Application of Management Accounting
How management accounting is applied at ICEA ASSET MANAGENT LTD Management accounting or managerial accounting[1] is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions. In contrast to financial accountancy information, management accounting information is: * forward-looking, instead of historical;
* model based with a degree of abstraction to support decision making generically, instead of case based;
* designed and intended for use by managers
within the organization, instead of being intended for use by shareholders,
creditors, and public regulators; * usually confidential and used by
management, instead of publicly reported;
* computed by reference to the needs of
managers, often using management information systems, instead of by reference
to general financial accounting standards.
According to the Chartered Institute of
Management Accountants (CIMA), Management Accounting is "the process of
identification, measurement, accumulation, analysis, preparation,
interpretation and communication of information used by management to plan,
evaluate and control within an entity and to assure appropriate use of and
accountability for its resources. Management accounting also comprises the
preparation of financial reports for non-management groups such as
shareholders, creditors, regulatory agencies and tax authorities" (CIMA
Official Terminology) The Institute of Management Accountants(IMA)[2] recently
updated its definition as follows: "management accounting is a profession
that involves partnering in management decision making, devising planning and
performance management systems, and providing expertise in financial reporting
and control to assist management in the formulation and implementation of an
organization’s strategy." The American Institute of Certified Public
Accountants(AICPA) states that management accounting as practice extends to the
following three areas:
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* 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. * Risk Management—Contributing to frameworks and practices for
identifying, measuring, managing and reporting risks to the achievement of the
objectives of the organization. The Institute of Certified Management
Accountants(ICMA), states "A management accountant applies his or her
professional knowledge and skill in the preparation and presentation of
financial and other decision oriented information in such a way as to assist
management in the formulation of policies and in the planning and control of
the operation of the undertaking." Management Accountants therefore are
seen as the "value-creators" amongst the accountants. They are much
more interested in forward looking and taking decisions that will affect the
future of the organization, than in the historical recording and compliance
(score keeping) aspects of the profession. Management accounting knowledge and
experience can therefore be obtained from varied fields and functions within an
organization, such as information management, treasury, efficiency auditing,
marketing, valuation, pricing, logistics, etc. Role within the corporation
Consistent with other roles in today's corporation, management accountants have a dual reporting relationship. As a strategic partner and provider of decision based financial and operational information, 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. 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. ICEA ASSET MANAGEMENT derives much of its profits from the information economy, IT costs are a significant source of uncontrollable spending, which in size is often the greatest corporate cost after total compensation costs and property related costs. A function of management accounting in the organization is to work closely with the IT department to provide IT Cost Transparency. Given the above, one widely held view of the progression of the accounting and finance career path is that financial accounting is a stepping stone to management accounting. Consistent with the notion of value creation, management accountants help drive the success of the business while strict financial accounting is more of a compliance and historical endeavor. An alternative view
A very rarely expressed alternative view of management accounting is that it is neither a neutral or benign influence in organizations, rather a mechanism for management control through surveillance. This view locates management accounting specifically in the context of management control theory. Stated differently, Management Accounting information is the mechanism which can be used by managers as a vehicle for the overview of the whole internal structure of the organization to facilitate their control functions within an organization. Management accounting encompasses the following areas:
* Performance evaluation
* Costing(relevance,behaviour,function)
* Budgeting.
Performance evaluation is concerned with accountability, responsibility and control. In this area managers are analyze in their job areas and made accountable for the results and performance in a time period, as set by the management accountant or the board as the case may be. There are three responsibility centers that are analyzed:
It is important to read out carefully:acc 104 business finance
Consistent with other roles in today's corporation, management accountants have a dual reporting relationship. As a strategic partner and provider of decision based financial and operational information, 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. 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. ICEA ASSET MANAGEMENT derives much of its profits from the information economy, IT costs are a significant source of uncontrollable spending, which in size is often the greatest corporate cost after total compensation costs and property related costs. A function of management accounting in the organization is to work closely with the IT department to provide IT Cost Transparency. Given the above, one widely held view of the progression of the accounting and finance career path is that financial accounting is a stepping stone to management accounting. Consistent with the notion of value creation, management accountants help drive the success of the business while strict financial accounting is more of a compliance and historical endeavor. An alternative view
A very rarely expressed alternative view of management accounting is that it is neither a neutral or benign influence in organizations, rather a mechanism for management control through surveillance. This view locates management accounting specifically in the context of management control theory. Stated differently, Management Accounting information is the mechanism which can be used by managers as a vehicle for the overview of the whole internal structure of the organization to facilitate their control functions within an organization. Management accounting encompasses the following areas:
* Performance evaluation
* Costing(relevance,behaviour,function)
* Budgeting.
