Basic Management Accounting Concepts CHAPTER 1 Basic Management Accounting Concepts

Objectives Discuss the need for management accounting information. Differentiate between management accounting and financial accounting. Provide a brief historical description of management accounting. Identify the current focus of management accounting. Continued

Objectives 5. Describe the role of management accountants in an organization. 6. Explain the importance of ethical behavior for managers and management accountants. 7. List three forms of certification available to management accountants.

Objectives Describe the cost assignment process. Define tangible and intangible products and explain why there are different product cost definitions. Prepare income statements for manufacturing and service organizations. Outline the differences between functional-based and activity-based management accounting systems.

The managerial accounting system has three broad objectives: 1. To provide information for costing out services, products, and other objects of interest to management. 2. To provide information for planning, controlling, evaluating, and continuous improvement. 3. To provide information for decision making.

Personal Communication Management Accounting Information System Collecting Measuring Storing Analyzing Reporting Managing Special Reports Product Costs Customer Costs Budgets Performance Reports Personal Communication Economic Events Inputs Processes Outputs Users

Management Process Planning Controlling Decision Making The Management Process is defined by the following activities: Planning requires setting objectives and identifying methods to achieve those objectives. Planning Controlling Decision Making

Management Process Planning Controlling Decision Making The Management Process is defined by the following activities: Controlling is the managerial activity of monitoring a plan’s implementation and taking corrective action as needed. Planning Controlling Decision Making

Management Process Planning Controlling Decision Making The Management Process is defined by the following activities: Planning Controlling Decision Making Control is usually achieved with the use of feedback.

Management Process Feedback is information that can be used to evaluate or correct the steps being taken to implement a plan.

Management Process Planning Controlling Decision Making The Management Process is defined by the following activities: Planning Controlling Decision Making Decision making is the process of choosing among competing alternatives.

Differentiate Between Management Accounting and Financial Accounting

Management Accounting Financial Accounting 1. Internally focused 1. Externally focused

Targeted Users Management accounting focuses on providing information for internal users.

ABC Company Annual Report Targeted Users ABC Company Annual Report Financial accounting focuses on provided information for external users.

Management Accounting Financial Accounting 1. Internally focused 1. Externally focused 2. No mandatory rules 2. Must follow externally imposed rules

Restrictions on Inputs and Processes Financial accounting reporting must follow the accounting procedures set by the SEC and the FASB. Management accounting is not subject to the requirements of generally accepted accounting principles.

Management Accounting Financial Accounting 1. Internally focused 1. Externally focused 2. No mandatory rules 2. Must follow externally imposed rules 3. Financial and nonfinancial informa-tion; subjective information possible 3. Objective financial information

Types of Information For management accounting, the financial or nonfinancial information may be much more subjective in nature. The restrictions imposed on financial accounting tend to produce objective and verifiable financial information.

Management Accounting Financial Accounting 1. Internally focused 1. Externally focused 2. No mandatory rules 2. Must follow externally imposed rules 3. Financial and nonfinancial informa-tion; subjective information possible 3. Objective financial information 4. Emphasis on the future 4. Historical orientation

Time Orientation Management accounting strongly emphasizes providing information about future events.

Time Orientation Financial accounting records and reports events that have already happened.

Management Accounting Financial Accounting 1. Internally focused 1. Externally focused 2. No mandatory rules 2. Must follow externally imposed rules 3. Financial and nonfinancial informa-tion; subjective information possible 3. Objective financial information 4. Emphasis on the future 4. Historical orientation 5. Internal evaluation and decisions based on very detail information 5. Information about the firm as a whole

Degree of Aggregation Management accounting provides measures and internal reports used the evaluate performance of entities, product lines, departments, and managers.

Financial accounting focuses on overall firm performance. Degree of Aggregation Financial accounting focuses on overall firm performance.

Management Accounting Financial Accounting 1. Internally focused 1. Externally focused 2. No mandatory rules 2. Must follow externally imposed rules 3. Financial and nonfinancial informa-tion; subjective information possible 3. Objective financial information 4. Emphasis on the future 4. Historical orientation 5. Internal evaluation and decisions based on very detail information 5. Information about the firm as a whole 6. Broad, multidisciplinary 6. More self-contained

Management accounting is much broader than financial accounting. Breadth It includes aspects of managerial economics, industrial engineering, and management science. Management accounting is much broader than financial accounting.

