LECTURE NOTES

Three objectives of management accounting: Three roles of management accountants

1. To provide information for costing services, • Problem-solving: comparative analysis for decision
products, and other objects of interest to
making
management.
2. To provide information for planning, controlling, • Scorekeeping: accumulating data and reporting
evaluation, and continuous improvement. reliable results
3. To provide information for decision making. • Attention directing: The function of managerial-
accounting information in pointing out to managers
issues that need their attention, thereby helping
managers properly focus their attention.

Distinctions Between Management Accounting and Financial Accounting

Management Accounting Financial Accounting

Targeted user: internal users external users

managers stockholders and creditors

Restrictions: no mandatory rules for preparing must follow GAAP when preparing
reports financial statements

Types of information: financial and nonfinancial information financial information

Time orientation: emphasizes the future (planning and historical orientation (reports what
decision making) has already occurred)

Aggregation: detailed information about product information about overall firm

line, departments, etc. performance

In general, accounting information needed by internal includes financial and nonfinancial data to help
users differs from that needed by external users in the managers with strategic planning and decision
following ways: making.
a. More flexible • Assists in directing and controlling (analyzing and
b. Does not have to comply with GAAP or other rules comparing actual performance to budgeted plans;
c. Forward looking attention-directing to highlight successful or
d. Timely problem areas).
e. Emphasizes segments, not necessarily the entire • Motivates managers to achieve the organization's
organization goals by communicating the plans, providing a
measurement of how well the plan was achieved, and
The Work of Management and the Planning and prompting an explanation of deviations from plans.
Control Cycle. The work of managers can be usefully • Measures performance not only for the entire
classified into three major categories: planning, organization, as in financial accounting, but also for
directing and motivating, and controlling. All of these many subunits (divisions, departments, managers).
activities involve making decisions. • Assesses the organization's competitive position in the
1. Planning consists of strategic planning and rapidly changing business environment. Looks at
developing more detailed short-term plans. Most of how well the firm is doing internally, in the eyes of
what we refer to below is with reference to the more its customers, from the standpoint of innovation and
detailed short-term plans. continuous improvement, and financially.
2. Directing and motivating involves mobilizing
people to implement the plan. The Changing Business Environment
3. Control is concerned with ensuring that the plan 1. Just-In-Time - The term JIT means that materials
is followed. Accountants maintain the databases and are received just in time to be used in production,
prepare the reports that provide feedback to manufactured parts are completed just in time to
managers. The feedback can be used to reward be assembled into products, and products are
particularly successful employees, but more completed just in time to be shipped to customers. As
importantly the feedback can be used to identify a result, inventories are virtually eliminated in a JIT
potential problems and opportunities that were not system.
anticipated in the plan.
4. Decision-making is an integral part of the other Key Elements of JIT
three management activities. • Improved plant layout
• Reduced setup time
HOW MANAGERIAL ACCOUNTING ADDS VALUE • Low defect rates
• Provides managers with information (e.g., product
costs, budgets, cash flows). The information
 • Flexible workforce Value Chain - The value chain is a set of value-
adding functions or processes that convert inputs into
Benefits of JIT products and services for the organization’s
• Inventories are reduced. customers:
• Space is freed up.
• Throughput time is reduced. 1. Research and Development—experimenting to
reduce costs or improve quality.
• Defect rates are reduced.
2. Design—developing alternative product, service,
or process designs.
2. Total Quality Management (TQM) - Total Quality
3. Supply—managing raw materials received from
Management means different things to different vendors to reduce costs and improve quality.
people. Nevertheless, most TQM programs seem to 4. Production—acquiring and assembling resources
share at least two common elements—a focus on the to produce a product or render a service.
customer and systematic problem-solving using 5. Marketing—promoting a product or service to
teams made up largely of front-line workers. current and prospective customers.
6. Distribution—delivering a product or service to
3. Process Reengineering - involves completely a customer.
redesigning a business process from the ground up. 7. Customer Service—supporting customers after
In this respect, it can be differentiated from TQM the sale of a product or service.
which tends to emphasize small, incremental
Corporate governance
