THE NATURE OF MANAGEMENT ACCOUNTING

Management accounting relates to the process of organizing resources and directing activities for the purpose of achieving organizational objectives; consist of 4 phases: 1. planning mission; reason of companys existence vision; what to do to reach the mission objective strategy; Corporate (expansion/ shutdown/ no change) Business unit (Differentiation, cost leadership, focus), Operational (mktg, finance, HR, R&D) 2. organizing organization structure amount of resources task Standard Operation Procedure 3. leading Implementation 4. controlling Performance Evaluation Actual-Target comparison Management process: 1. Objective setting; important for design of management control system; doesnt have to be quantified, neednt be financial, must be understood by the employees 2. Strategy formulation; define how organizations must use their resources to meet their objectives, can be formulated thru SWOT analysis, it emerged from the interaction between management, employees and environment 3. Strategic control; to see whether the companys strategy should be changed, considering the environment, competition and other factors; primarily focused on external (SWOT factors) 4. Management control; to ensure the employees (behavior) do the best for the company, so that they understand companys expectation, implement the companys strategy as intended, capable to do their job, actions taken to solve management problems Causes of management control problems: 1. Lack of direction: causes employee to behave inversely to the desired behavior. Employees must be informed on how to maximize their contribution to the fulfillment of companys objectives
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2. Motivational problems: employees are reluctant to give 100% effort, because individual and company goal dont naturally coincide 3. personal limitation: caused by lack of knowledge, training, experience, or jobs that are not designed properly CONTROLS There are a lot of internal control options, most of which involve options that go far beyond the accounting. I like to divide the options into three categories, (1) action controlsthose that limit the managers ability to perform the specific bad actions, (2) results controlsthose that improve the pay-for-performance system, and (3) personnel/cultural controlsthose that encourage either more employee honesty (selfcontrol) or encourage employees to monitor each others behaviors (social control). CHARACTERISTICS OF GOOD MANAGEMENT CONTROL Good management control: management are confident that no major unpleasant surprise will occur, but still allows probability of failure because perfect control is rare and the control loss(cost of not having perfect control) must be achieved to reach optimal control (cost of implementing more control > control loss) future oriented (no unpleasant surprises in future) objective driven (objective represents what the organization seeks)

Control problem avoidance:

activity elimination; potential risk in particular activity can be turned over to 3rd party (Subcontract, licensing agreements, divestment) Automation; automated devices can be set to behave consistently in accordance to the companys wants (lower inaccuracy, inconsistency, lack of motivation, unlike human) but maybe costly and lack of feasibility Centralization; centralization in decision making of key risk areas is needed (Mergers and divestment) Risk sharing; to limit loss; thru insurance 3 CATEGORIES OF CONTROL

1. Action control - involves taking steps to ensure that employees act in the

organizations best interest by making their actions themselves the focus of control

Forms of action controls:

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o behavioral constraints It is a negative form of action control, it is divided into 2 kinds: physical constraints (locks on desks, passwords, access limit to certain areas) and administrative constraints, limit on employees ability to perform all/ a portion of a specific act; low grade manager can only approve $1000 expenditures, while med-grade manager can approve $10000 expenditure Another admin cons separation of duties; different person for positions that closely related(checks receiver must be separated from the accountant who entries that account receivable ledger)
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precaution reviews Scrutiny of the action plans of the employees being controlled (approval/checking made by the supervisors about certain proposals)

o action accountability Holding employees accountable for the actions they take. Its implementation requires: 1. 2. 3. 4. defining of actions which is good/bad communicating the definitions to employees observing / tracking what happens rewarding/punishing the actions

o redundancy assigning more employees / machines to a task than is strictly necessary, or at least having backup employees / machines available, can also be seen as a control because it increases the probability that a task will be satisfactorily accomplished.