Historical Description of Management Accounting 1880 - 1925 Most of the product-costing and internal accounting procedures used in this century were developed 1925 Emphasis of inventory costing for external reporting 1950s/60s Effort to improve the managerial usefulness of traditional cost systems 1980s/90s Significant efforts have been made to radically change the nature and practice of management accounting

Current Focus of Management Accounting Activity-Based Management Activity-based management is a system wide, integrated approach that focuses management’s attention on activities with the objective of improving customer value and the resulting profit.

Current Focus of Management Accounting Customer Orientation Customer value is the difference between what the customer receives (customer satisfaction) and what the customer gives up (customer sacrifice). What is received is called the total product.

Current Focus of Management Accounting Strategic Positioning Strategic cost management is the use of cost data to develop and identify superior strategies that will produce a sustainable competitive advantage. Strategies: Cost leadership Superior products through differentiation

Current Focus of Management Accounting Value-Chain Framework The internal value chain is the set of activities required to design, develop, produce, market, and deliver products and services to customers. The industrial value chain is the linked set of value-creating activities from basic raw materials to the disposal to the final products by end-use customers.

Value Chain: Apple Industry Firm A Planting and Cultivating Harvesting Distribution of Apples Firm B Value Chain: Apple Industry Applesauce Production Applesauce Distribution Firm C Product Disposal Supermarkets End-Use Customer

Managing the value chain means that a management accountant must understand many functions of the business, from manufacturing to marketing.

This emphasis on quality has created a demand for management accounting systems that provide financial and nonfinancial information about quality. The philosophy of total quality management is to manufacture perfect products.

The role of management accountants in an organization is one of support.

Partial Organization Chart, Manufacturing Company President Production Vice President Line Function Financial Vice President Staff Function Production Supervisor Machining Foreman Assembly Foreman Controller Treasurer Internal Audit Cost Financial Systems Tax

Ethical Behavior Michael Josephson’s* Ten Ethical Values: Honesty Integrity Promise keeping Fidelity Fairness Caring for others Respect for others Responsible citizenship Pursuit of excellence Accountability *Michael Josephson, “Teaching Ethical Decision Making and Principled Reasoning”

Professional Certifications CMA: One of the main purposes of the CMA was to establish management accounting as a recognized, professional discipline, separate from the profession of public accounting. CPA: The responsibility of a CPA is to provide assurance concerning the reliability of financial statements. CIA: The focus of the CIA is to recognize competency in internal auditing rather than external auditing as with the CPA.

The CMA Four areas emphasized on the exam: Economics, finance, and management Financial accounting and reporting Management report, analysis, and behavioral issues Decision analysis and information systems

Exactly what is meant by “cost”? Cost is the cash or cash-equivalent value sacrificed for goods and services that is expected to bring a current or future benefit to the organization. I see… It’s a dollar measure of the resources used to achieve a given benefit. Cost Assignment Exactly what is meant by “cost”?

Cost Assignment A cost object is any item such as products, customers, departments, projects, activities, and so on, for which costs are measured and assigned. Example: A bicycle is a cost object when you are determining the cost to produce a bicycle. An activity is a basic unit of work performed within an organization. Example: Setting up equipment, moving materials, maintaining equipment, designing products, etc.

Cost Assignment Traceability is the ability to assign a cost to a cost object in an economically feasible way by means of a cause-and-effect relationship. Direct costs are those costs that can be easily and accurately traced to a cost object. Example: If a hospital is the cost object, the cost of heating and cooling the hospital is a direct cost.

Cost Assignment Indirect costs are those costs that cannot be easily and accurately traced to a cost object. Example: The salary of a plant manager, where departments within the plant are defined as the cost objects.

Cost Assignment Tracing is the actual assignment of costs to a cost object using an observable measure of the resources consumed by the cost object. Tracing costs to cost objects can occur in the following two ways: Direct tracing is the process of identifying and assigning costs that are exclusively and physically associated with a cost object to that cost object. Driver tracing is the use of drivers to assign costs to cost objects. Drivers are observable causal factors that measure a cost object’s resource consumption.

