Managerial

Accounting

Dr. Zubair Ahmad

Lecture 1
 Agenda this week

•Lecture 1
•Introduction to Management Accounting
•Lecture 2
•Managing via Accounting and Cost concepts
•Research and critical thinking skills: Introduction to
capstone
 Agenda: Lecture 1

Part A
• Module Overview
• Assessment
• Sessional marks
• Attendance

Part B
• Cost concepts and their usefulness
• Management via Accounting [Chandler (1977); Hoskin
and Macve (1990)]
• Analytical reading and writing as transferable skills
(Workshop)
Introduction to Management
Accounting 4

(SEAL ET AL., 2015 CH. 1 AND 2)

 Module Learning Objectives

Understand Management Accounting (MA) in terms of

•Basic techniques and modern variations
•Roles in the managerial business organisation

Become competent in MA techniques (basic and modern)

Understand MA applications for

•Coordinating firm and department costs, activity and
performance
•Accounting for and improving costs, activity and performance
•Planning and budgeting
 How we get from here to there …

Module Outline
Overview and Objectives
Assessment information
Lectures/seminars and readings
How to prepare before and during the module

Exercise Handbook
Lectures/seminars and readings
All exercises
Sessional mark information
 How we get there from here…

Required Text plus additional resources/readings

Seal et al. (2015) Management Accounting (5th edition)
Hoskin and Macve (1990)
Chandler (1977) pp. 1-12
 Assessments

Mid-term exam 30%

Final Exam 50% (Summer term)

Sessional Marks 20%
What is Management Accounting?
Textbook View: Two categories of
User:

External- Financial Accounting

Internal- Management
Accounting
“Techniques and processes that are intended to
provide financial and non-financial information to people within
an organisation to help them make better decisions and thereby
achieve organisational control and enhance organisational
effectiveness”
 Textbook Comparison of Financial and Management Accounting

Management Accounting Financial Accounting

Targeted user: internal users external users

managers stockholders and creditors

Restrictions: no mandatory rules for must follow GAAP/IFRS

preparing reports when preparing financial
statements
Types of financial and nonfinancial financial information
information: information

Time orientation: emphasizes the future historical orientation

(planning and decision (reports what has already
making) occurred)
Aggregation: detailed information about information about overall
product line, departments, firm performance
and so on
 Other MA areas: MA as Ethics
Questions are asked about costs. It is ethical
to ignore heavy costs within and beyond the
organisation for humans, animals and the
environment, despite the fact the
organisation are causing them due of how
they define and think about costs?
Poultry Industry:
https://www.youtube.com/watch?v=rpbtBgLfl90
(warning: video contains violence against animals)

Textiles Industry:
http://archive.thedailystar.net/beta2/news/cheap-for-retailers-costly-
for-workers/
 Ethical as part of being professional
Chartered Institute of Managements Accountant(CIMA) and cods of
Ethics

‘As chartered management accountants CIMA members (and

registered students) throughout the world have a duty to observe the
highest standards of conduct and integrity, and to uphold the good
standing and reputation of the profession. They must also refrain from
any conduct which might discredit the profession. Members and
registered students must have regard to these guidelines irrespective of
their field of activity, of their contract of employment or of any other
professional memberships they may hold.’ (CIMA’s cods of Ethics p.3)

Full document see link below:

http://www.cimaglobal.com/Documents/Professional%20e
thics%20docs/2015%20code%20of%20ethics/CIMA_Code
_of_Ethics2.pdf
MA and the Environment

‘Prevailing approaches to costing certainly ignore many of the

indirect consequences of corporate actions on the environment,
but this is something that is increasingly being acknowledged’
(Hopwood, 2009)

Environmental Management
Accounting EMA

See the link: http://www.accaglobal.co.uk/en/student/acca-qual-student-

journey/qual-resource/acca-qualification/p5/technical-articles/environmenta-
management.html
 Management Accounting
Management via Accounting
Managing by past numbers to shape futures
Coordinating time, space and action

Not just ‘providing information to people within an

organization’ (as per slide above)

Also measuring human performance

Shaping action and thinking via ‘accounting information’
Part of inventing the modern form of business
 Where is MA going?