improvements. The process is redesigned with a focus Corporate governance is designed to compensate for
on simplification and elimination of non-value- added the agency problem resulting from the fact that
activities. corporations are managed by professional
management that may not operate them in the best
4. Theory of Constraints (TOC) - The goal in the interest of the shareholders.
Theory of Constraints is not to eliminate all
constraints; there is always a constraint somewhere Components of Corporate governance
in the system if the goal is to make more money. Policies, procedures and mechanism that are
However, constraints determine the performance of established to control management. These major
the entire system, so they should be intelligently controls over management include:
managed. • compensation systems,
o boards of directors (including major committees),
5. Organizational Structure o external auditors, internal auditors, attorneys,
• Centralization vs. decentralization regulators, creditors, securities analysts. and
• Line and staff relationships internal control systems.
• The controller
Forms of Executive Compensation
6. Strategic decisions and management accounting - A key objective in setting executive compensation is to
key to a company’s success in creating value for align management's decisions and actions
customers while differentiating itself from its with the long-term interests of shareholders (e.g., long-
competitors. term stock price). If managers are given too much fixed
compensation, they may become too complacent and not
• Providing a quality product or service at a lower
take appropriate risks to increase share price. If
price than competitors managers are given too much incentive compensation
• Providing a unique product or service at a higher based on operating profit or short-term stock price, they
price than competitors have incentives to manage profit or take excessive risks
to maximize their compensation.
Role of Accountants and Treasurer
The chief financial officer (CFO) or controller is Common types of management compensation
the chief accountant responsible for: a. Base salary and bonuses. Using this system,
• the supervision of the accounting department managers are compensated based on performance
• preparation of reports which is typically measured by accounting profit.
• the interpretation of information to line Compensation systems based on accounting
managers. measures of profit are problematic because
accounting profit can be manipulated or managed.
The treasurer is responsible for: b. Stock options. The use of stock options as a form of
• raising capital compensation provides managers with an incentive to
• safeguarding assets manage the corporation to increase the stock price,
• managing investments which is consistent with the goal of shareholders. A
• insurance coverage disadvantage of stock options is that managers may
• credit policy of an organization. have an incentive to increase the stock price in the
short-term at the expense of long- term stock value,
Line personnel are directly involved in carrying out the even by manipulating accounting income to increase
mission of the organization (e.g., assembly workers stock price. In addition, stock options may encourage
in a factory, doctors in a hospital, teachers in a management to take on risks that are that are in
school). excess of shareholders' risk appetite.
Staff personnel (accountants, lawyers, personnel
directors, and other administrative positions) provide
support for the organization's mission.
c. Stock grants- Stock grants involve issuing shares of assessing risks, prioritizing risks, determining risk
stock as part of management's compensation. Two responses. and monitoring risk responses.
common types of stock grants:
(1) Restricted stock. The issuance of stock that Interrelated components of ERM
cannot be sold by the manager for a specific (1) internal environment
period of time, usually about 10 years. This form (2) objective setting
of compensation is effective because it (3) event identification
encourages managers to undertake operations (4) risk assessment
that increase the long-term value of the (5) risk response
corporation's stock price. (6) control activities
(2) Performance shares. The issuance of stock to (7) information and communication
management if certain levels of performance are (8) monitoring.
met. If the price of the corporation's stock TERMINOLOGIES
increases, the value of the manager's Benchmarking (or competitive benchmarking) - The
compensation increases. continual search for the most effective method of
d. Executive perquisites (perks). Management also accomplishing a task, by comparing existing methods
may get various perquisites such as retirement and performance levels with those of other
benefits, use of corporate assets, golden parachutes, organizations or with other subunits within the same
and corporate loans. organization.
e. The best forms of executive compensation-It is
generally believed that the best compensation Continuous improvement - The constant effort to
systems include a combination of fixed compensation eliminate waste, reduce response time, simplify the
and incentive compensation that is related to long- design of both products and processes, and improve
term stock price. quality and customer service.