2. Result control Rewarding for good result (meritocracies), punishing for bad results Reminds employees of the consequences of actions taken Employees are empowered to take any actions, not dictated by the company Cannot be used in every situation, effective only where the desired result areas can be controlled (to a considerable extent) by the employees whose actions are being influenced and where the controllable result areas can be measured effectively Preventive type control, effective in addressing motivational problems, personal limitation problems

Steps in result control: 1. defining performance dimensions

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What you measure is what u get; goals and measurement are the factors that shape up the employees mind of what is important, therefore it must be clear 2. measuring performance Measurement is done in a specific period 3. setting performance targets affect behavior in 2: stimulate action and motivation; allow employee to self evaluation 4. providing rewards/punishments extrinsic (bonus, promotions) / intrinsic(self-esteem)

Conditions determining the effectiveness of result controls: knowledge of desired results Must be communicated effectively to employees, result desirabilitymore of the quality represented by the result measure is preferred to less, everything else being equal ability to influence desired results (controllability) Person whose behavior are being controlled must be able to affect the result in a material way in a given time span; a manager only accountable for mistakes made under his control Result control will not be effective where the results that can be measured are either not controllable or largely uncontrollable ability to measure controllable results effectively To judge the effectiveness of result measures is ability to evoke the right behaviors. To evoke right behaviors, result measures should be: 1. precise hi precision = small dispersion of results given by independent measurers =give good evaluation 2. objective Freedom of bias; objective evaluation can be done by people who are independent of the process(personnel on controllers staff); independent people (auditor) 3. timely Timeliness: lag between the employees performance and the measurement of results; good for 2 reasons: employees need consistent, a short term pressures to perform well; it increases the value of interventions that might be necessary 4. understandable
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Employee w/controlled behavior must understand his accountability and what he must do to influence the measure. E.g: customer service employee must understand what the their customers value (cust. Satisfaction)

Personnel and Cultural control It builds on employees natural tendencies to control and/ or motivate themselves. It serves any of 3 basic purposes:
1. clarify expectations, help ensure employees understands what the

organization wants 2. help ensure that the employees are able to do a good job(have the capability; experience, intelligence and resources) 3. increase the likelihood that each employee will engage in self-monitoring Self-monitoring is the naturally present force that pushes most employees to want to do a good job, to be naturally committed to the organizations goals. It is also effective because most people have a conscience that leads them to do what is right and able to derive positive feelings of self-respect and self-satisfactions when they do a good job and see the organization succeeds

3 major methods of implementing personnel controls: 1. selection and placement of employees Finding the right people to do a right job and giving them a good workenvironment and the necessary resources can obviously increase the profitability that a job will be done properly 2. Training Training can provide useful information about what results and actions expected and how the assigned task can be best performed (2 methods: on the job training and class training), also it can have positive motivational effects because employees can be given a greater sense of professionalism, and they are often more interested in performing well in jobs they understand better 3. Job design and provision of necessary resources A well designed job allows motivated and qualified employees a high probability of succeed

Cultural controls are designed to encourage mutual monitoring, a powerful for m of group pressure on individuals who deviate from the group norms and values; it is most effective where members of a group have emotional ties to one another. And cultures are built on shared traditions, norms, beliefs, values, ideologies, attitudes, and ways of behaving. Organizational cultures remain relatively fixed over time, even while their strategies, tactics, and goals necessarily adapt to changing business conditions.

5 important methods in shaping culture , and thus effecting cultural controls: 1. codes of conduct The codes of conduct provide broad, general statements of corporate values, commitments to stake holders, and the ways in which top management would like the organization to function. These codes are designed to help the employees to understand what behaviors are expected even in the absence of a specific rule or principle. Some codes of conduct may fail because they are not supported by strong leadership and proper tone from the top. 2. group-based rewards In group-based rewards, the link between individual efforts and the result being rewarded is weak, perhaps near 0. Thus , communication of expectations and mutual monitoring are the primary forces in group rewards. The use of group reward also reduces measurement cost because each individuals unique contribution to overall performance doesnt have to be measured.
3. Intra organizational transfers (employee rotation)

Transfers tend to improve the socialization of the employees throughout the organization and thereby inhibit the formation of incompatible goals and perspectives 4. physical and social arrangements Physical arrangements, such as office plans, architecture, and interior dcor and social arrangements, such as dress codes and vocabulary can also shape the organizational culture 5. tone at top Top level managers must be consistent with the type of culture they try to create, and their behavior must be in accordance with their statements

MANAGEMENT ACCOUNTING (MA) VS. FINANCIAL ACCOUNTING (FA) 1. Necessity

FA: SEC (or banks or suppliers) requires publicly traded companies to publish financial statements according to GAAP. MA: is optional.

