identifying, measuring, managing and

reporting risks to the achievement of the objectives of the organization.

1.2. Comparison of management accounting and financial accounting

Management accounting information differs from financial accounting information in

several ways:

 Users of information

Financial accounting is concerned with reporting to external parties such as owners,

analysts and creditors.

Only managers within the organization use the normally confidential management
accounting information.

 Standards

Financial accounting information is computed by reference to general financial accounting

standards (IFRS, GAAP, PCG, etc.)

Management accounting information is computed by reference to the needs of managers,

often using management information systems.

 Focus

Financial accounting focusses on the company as a whole, and provides summarized or

aggregated data for an entity.

Management accounting provides detailed and disaggregated information about

products, individual activities, divisions, plants, operations and tasks.

 Methodology

Financial accounting information is historical.

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Management accounting information is primarily forward-looking.

 Principles

Financial accounting information is case-based.

Management accounting information is model-based with a degree of abstraction in order

to support generic decision making;

1.3. The profession of management accounting : dual role of management

accountants

Management accountants are responsible for managing the business team and at the same
time having to report relationships and responsibilities to the corporation’s finance
organization and finance of an organization.

A management accountant is person interpreting “financial language” to “business

language”.

The activities management accountants provide inclusive of forecasting and planning,

performing variance analysis, reviewing and monitoring costs inherent in the business are
ones that have dual accountability to both finance and the business team.

Examples of tasks where accountability may be more meaningful to the business

management team vs. the corporate finance department are the development of new

product costing, operations research, business driver metrics, sales management

scorecarding, and client profitability analysis.

Conversely, the preparation of certain financial reports, reconciliations of the financial data
to source systems, risk and regulatory reporting will be more useful to the corporate

finance team as they are charged with aggregating certain financial information from all
segments of the corporation.

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Managers make numerous decisions during the day-to-day operations of a business and
in planning for the future. Managerial accounting provides much of the information used

for these decisions.

Some examples of managerial accounting information are listed below.

 Identifying and calculating the cost of a product or service, using a given cost
accounting technique.
 Explaining the performance of a unit or of a project and suggesting
improvements on cost reduction and/or higher profitability.
 Analysing the cost and benefit of a one-shot operation launched by the
company.
 Plan the resources required by a launching of a new concept and suggest on
the strategy to be adopted.
 Compare the actual and the planned results of a project and explain its
performance.

1.4. Related qualifications

There are several related professional qualifications and certifications in the field of
accountancy including:

 Chartered Management Accountant (CIMA)

 Certified Management Accountant (CMA)
 Chartered Certified Accountant (ACCA)
 Chartered Accountant (CA, ACA, National CA : DEC, DEX)
 Certified Public Accountant (CPA)
 Certified Practicing Accountant (CPA Australia)
 Chartered Global Management Accountant (CGMA)
 Chartered Institute of Public Finance and Accountancy (CIPFA)
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Chapter II

PLANNING, DIRECTING, AND CONTROLLING

1. Managing

Managing requires more skill sets. Among these skills are vision, leadership, and the ability
to procure and mobilize financial and human resources.

Managers are especially required to take numerous decisions as part of their function.
Some decisions are more regular but some need more comprehensive information as they

may be strategic for the company.

Business Value

Management
Decisions

Planning Directing Controlling

Business value results from good management decisions.

Management accounting comes in providing the information needed to fuel the decision-

making process.

Managerial decisions can categorized according to three interrelated business processes:

Planning, Directing and Controlling. Correct execution of each of these activities culminates

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in the creation of business value. Conversely, failure to plan, direct or control is a roadmap
to business failure.

Let’s now take a closer look at the component of Planning, Directing and Controlling.

2. Planning

Planning

Strategy Positioning Budget

Planning is about thinking ahead.

Planning starts by setting a strategy. Then, it moves to broad-based thought about how to

establish an optimum “position” to maximize the potential of realizations of goals. Finally,

planning must be undertaken from the perspective of thoughtful consideration of financial

outcomes (budgets).

2.1. Strategy

Strategic planning is the process of deciding on objectives of the organisation, on changes

in these objectives, on the resources used to attain these objectives, and on the strategies

that are to govern the acquisition, use and disposition of these resources.
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Specific strategy setting can take many forms, but generally, includes elements pertaining
to the definition of core value, mission, and objectives.