Performance evaluation is concerned with accountability, responsibility and control. In this area managers are analyze in their job areas and made accountable for the results and performance in a time period, as set by the management accountant or the board as the case may be. There are three responsibility centers that are analyzed:
It is important to read out carefully:acc 104 business finance
* Cost centre
* Profit centre
* Investment centre
Performance evaluation in a cost centre
When evaluating costs, benchmarking has to be done to compare the costs of one department with the other to establish if there is misuse of resources. Then variance analysis is conducted in which you measure the actual cost with the budgeted cost to establish if there is over or under spending. Lastly, an efficiency ratio is calculated to show how well the department has performed in terms of utilization of inputs to produce outputs. Efficiency ratio=Output/Input
Performance evaluation in a profit centre
Performance measurement is accomplishment through the use of profitability ratios e.g. Gross profit ratio, net profit ratio etc. Performance measurement in an Investment centre
This is a sub unit of an organization where managers have control over costs, revenues and some investment decisions i.e. managers have power to buy assets otherwise known as fund managers. Performance in this department is evaluated through use of such ratios such as return on investment, return on capital employed, return on equity , performance attribution etc.;Absolute measure like residual income is also used. I work at ICEA Asset management where performance is measured against all these areas. The management accountant will analyze the Investment centre which is the fund management division, the profit centre that is the finance division and the Cost centre which encompasses Zero-based budgeting that critically analyzes all areas and activities within the organization . Which takes us to the other area of management accounting known as Budgeting. Budgeting is a very effective way of efficient use of resources. if businesses fail to budget, they can't have a clue how much resources are available and where the business has to spend first(prioritizing your expenses/payout),budgeting is all about planning and implementation, and if you fail to plan, you plan to fail. The budget of a company is often compiled annually, but may not be. A finished budget, usually requiring considerable effort, is a plan for the short-term future, typically one year (see Budget Year). While traditionally the Finance department compiles the company's budget, modern software allows hundreds or even thousands of people in various departments (operations, human resources, IT, etc.) to list their expected revenues and expenses in the final budget. If the actual figures delivered through the budget period come close to the budget, this suggests that the managers understand their business and have been successfully driving it in the intended direction. On the other hand, if the figures diverge wildly from the budget, this sends an 'out of control' signal, and the share price could suffer as a result. [3] At ICEA Asset Management the annual budgeted is drafted before end of July as the accounting period ends in June. This budget normally applies for the financial year July-June of the next year. Budgets are normally internal reports that are used to measure actual cost against budgeted and as well as income. They also reflect if the various departments are working as hard they should and also point out on the weak areas. The main roles of budgeting are:
* Relates long-term organizational goals to its short-term activities * Distributes resources and workloads
* Communicates responsibilities and enhances communication between the manager and his subordinates where everyone is allowed to contribute to the budget. * Enhances motivation among the employees who are made to feel as important resources in the organization through profit share * Provides a continuous feedback, that is if you are using rolling budgeting Through budgeting deriving all these functions, ICEA Asset Management has been able to develop a strong social culture built on definite direction/goal in mind.
When it comes to costing , costs must be classified according to either behavior function or relevance which is essential when coming up with budgeted financial statements and contribution margin statements , well overall a company’s financial statements. Ways of classifying Costs
Costs may be classified by
* Function(Direct vs. Indirect costs, Manufacturing costs, Prime vs. Conversion costs, Product vs. Periodic costs) * Behaviour(Fixed costs, Variable costs, Semi-variable costs) * Relevance(Relevant vs. Irrelevant costs)
Costs Classification by function
Direct vs. Indirect
Direct Costs - those costs that are directly traceable to an object. The wages of a factory line worker that only works on the producing a Volkswagen Beetle would be considered a direct cost of the Beetle. However the VP of production's salary who is in charge of production on all cars would be an indirect cost to the Beetle. Indirect costs cannot be traced to a specific object.