To know that,
we need to know….
Where does it come from?

•Linkingpasts with presents to futures

•Understanding basics plus constant innovations
•New ‘breakthroughs’ or variations on old themes
 Evolution of Modern Business

Alfred Chandler, The Visible Hand (1977)

Management develops in the US, 1830-60

A new kind of ‘administrative coordination’ makes

possible ‘modern business enterprise’
 ‘Administrative Coordination’

New kind of STRUCTURE

The ‘line and staff’ based organization

New kind of PROCESS

Constant prescribing, tracking and evaluating of machine plus
human performance

Via ‘Accounting and Statistical Innovation’

So that Every Unit from Top to Bottom…

has: ‘its own administrative office (and) own set of books and
accounts which can be audited separately’ (Chandler, 1977 1-2)
Constant tracking, monitoring, and evaluating

Bus drivers’ actual work hours Lost miles

 Classic Management Structure
The ‘Unitary’ or U-form Firm
PRESIDENT
(General
Manager)

Staff

Manufacturing Marketing
Manager Manager

Staff Staff

Manager Manager Manager Manager Manager Manager

Plant 1 Plant 2 Plant 3 Product A Product B Product C
 Multidivisional or M-Form

CEO

Planning
Office

Manager Manager Manager

Division X Division Y Division Z

Staff Staff Staff

Manager Manager Manager Manager Manager Manager

Plant 1 Product A Plant 2 Product B Plant 3 Product C
 Outcomes of Admin Coordination

Internally within a firm

- Routinizes transactions, reduces information costs, enables effective
scheduling of flows
- Generates ‘more certain cash flow and … payment for services
rendered’ (Chandler, 1977, p6)

Across groups of firms and market sectors

‘permitted greater productivity, lower costs and higher profits than
coordination by market mechanisms’

So management produces the modern business

world
[NB: Seal (pp.9-10) sees this world as evolving gradually]
 New 19th century ideas that are now ‘natural’

The Three ‘E’s’

Economy – optimal costs for inputs
Efficiency – optimal performance in throughputs
Effectiveness – optimal outputs and outcomes

NB:
Outputs – what you do/produce (service / product)
Outcomes – what happens next (success / failure / customer
satisfaction, etc)
 Planning, control and decision-making

Central to ‘administrative coordination’

Enabling ‘managers to manage other managers’
And firms to gain ‘economies of scale and scope’
Scale: Lower costs plus higher activity levels
Scope: Lower costs plus wider activities, services, etc

First focus is on key costs

Costs of services or products
Costs of operating line departments
Costs of coordination (the staff function)
 Why study Management Accounting?

Central feature of ‘management’ - to get things done

Central and essential to forming and running the ‘modern

business enterprise’

Impossible to generate ‘administrative coordination’

without MA processes distributed across a whole
organizational structure
Cost concept and classifications
Critical writing and developing transferrable
skills
25

(SEAL ET AL., 2015 CH. 1 AND 2)

 What is a cost?

Consumptions of resources

Starting and running a Business: what resources would you

consume?

It depends…..

What your business or organisation is about

Producing products or service or both?
 You need Cost Objects

‘Anything for which cost data are desired. Examples of

possible cost objects are products, product lines , customers,
jobs and organizational subunits such as departments or
divisions of a company’ (Seal et al 2015, p.839)

Business Output: Products and services

Operational (internal): Departments, Stores, Machining

Operation, Production Line, or a Process,

Business Relationship (external): Suppliers and Customers

 Assigning costs to cost objects: How?

Step 1. Accumulate costs by classifying costs into certain

categories:

The most common costs ones are:

Labour
Material
Overhead

Step 2. Assigning these costs to cost objects (e.g. product)

Step 3. Based on how easy costs can be traced to each cost

object they are defined as either: Direct or Indirect
Direct and indirect costs

Assigning costs to cost objects and supporting administrative

coordination focusing on line and staff costs

Three major elements of production costs in a manufacturing

concern are
Raw Material
Labour
Overhead
Direct and Indirect (Overhead) Costs
All Costs

Manufacturing Costs Non-Manufacturing Costs

Direct Costs Indirect Costs Distribution

Selling
Marketing
Direct Material Manufacturing Support Research and Development
Direct Labor General and Administrative
 Direct Materials

Materials that become an integral part of the product

and that can be conveniently traced directly to it.