2.2. Positioning

Positioning is about to assess the strategic position of an organization (environmental

analysis, capabilities and assumptions, culture, stakeholders) and to proceed to a strategic

choice.

2.3. Budget

Budget is the financial perspective of the strategic choice of the organization. For example,
if it choose to pursue a growth strategy by external development (merger acquisition),

budget should show the financial results of this strategy and highlights the constraints
(external financing, human resources, etc.).

3. Directing

Directing is concerned with realizing the plan.

Managerial accounting supports the “directing” function in many ways. Area of supports
include Costing, Production and Special Analysis.

Directing

Costing Production Analysis

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 3.1. Costing

Cost accounting can be defined as the collection, assignment, and interpretation of cost.
In the subsequent chapter, we will go in depth into the costing techniques.

3.2. Production

Successfully directing requires prudent management of production.

Production management is about running a “lean” business model. This means that costs
must be minimized and efficiency maximized, while seeking to achieve enhanced output

and quality standards.

Managerial accounting provides numerous tools for managers to use in support of

production and production logistics, such as managing inventory (just-in-time technique

or economic order quantity), managing quality of services.

3.3. Analysis

Analysis entails more information and reflexion about business decisions to be taken by
the managers such as make-or-buy decisions, outsourcing of production or support
functions, pricing decisions, investing and financing decisions, and so forth.

Managerial accounting provides theoretical models of calculations that are needed to

support these types of decisions.

Subsequent chapters will provide insight into logic and methods that need to be employed

to manage these types of decisions.

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4. Controlling

Controlling relates to the “Check” and “Act” of the Deming Cycle of management process.
In other words, after the “Plan” and “Do” processes, management must take a concerted

effort to monitor (check) and adjust for derivations (act).

Controlling

Certification and
Reliability

Monitor Scorecard

Flexible
Standard Costs Variances Balance Improvement
Tools

4.1. Certification and Reliability

After several major accounting scandals in the early 2000’s perpetrated by companies such

as Enron, Tyco, and WorldCom, several countries mandated strict reforms to improve
financial disclosures from corporations and prevent accounting fraud (SOX in the USA,

EuroSOX in Europe or Internal Control Report in Madagascar).

In this context, managers (CEOs and CFOs) are required to enhance internal controls and

to certify the accuracy of financial reports.

4.2. Monitor

Monitoring is about following some indicators to ensure the good conditions of “driving”

the business. In case of significant variance or warning signs, corrective actions must be
taken to correct the situation.

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 4.3. Scorecard

Scorecard retains an emphasis on achieving both financial and non-financial objectives,

which can be perceived as the performance drivers of these financial objectives.

Increasingly, companies realize that financial measures and outcomes alone are not
sufficient to explain or assess the performance.

With a scorecard approach, companies attempt to measure, using predefined “scores”,

both financial and non-financial performance, or both short-term and long-term

performance, or goals and the methods for attaining those goals.

Scorecard may be balanced (see Balanced Scorecard by Kaplan & Norton) or focused on

improvements to be made (for example, TQM).

So far, this chapter has provided snippets of how management accounting supports
organizational planning, directing, and controlling.

The next chapters will explain specific techniques related to these three dimensions of
management (planning, directing, and controlling) for the purpose of taking the right
decision.
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Chapter III

COST ACCOUNTING

Cost accounting is a task of collecting, analyzing, summarizing and evaluating various

alternative courses of action.

Its goal is to advise the management on the most appropriate course of action based on

the cost efficiency and capability. Cost accounting provides the detailed cost information
that management needs to control current operations and plan for the future.

Classification of costs

Classification of cost means, the grouping of costs according to their common

characteristics. The important ways of classification of costs are:

1. By Element: There are three elements of costing i.e. material, labor and expenses.

2. By Nature or Traceability: Direct Costs and Indirect costs. Direct Costs are directly
attributable/traceable to Cost object. Direct costs are assigned to Cost Object. Indirect
Costs are not directly attributable/traceable to Cost Object. Indirect costs are allocated or

apportioned to cost objects.

3. By Functions: production, administration, selling and distribution, R&D.

4. By Behavior: fixed, variable, semi-variable. Costs are classified according to their behavior
in relation to change in relation to production volume within given period of time. Fixed

Costs remain fixed irrespective of changes in the production volume in given period of
time. Variable costs change according to volume of production. Semi-variable costs are

partly fixed and partly variable.