Audit committee - a "committee established by and Empowerment - The concept of encouraging and
amongst the board of directors of an issuer for the authorizing workers to take the initiative to improve
purpose of overseeing the accounting and financial operations, reduce costs, and improve product quality
reporting processes of the issuer, and audits of the and customer service.
financial statements of the issuer." A major responsibility
of the audit committee is the appointment, compensation Line position - Position held by managers who are
and oversight of the corporation's external auditor, directly involved in providing the goods or services
including the resolution of any disagreements between that constitute an organization's primary goals.
management and the external auditor
Non-value-added costs - The costs of activities that can
Other important characteristics of an audit be eliminated without deterioration of product quality,
committee performance, or perceived value.
(a) At least one member should be a "financial expert."
The names of the financial experts must be disclosed. Reengineering - The complete redesign of a process, with
A financial expert is one that possesses all of the an emphasis on finding creative new ways to
following attributes: accomplish an objective.
1] An understanding of generally accepted
accounting principles and financial statements; Total quality management (TQM) - The broad set of
2] Experience in preparing, auditing, analyzing, or management and control processes designed to focus
evaluating financial statements of the breadth and an entire organization and all of its employees on
complexity expected to be encountered with the providing products or services that do the best
company; possible job of satisfying the customer.
3] An understanding of internal controls and
procedures for financial reporting: and Treasurer - An accountant in a staff position who is
4] An understanding of audit committee functions. responsible for managing an organization's
relationships with investors and creditors and
Enterprise risk management: Enterprise risk maintaining custody of the organization's cash,
management is a process, effected by an entity's board of investments, and other assets.
directors, management and other personnel, applied in a
strategy-setting and across the enterprise, designed to Theory of constraints - A management approach that
identify potential events that may affect the entity, and focuses on identifying and relaxing the constraints
manage risk to be within its risk appetite, to provide that limit an organization's ability to reach a higher
reasonable assurance regarding the achievement of entity level of goal attainment.
objectives.
ERM helps align the risk appetite of the organization with Type of Cost
its strategy, enhances risk response decisions, reduces Out-of-pocket costs require a cash outlay.
operational surprises and losses, identifies and manages Opportunity costs are the benefits you give up when
cross-enterprise risks, provides integrated responses to you choose one alternative over another.
multiple risks, helps the organization seize opportunities,
Direct costs can be directly and conveniently traced
and improves the deployment of capital.
to a specific cost object.
A key aspect of ERM is the identification and management
of events that have a negative impact, positive impact, or Indirect costs either cannot be traced to a specific
both. Events with negative impact represent risks. Events cost object or are not worth the effort of tracing.
with positive impact may offset negative impacts or Variable costs change, in total, in direct proportion to
represent opportunities. The risk management process changes in activity.
involves (1) identifying risks, Fixed costs remain the same, in total, regardless of
activity.
 Manufacturing costs are associated with making a opinions.
physical product. They can be classified as direct • Refrain from engaging in or supporting any activity
materials, direct labor, or manufacturing
that would discredit the profession.
overhead.
Nonmanufacturing costs are associated with selling a
product or service or running the overall business. 4 Objectivity
• Communicate information fairly and objectively.
Product costs are assigned to a product as it is being
• Disclose full all relevant information that could
produced; they accumulate in inventory accounts
reasonably be expected to influence an intended
until the product is sold.
user’s understanding of the reports, comments,
Period costs are reported as expenses as they are
and recommendations presented.
incurred.
Relevant costs are future oriented costs that differ Resolution of Ethical Conflict
among decision alternatives. In applying the standards of ethical conduct, management
Irrelevant costs are those that remain the same accountants may encounter problems in identifying
regardless of the alternatives and thus will not unethical behavior or in resolving an ethical conflict. When
affect the decision. faced with significant ethical issues, management
accountants should follow the established polies of the
IMA Standards of Ethical Conduct for Management organization bearing on the resolution of such conflict.
Accountants If these polies do no resolve the ethical conflict,
1. Competence management accountants should consider the following
• Maintain an appropriate level of professional courses of actions:
• Discuss such problems with the immediate
competence by ongoing development of their
superior except when it appears that the superior
knowledge and skills. is involved, in which case the problem should be
• Perform their professional duties in accordance presented initially to the next higher management
with relevant laws, regulations, and technical level. If satisfactory resolution cannot be
standards. achieved when the problem is initially
presented, submit the issues to the next higher
• Prepare complete and clear reports and
managerial level.
recommendations after appropriate analyses of • If the immediate superior is the chief executive
relevant and reliable information. officer, or equivalent, the acceptable reviewing
authority may be a group such as the audit
2. Confidentiality committee, executive committee, board of
• Refrain from disclosing confidential information directors, board of trustees or owners. Contact
with levels above the immediate superior should
acquired in the course of their work except when
be initiated only with the superior’s knowledge,
authorized unless legally obligated to do so. assuming the superior is not involved.
• Inform subordinates as appropriate regarding the • Clarify relevant concepts by confidential
confidentiality of information acquired in the discussion with an objective advisor to obtain
course of their work and monitor their activities to an understanding of possible courses of action.
• If the ethical conflict still exists after exhausting
assure the maintenance of that confidentiality.
all levels of internal review, the management
• Refrain from using or appearing to use confidential accountant may have no other recourse on
information acquired in the course of their work for significant matters that to resign from the
unethical or illegal advantage either personally or organization and to submit an informative
through third parties. memorandum to an appropriate representative of
the organization.
Except where legally prescribed, communication of such
3 Integrity problems to authorities or individuals not employed or
• Avoid actual or apparent conflicts of interest and engaged by the organization is not considered
advise all appropriate parties of any potential appropriate.
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 actively 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 judgments or