Manufacturing Costs Vs. Non manufacturing Costs
Manufacturing costs are the costs that go into making a product. There are three basic types of manufacturing costs that you will become very familiar with over the course of the semester:
* Profit centre
* Investment centre
Performance evaluation in a cost centre
When evaluating costs, benchmarking has to be done to compare the costs of one department with the other to establish if there is misuse of resources. Then variance analysis is conducted in which you measure the actual cost with the budgeted cost to establish if there is over or under spending. Lastly, an efficiency ratio is calculated to show how well the department has performed in terms of utilization of inputs to produce outputs. Efficiency ratio=Output/Input
Performance evaluation in a profit centre
Performance measurement is accomplishment through the use of profitability ratios e.g. Gross profit ratio, net profit ratio etc. Performance measurement in an Investment centre
This is a sub unit of an organization where managers have control over costs, revenues and some investment decisions i.e. managers have power to buy assets otherwise known as fund managers. Performance in this department is evaluated through use of such ratios such as return on investment, return on capital employed, return on equity , performance attribution etc.;Absolute measure like residual income is also used. I work at ICEA Asset management where performance is measured against all these areas. The management accountant will analyze the Investment centre which is the fund management division, the profit centre that is the finance division and the Cost centre which encompasses Zero-based budgeting that critically analyzes all areas and activities within the organization . Which takes us to the other area of management accounting known as Budgeting. Budgeting is a very effective way of efficient use of resources. if businesses fail to budget, they can't have a clue how much resources are available and where the business has to spend first(prioritizing your expenses/payout),budgeting is all about planning and implementation, and if you fail to plan, you plan to fail. The budget of a company is often compiled annually, but may not be. A finished budget, usually requiring considerable effort, is a plan for the short-term future, typically one year (see Budget Year). While traditionally the Finance department compiles the company's budget, modern software allows hundreds or even thousands of people in various departments (operations, human resources, IT, etc.) to list their expected revenues and expenses in the final budget. If the actual figures delivered through the budget period come close to the budget, this suggests that the managers understand their business and have been successfully driving it in the intended direction. On the other hand, if the figures diverge wildly from the budget, this sends an 'out of control' signal, and the share price could suffer as a result. [3] At ICEA Asset Management the annual budgeted is drafted before end of July as the accounting period ends in June. This budget normally applies for the financial year July-June of the next year. Budgets are normally internal reports that are used to measure actual cost against budgeted and as well as income. They also reflect if the various departments are working as hard they should and also point out on the weak areas. The main roles of budgeting are:
* Relates long-term organizational goals to its short-term activities * Distributes resources and workloads
* Communicates responsibilities and enhances communication between the manager and his subordinates where everyone is allowed to contribute to the budget. * Enhances motivation among the employees who are made to feel as important resources in the organization through profit share * Provides a continuous feedback, that is if you are using rolling budgeting Through budgeting deriving all these functions, ICEA Asset Management has been able to develop a strong social culture built on definite direction/goal in mind.
When it comes to costing , costs must be classified according to either behavior function or relevance which is essential when coming up with budgeted financial statements and contribution margin statements , well overall a company’s financial statements. Ways of classifying Costs
Costs may be classified by
* Function(Direct vs. Indirect costs, Manufacturing costs, Prime vs. Conversion costs, Product vs. Periodic costs) * Behaviour(Fixed costs, Variable costs, Semi-variable costs) * Relevance(Relevant vs. Irrelevant costs)
Costs Classification by function
Direct vs. Indirect
Direct Costs - those costs that are directly traceable to an object. The wages of a factory line worker that only works on the producing a Volkswagen Beetle would be considered a direct cost of the Beetle. However the VP of production's salary who is in charge of production on all cars would be an indirect cost to the Beetle. Indirect costs cannot be traced to a specific object.
Manufacturing Costs Vs. Non manufacturing Costs
Manufacturing costs are the costs that go into making a product. There are three basic types of manufacturing costs that you will become very familiar with over the course of the semester:
1) Direct Materials
2) Direct Labor
3) Factory Overhead
acc 102 introductory accounting 22) Direct Labor
3) Factory Overhead
Direct Materials - Materials that are directly traceable to the product and
represent a significant portion of the total cost.
Direct Labor - The- cost of wages of employees who are directly involved in manufacturing the product. Sometimes referred to as 'touch labor"...if they touch it, their time is probably classified as direct labor.