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5. By control ability: controllable, uncontrollable costs. Controllable costs are those which
can be controlled or influenced by a conscious management action. Uncontrollable costs

cannot be controlled or influenced by a conscious management action.

6. By normality: normal costs and abnormal costs. Normal costs arise during routine day-

to-day business operations. Abnormal costs arise because of any abnormal activity or event
not part of routine business operations. E.g. costs arising of floods, riots, accidents etc.

7. By Time: Historical costs and predetermined costs. Historical costs are costs incurred in
the past. Predetermined costs are computed in advance on basis of factors affecting cost

elements. Example: Standard Costs.

8. By Decision making Costs: These costs are used for managerial decision making.

 Marginal costs: Marginal cost is the change in the aggregate costs due to change in
the volume of output by one unit.

 Differential costs: This cost is the difference in total cost that will arise from the
selection of one alternative to the other.

 Opportunity costs: It is the value of benefit sacrificed in favor of an alternative course

of action.
 Relevant cost: The relevant cost is a cost which is relevant in various decisions of

management.
 Replacement cost: This cost is the cost at which existing items of material or fixed

assets can be replaced. Thus this is the cost of replacing existing assets at present
or at a future date.

 Shutdown cost: These costs are the costs which are incurred if the operations are
shut down and they will disappear if the operations are continued.

 Capacity cost: These costs are normally fixed costs. The cost incurred by a company
for providing production, administration and selling and distribution capabilities in

order to perform various functions.

 Sunken cost: cost already incurred.
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1. Standard Costing

A standard cost for a product or service is a predetermined unit cost set under specified
working conditions.

This method essentially enables managers to ignore the fixed costs, and look at the results
of each period in relation to the “standard cost” for any given product.

Example 1:

A bakery normally produced 600.000 breads per month, and the fixed costs are Ar

1.200.000/month.

Using, standard costing, it could be said that each bread incurs an operating cost/overhead

of Ar 20. Say that variable costs are Ar 300, then each bread has a full cost of Ar 320.

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.

Example 2:

If the bakery made 500.000 breads a month, then the operating cost would be Ar 24 per

bread, and the unit cost would become Ar 324, a relatively minor difference.

1.1. Use of standard cost

The main purposes of standard costs are:

 Control: the standard cost can be compared to the actual costs and any differences
investigated.

 Planning: standard costing can help with budgeting.

 Performance measurement: any differences between the standard and the actual
cost can be used as a basis for assessing the performance of cost centre managers.

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  Inventory valuation: for internal and/or external use.
 Accounting simplification: there is only one cost, the standard.

 Pricing: as a basis of pricing decision

Standard costing is most suited to organisations with:

 mass production of homogenous products

 repetitive assembly work.

Standard costing is less suited to organisations that produce non homogenous products
or where the level of human intervention is high.

To complete and enhance standard cost accounting, managers may require variance
analysis method, which breaks down the variation between actual cost and standard costs

into various components (volume variation, material cost variation, labour cost variation,
etc.).

Example 3:
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2. Throughput accounting
2.1. Introduction

This method deals with managing the limited factor in order to maximize profitability. The

Theory of Constraints has an important place with this method, and it tends to identify and
manage each unit of constrained resource and then “maximize the throughput profit”.

Throughput accounting aims to make the best use of scarce resources (bottleneck) in a JIT
environment.

In this section we will look at key factor analysis first, and then explain how this may be
adapted in a modern environment to perhaps a more meaningful approach known as

throughput accounting.

2.2. Key Factor Analysis

In a situation where we are manufacturing several products, all of which use the same

limited resource, then we need to decide on how best to use the limited resource in
production.

The standard key factor approach is to rank the products on the basis of the contribution
earned per unit of the limited resources.

Example 1
Lobaka SARL manufactures 2 products, Fohy and Lava. The cost cards are as follows:
Fohy Lava
Selling price 30,000 35,000
Materials 10,000 22,000
Labour 6,000 4,000
Other variable costs 8,000 3,000
Fixed costs 2,500 2,500
26,500 31,500
Profit Ar 3,500 Ar 3,500
Machine hours p.u. 2 hrs 1 hr

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Maximum demand 30,000 units 15,000 units
The total hours available are 60,000.

Calculate the optimum production plan and the maximum profit using conventional key

factor analysis.

2.3. Throughput accounting