Example: An engine fitted into a car

 Direct Labour

Labour costs (e.g., wages/salaries) that can be easily

traced to individual units of product
(also known as ‘touch labour’)

Example: Wages of car assembly workers

 Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples: Indirect labour and indirect materials

Wages paid to employees Materials used to support

who are not directly the production process.
involved in production
work.
Examples: maintenance Examples: lubricants and
workers, cleaners and cleaning supplies used in the
security guards. car assembly plant.
 Determination of Manufacturing Cost
M
P
Direct materials R A T
N
I O
U
M T
Direct Labour F
E
C A A
C
O L
T
S
U
T C
R
I O
INDIRECT EXPENSES N S
G
T
SELLING AND ADMIN
Preparation of financial statements

Schedule of cost of goods manufactured

(For a specific period)

Beginning raw material inventory

Add: Purchases of raw materials
Raw materials available for use
Deduct: Ending raw material inventory
(A) Raw materials used in production
(B) Direct labour
(C) Manufacturing overhead
Total manufacturing costs [A+B+C]
Add: Beginning work in progress inventory
Deduct: Ending work in progress inventory
Cost of goods manufactured
Cost of goods manufactured
Add: Beginning finished goods inventory
Cost of goods available for sale
Deduct: Ending finished goods inventory
Cost of goods sold (reported in the profit and loss account)
 Fixed and Variable Costs

Enabling informed managerial decision-making (for

predicting cost behaviour)
 Fixed and Variable Costs
i. Variable Costs: varying with Activity Levels

Total Unit
Cost Cost

30 £3

10 Output Output

E.g. Direct Materials (product or service)

 Fixed costs: for a given period
Total Unit
Cost Relevant Range Cost

500

Output Output
E.g Rent & rates
.
Factory insurance
 Relevant range
The range of activity across the period within which the
assumptions made about fixed and variable costs are valid.

Example: The assumption that the lease or rent for a chair frame
manufacturing machine is £8,000 per month is valid within the
relevant range of 0 to 2,000 units per month. Over this number
of steel frames they need one extra machine.

This would be a ‘step cost.’

 Relevant range and fixed cost ‘steps’
90
Rent Cost in thousands of pounds

Relevant
Range Fixed cost doesn’t
change for a quite a
60 wide range of activity.
Then it jumps a step to
a new fixed cost level
for the next range of
30 activity.

0
0 1,000 2,000 3,000

Rented Area (Square metres)

 Total cost
Total
Cost Total cost line

Variable Costs

Fixed costs

Output

Total cost = Fixed cost + Total Variable

cost
 Cost Structure
Refers to the relative proportion of variable and fixed costs in a given
product, service or department

Gives you information about what you can change in the short term
(i.e. variable costs) and longer term (variable and fixed costs).

Note that a high volume car manufacturer may have a different cost
structure to a luxury manufacturer (e.g. Toyota versus Ferrari).

 http://www.youtube.com/watch?v=82w_r2D1Ooo&feature=related
(Car Factory, Japan)

 http://www.youtube.com/watch?v=La73Oy9ZGVw&feature=related
(Car Factory, Italy)
 Cost Classification and Predicting ‘Cost
Behaviour’
Cost In Total
Variable Total variable costs change as
activity level changes within
the relevant range: e.g. Direct
materials in a lecture chair
Fixed Total fixed costs remain the
same as activity level changes
within the relevant range: e.g.
Machine rented or leased to
produce up to 2000 lecture
chairs.
Per Unit
Variable cost per unit remains
the same over a total range of
activity within the relevant
range.
Fixed cost per unit goes down
as activity level goes up within
the relevant range
Exploring Variable and fixed in everyday
life….