Factory Overhead - All other product costs or costs related to the factory other than direct materials or direct labor. By definition, factory overhead costs are indirect. This is a catch-all category for product costs. These overhead costs are also called 'burden". This category includes insignificant materials and labor costs. Prime Costs vs. Conversion Costs
The difference in classifying these costs will become very important in the process-costing chapter, In summary; prime costs are the combination of direct materials and direct labor. Conversion costs are the combination of direct labor and factory overhead costs. Product Costs vs. Period Costs
Product costs are the combination of the three basic types of manufacturing costs' direct materials, direct labor, and factory overhead as we described above. Period costs are expenses that are generally classified into two categories: Selling and administrative expenses. The importance in identifying the costs properly cannot be overemphasized: product costs go on the balance sheet as they are incurred and they eventually make their way to the income statement, periodic costs go directly to the income statement. Financial statements and managerial reports can be misleading if these costs are not accounted for properly. Costs classification according to behaviour
Costs can also be classified according to behaviour. Such as Fixed costs, variable cost and semi-variable costs. This is the classification used in most investment companies like ICEA Asset Management Ltd. Fixed costs are depreciation,salaries,rent etc. while variable costs are like overheads(transport to client meeting, occupancy at those venues, stationery),casual workers etc.These costs are presented in a budgeted contribution margin statement to measure the controllable and non- controllable profit. Costs classification by relevance
This forms the main reason why costs are classified. Costs are classified to segregate the relevant from the irrelevant costs. Relevant costs are future costs while irrelevant costs are costs which have already been incurred like sunk costs. Here we look at sunk vs. opportunity costs. Opportunity costs are costs of forgoing a potential benefit while sunk costs are retrospective (past) costs that have already been incurred and cannot be recovered. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken. Both retrospective and prospective costs may be either fixed (that is, they are not dependent on the volume of economic activity, however measured) or variable (dependent on volume) e.g. Depreciation. Classification by relevance is vital to a management accountant working in an investment industry, as he will need to make sure that the costs included in the financial statements are relevant for the financial year and to the industry as well as accounting for sunk costs when it comes to property investments. Managerial accounting is therefore vital in any organization to ensure adequate accountability in all areas of the business.
References
1. http://en.wikipedia.org/wiki/Management_accounting
2. ^ * "Taking Control of IT Costs". Nokes, Sebastian. London (Financial Times / Prentice Hall): March 20, 2000. ISBN 978-0-273-64943-4 3. http://en.wikipedia.org/wiki/Budget#Corporate_budget
Direct Labor - The- cost of wages of employees who are directly involved in manufacturing the product. Sometimes referred to as 'touch labor"...if they touch it, their time is probably classified as direct labor.
Factory Overhead - All other product costs or costs related to the factory other than direct materials or direct labor. By definition, factory overhead costs are indirect. This is a catch-all category for product costs. These overhead costs are also called 'burden". This category includes insignificant materials and labor costs. Prime Costs vs. Conversion Costs
The difference in classifying these costs will become very important in the process-costing chapter, In summary; prime costs are the combination of direct materials and direct labor. Conversion costs are the combination of direct labor and factory overhead costs. Product Costs vs. Period Costs
Product costs are the combination of the three basic types of manufacturing costs' direct materials, direct labor, and factory overhead as we described above. Period costs are expenses that are generally classified into two categories: Selling and administrative expenses. The importance in identifying the costs properly cannot be overemphasized: product costs go on the balance sheet as they are incurred and they eventually make their way to the income statement, periodic costs go directly to the income statement. Financial statements and managerial reports can be misleading if these costs are not accounted for properly. Costs classification according to behaviour
Costs can also be classified according to behaviour. Such as Fixed costs, variable cost and semi-variable costs. This is the classification used in most investment companies like ICEA Asset Management Ltd. Fixed costs are depreciation,salaries,rent etc. while variable costs are like overheads(transport to client meeting, occupancy at those venues, stationery),casual workers etc.These costs are presented in a budgeted contribution margin statement to measure the controllable and non- controllable profit. Costs classification by relevance
This forms the main reason why costs are classified. Costs are classified to segregate the relevant from the irrelevant costs. Relevant costs are future costs while irrelevant costs are costs which have already been incurred like sunk costs. Here we look at sunk vs. opportunity costs. Opportunity costs are costs of forgoing a potential benefit while sunk costs are retrospective (past) costs that have already been incurred and cannot be recovered. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken. Both retrospective and prospective costs may be either fixed (that is, they are not dependent on the volume of economic activity, however measured) or variable (dependent on volume) e.g. Depreciation. Classification by relevance is vital to a management accountant working in an investment industry, as he will need to make sure that the costs included in the financial statements are relevant for the financial year and to the industry as well as accounting for sunk costs when it comes to property investments. Managerial accounting is therefore vital in any organization to ensure adequate accountability in all areas of the business.
References
1. http://en.wikipedia.org/wiki/Management_accounting
2. ^ * "Taking Control of IT Costs". Nokes, Sebastian. London (Financial Times / Prentice Hall): March 20, 2000. ISBN 978-0-273-64943-4 3. http://en.wikipedia.org/wiki/Budget#Corporate_budget
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ACC 101 Introductory accounting 1
ACC 101 Introductory accounting 1
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