2. Purpose 3. Users. FA: faceless group, external users, present or potential shareholders. MA: Known managers who influence what information is needed. FA: Produce financial statements for outside users. MA: Help managers plan, implement and control.

4. Underlying structure. FA: built around: Assets = Liabilities + Stockholders Equity. MA: 3 purposes each with its own set of concepts and constructs (addressed later).

5. Source of principles. FA: GAAP(Generally Accepted Accounting Principle) MA: whatever managers believe is useful.

6. Time orientation. 7. FA: historical, tell it like it was. MA: future/decision oriented, tell it like it will be. (However, the past is often a good predictor of the future.) Information content. FA: financial statements are the end product and include primarily financial info. MA: non-monetary as well as monetary info.

8. Information precision. FA: Uses approximations but as a generalization is more precise than MA.
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MA: Management needs info rapidly to be useful in decision making and therefore precision is sometimes sacrificed.

9. Report frequency: FA: Publicly traded, SEC: quarterly, with more detailed info annually. MA: Up to management.

10. Report timeliness. FA: Usually, several weeks to months after fiscal close of accounting period. MA: Quickly to be useful for decision making.

11. Report entity. FA: Organization as a whole. MA: Relatively small parts (responsibilities centers such as departments, product lines, divisions, subsidiaries as well as organization as a whole.)

USES OF MANAGEMENT ACCOUNTING 1. Measurement of revenues, costs, and assets. 2. Control. 3. To aid in choosing among alternative courses of action.

Measurement Full cost accounting measures the resources used in performing some activity. Full cost of producing goods or providing services = direct costs + indirect costs. o Direct costs = costs directly traced to the goods or services. o Indirect costs = a fair share of costs incurred jointly in producing goods or services. Control

 Costs (also, revenues and assets) are identified to and measured by responsibility center. o A manager heads each responsibility center. o Corrective action can only be taken by individuals. o To help identify problems (and opportunities) actual costs are measured and compared to a benchmark (budget, last year, industry average). Alternative Choice Decisions Differential costs of alternative possible actions are developed.

General Observations on MA Different numbers for different purposes. o Many different types of costs: historical, standard, overhead, variable, fixed, differential, marginal, opportunity, direct, estimated, full, etc. o Clarify which type you are talking about. Accounting numbers are approximations. Best that we can with incomplete data. Accounting evidence is only partial evidence other factors help make decisions. People not numbers get things done. How you use the numbers is as important as how the numbers are produced.

THE BEHAVIOR OF COSTS AND DECISION-MAKING What will be covered A general overview of how costs behave. Several applications of how this knowledge can help you make better, informed, decisions. Some examples of what we will be able to solve:
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 Breakeven analysis You are considering offering a new service (such as delivery of take-out) and you wish to determine what volume you will need to generate to cover your costs.

Close a location decision You are responsible for several locations. One location consistently shows a loss on its income statement. Should it be closed? If so, will your region be better off?

Special orders decisions You have been offered a one-time special order. You need to determine if you should accept the order given the price is lower than the normal charge for comparable meals you serve.

Behavior of Costs Cost-volume relationships. o Fixed and variable costs. o Step-function costs. Relation of Costs to Volume

Variable costs = items of cost that vary, in total, directly and proportionately with volume. Fixed costs = items of cost that, in total, do not vary at all with volume Semi-variable costs (semi-fixed costs) = costs that include a combination of variable cost and fixed cost items.

Variable Costs Items of cost that vary, in total, directly and proportionately with volume. o Volume refers to activity level. o Examples: A material cost varies with units sold.
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 Fixed costs

An electricity cost varies with production hours. A stationery and postage cost varies with number of letters written.

Items of cost that, in total, do not vary at all with volume. o Examples:

Building rent, property taxes, management salaries. o Fixed cost per unit of activity decreases as the level of activity increases.
o Fixed costs are fixed for a range of activity and a

limited period of time.

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