Variable and fixed costs at Arriva

Decision making:
Expanding or dropping
Routes?
Managerial aspects of fixed and variable costs

Enabling informed managerial decision-making (for

predicting of cost behaviour)

In the long term everything is variable

- But how to decide the time horizon for when a fixed cost is
fixed?
- What is the relevant range of production/service?
- Different ‘big’ investments decisions are made at different
levels and within different time horizons

(more about relevant cost/volume/profit information analysis for

decision making in later Lectures)
 Product and Period Costs

For allocating costs to costs of goods sold / inventories

and ensuring good financial accounting
 Product and Period Costs
Product Unsold
Recorded as Asset
(Inventory)
Manufacturing in the Balance Sheet
Cost
Product Cost
Product Sold
Becomes Expense in the
Profit and Loss Account

Recorded as an
Non- Manufacturing Expense
Period Cost in the Profit and Loss
Cost account in the current
accounting period

Source: Drury (2000)

Treatment of Product and Period Cost
 Example: Product and Period Costs

 During the current year, Springboat has incurred

manufacturing costs of £420,000 in building three large
sailboats. At the year-end, each boat is about 70% complete.

 How much of these manufacturing costs should be recognized

as Expense in the Springboat’s income statement for the
current year?
None!!!

Until completion & sale, costs remain in Inventory

Boats are recorded as Assets in Balance Sheet

Managerial aspects of product and period costs

• Not a focus for day-to-day internal (e.g. production

department) management

• Instead a top management focus with a financial

accounting emphasis on issues like
• Overall company profitability
• Financial reporting decisions
• Asset sale/disposal (e.g. What do we do with last
year’s boats? Sell at discount (or even write off)?)
 Three managerial aspects of costs

1. Direct and Indirect (overhead) costs

Assignment of costs to cost objects focusing on line and
staff costs

1. Fixed and Variable Costs

Enabling informed managerial decision-making (for
predicting of cost behaviour)

2. Product and Period Costs

For allocating costs to costs of goods sold / inventories &
ensuring good financial accounting
From Managing Costs to Accountability

Why have ‘adverse’ variances happened?

Material prices up? Labour costs up?
Purchasing or top management are accountable?
Poor (or good) line management?
NB Cost centre B has no variance. Manager accountable
for good performance perhaps?

Key outcome….
Tracking costs to each product and each department
ensures universal accountability…
 ‘The VW scandal –
the unanswered questions’
Source: http://www.bbc.co.uk/news/business-34400305

“This was not the

action of some
rogue employee.
There will have
been a chain of
command that
approved the use
of the cheat
software in 11
Unintended consequences? million cars.”
Who is accountable?
 What to prepare for seminar 1 in week 3

Seminar 1 :

Compulsory Exercises
1. Prepare P2-18 (Seal et al. 2015, p. 56)
2. Prepare P2-13 (Seal et al. 2015, p. 52)
3. Nielsen, L. B., Mitchell, F., & Nørreklit, H. (2015, March).
Management accounting and decision making: Two case studies of
outsourcing. Accounting Forum (Vol. 39, No. 1, pp. 64-82). Elsevier.
Additional exercises:
1. Prepare P2-8 (Seal et al. 2015, p. 48)
2. Prepare P2-14 (Seal et al. 2015, p. 53)
References
Chandler A.D. (1977), The Visible Hand: the Managerial revolution in
American Business ,Cambridge, MA: Harvard University Press,
Introduction
Drury, C. (2015). Management and Cost Accounting (9th ed.). South-
Western/Cengage Learning.
Hoskin, K & Macve, R. (1990) Understanding Modern Management,
University of Wales Business and Economic Review, Vol. 5, pp. 17-22.
Seal, W., Garrison, R.,, Rohde C, and Noreen, E. (2015). Management
Accounting (5th ed.). McGraw-Hill
Hoskin, K. and Macve, R. (1988) “The Genesis of Accountability: The West
Point Connections”, Accounting, Organizations and Society, Vol 13, No 1,
pp37-73.
Johnson, H & R. Kaplan (1987), Relevance Lost: the rise and fall of
management accounting. Cambridge, MA: Harvard Business School Press.