Cost Assignment Methods Cost of Resources Direct Tracing Driver Allocation Physical Observation Causal Relationship Assumed Cost Objects

Interface of Services with Management Accounting Services cannot be stored. No patent protection. Cannot display or communicate services. Price difficult to set. 1. Intangibility 2. Perishability 3. Inseparability 4. Heterogeneity Services benefits expire quickly. Services may be repeated often for one customer. Customer directly involved with production of service. Centralized mass production of services difficult. Wide variation in service products possible. Derived Properties

Interface of Services with Management Accounting No inventories. Strong ethical code. Price difficult to set. Demand for more accurate cost assignments. 1. Intangibility 2. Perishability 3. Inseparability 4. Heterogeneity No inventories. Need for standards and consistent high quality. Costs often accounted for by customer type. Demand for measure-ment and control of quality to maintain consistency. Productivity and quality measurement and control must be ongoing. Total quality manage-ment critical. Impact on Management Accounting

Product cost is a cost assignment that supports a well-specified managerial object. Thus, what product cost means depends on the managerial objective being served.

Design Service Develop Produce Distribute Market

Product Costing Definitions Research and Development Production Marketing Customer Service Value-Chain Product Costs Production Marketing Customer Service Operating Product Costs Traditional Product Costs Production Managerial objectives served Pricing Decisions Product-Mix Decisions Strategic Profitability Analysis Strategic Design Decisions Tactical Profitability Analysis External Financial Reporting

Production Costs Direct materials are those materials that are directly traceable to the goods or services being produced. Steel in an automobile Wood in furniture Alcohol in cologne Denim in jeans Braces for correcting teeth

Production Costs Direct labor is the labor that is directly traceable to the goods or services being produced. Workers on an assembly line at Chrysler A chef in a restaurant A surgical nurse attending an open heart operation Airline pilot

Production Costs Overhead are all other production costs. Depreciation on building and equipment Maintenance Supplies Supervision Power Property taxes

Nonproduction Costs Noninventoriable (period) costs are expensed in the period in which they are incurred. Salaries and commissions of sales personnel (marketing) Advertising (marketing) Legal fees (administrative) Printing the annual report (administrative)

Production Costs Prime Cost : Direct Materials Costs + Direct Labor Costs Conversion Cost: Direct Labor Costs + Overhead Costs

External Financial Statements

Manufacturing Organization Income Statement For the Year Ended December 31, 2006 2-20 Sales $2,800,000 Less cost of goods sold: Beginning finished goods inventory $ 500,000 Add: Cost of goods manufactured 1,200,000 Cost of goods available for sale $1,700,000 Less: Ending finished goods inventory 300,000 1,400,000 Gross margin $1,400,000 Less operating expenses: Selling expenses $ 600,000 Administrative expenses 300,000 900,000 Income before taxes $ 500,000

continued on next slide Statement of Cost of Goods Manufactured For the Year Ended December 31, ,2006 2-21 Direct materials: Beginning inventory $200,000 Add: Purchases 450,000 Materials available $650,000 Less: Ending inventory 50,000 Direct materials used $ 600,000 Direct labor 350,000 Manufacturing overhead: Indirect labor $122,500 Depreciation 177,500 Rent 50,000 Utilities 37,500 Property taxes 12,500 Maintenance 50,000 450,000 Total manufacturing costs added $1,400,000 continued on next slide

Total manufacturing costs added $1,400,000 Add: Beginning work in process 200,000 Total manufacturing costs $1,600,000 Less: Ending work in process 400,000 Cost of goods manufactured $1,200,000 Work in process consists of all partially completed units found in production at a given point in time.

Service Organization Income Statement For the Year Ended December 31, 2006 2-23 Sales $300,000 Less expenses: Cost of services sold: Beginning work in process $ 5,000 Service costs added: Direct materials $ 40,000 Direct labor 80,000 Overhead 100,000 220,000 Total $225,000 Less: Ending work in process 10,000 215,000 Gross margin $ 85,000 Less operating expenses: Selling expenses $ 8,000 Administrative expenses 22,000 30,000 Income before income taxes $ 55,000

Functional-Based Management Model Resources Functions Products Cost View Efficiency Analysis Performance Analysis Operational View

Activity-Based Management Model Resources Activities Products and Customers Cost View Driver Analysis Performance Analysis Process View Why? What? How Well?

Functional-Based Activity-Based 1. Unit-based drivers 2. Allocation-intensive 3. Narrow and rigid product costing 4. Focus on managing cost 5. Sparse activity information 6. Maximization of individual unit performance 7. Use of financial measures of performance 1. Unit- and nonunit-based drivers 2. Tracing intensive 3. Broad, flexible product costing 4. Focus on managing activities 5. Detailed activity information 6. Systematic performance maximization 7. Use of both financial and nonfinancial measures of performance

Chapter Two The End