ACCA F2 Management Accounting - 2010 - Study text - Emile Woolf Publishing
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Chapter 1: The nature and purpose of cost and management accounting
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information might be provided in the form of routine performance reports or as
special warnings or alerts when something unusual has occurred.
‘One-off’ decision making
Decisions taken by managers include planning decisions and control decisions. In
addition, managers might need to make ‘one-off’ decisions, outside the formal
planning and control systems. Management accounting information can be
provided to help a manager decide what to do in any situation where a decision is
needed.
1.5 Strategic, tactical and operational planning
Managers carry out their responsibilities at different levels in the hierarchy of an
organisation, and decisions are made at all levels of management. These may be
planning decisions, control decisions or ‘one-off’ decisions. Decision-making can be
categorised into three levels: these different categories are probably most easily
understood in relation to planning decisions.
Strategic planning. Strategic planning involves setting overall objectives for the
organisation and developing broad plans, mostly over a fairly long-term, about
how the objectives should be achieved. An example of a strategic plan is a five-
year business plan. Strategic planning is the responsibility of senior
management, who plan the strategic direction that the entity should be taking.
To make long-term plans, managers need information. Much of this information
is not financial in nature, and much of it comes from external sources (from
sources outside the organisation). However some accounting and financial
information is needed for strategic planning purposes, and ‘strategic
management accounting’ is a term for the provision of information for strategic
planning purposes.
Tactical planning. Tactical planning involves developing shorter-term plans to
implement longer-term strategic plans. They have a shorter time frame than
strategic plans, and many tactical plans cover a period of six months or one year.
They might also be sub-divided into shorter control periods, such as monthly
periods, for the purpose of routine control reporting. They are also more
detailed than strategic plans. In a large organisation, tactical planning involves
managers below the most senior level (‘middle management’), although tactical
plans might require senior management approval. Much of the information for
tactical planning comes from sources within the organisation, such as the cost
accounting system, and much of it is financial in nature. An example of a tactical
plan is an annual budget.
Operational planning. Operational planning is planning the operational
activities of an entity in detail. Operational plans include production schedules,
work schedules, machine utilisation plans, maintenance schedules, delivery
schedules and so on. They are short-term plans such as daily or weekly
operating schedules and most are not financial in nature. Operational planning
should involve junior management and supervisors, although they might need
the approval of middle management.
Management accounting information is provided mainly for strategic planning and
tactical planning purposes, and for senior or middle management. However, the use
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of management accounting for tactical planning and control is probably more
widespread than strategic management accounting.
The techniques described in later chapters of this study text relate mainly to the
provision of information for planning and control at the tactical level.
1.6 Cost, revenue, profit and investment centres
Organisation structure and management responsibilities
Every business organisation has a management structure, and individual managers
are given responsibility for a particular aspect of operations or activity. The
operations or activity for which they are responsible can be called a responsibility
centre. Within a large organisation, there is a hierarchy of management, with a
hierarchy of delegated responsibilities.
A manager might be in charge of a department, such as a warehouse or the buying
department. A part of their responsibility should be to ensure that the department
operates efficiently and economically, and that costs (expenditures) are kept under
control. A departmental manager is likely to be responsible for preparing the annual
cost budget for the departments, subject to approval by his superiors. A manager
who is made responsible for costs must have some authority over spending in his
department (although a large proportion of departmental costs, such as employees’
salaries, might be outside his control).
A manager might be responsible for a department or activity that earns revenue,
and for the revenue earned by the department. For example a sales manager might
be made responsible for the activities of a sales team and the revenue that the sales
team earns. Similarly, the manager of a retail store (in a company that operates a
chain of stores) might be responsible for the revenues earned by the store. A
manager who is made responsible for revenues might have some authority to adjust
or decide selling prices; alternatively a manager might be told what the sales prices
will be and is them made responsible for the volume of sales at those prices.
When a manager is responsible for both the costs and the revenues of an operation
or department, he (or she) is also responsible for the profits that it earns.
In some cases, a manager might have the responsibility to make decisions about
capital investment for an operation, with authority to buy new capital equipment or
sell off unwanted assets. For example in a large company or a group of companies,
there might be operating divisions where the divisional manager has a large amount
of autonomy, with authority over capital spending (‘capital budgets’) as well as
revenues, costs and profits.
Definition of cost, revenue, profit and investment centres
As stated earlier, managers need management accounting information to help them
make decisions. For the purpose of cost and management accounting, responsibility
centres can be divided into four categories:
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Cost centres. A cost centre is a department or work group for which costs are
established, in order to measure the cost of output produced by the centre. For
example, in a factory a group of machines might be a cost centre. The costs of
operating the machines would be established, and a cost could then be
calculated for each unit of product manufactured by the machines.
In a cost centre, there is no measurement of revenue or profit.
Profit centres. A profit centre is a department or division within the
organisation for which revenues as well as costs are established. By measuring
the costs of the products or services produced by the centre, and the revenues
earned from selling them, it is possible to establish the profit (or loss) that the
centre makes.
Example: summarised profit centre report
$000
Revenues of the profit centre 250
Costs of the units sold by the profit centre 220
Profit (or loss) of the profit centre 30
A profit centre might consist of several cost centres. For example, a factory might
be treated as a profit centre, and within the factory, the machining department,
assembly department and finishing department might be three cost centres.
Investment centres. An investment centre is a division within an organisation
where the management is responsible not only for the costs of the division and
the revenues that it earns, but also for decisions relating to the investment in
assets for the division. An investment centre manager usually has authority to
purchase new assets, such as items of plant or equipment, and so should be
responsible for the profit or ‘return’ that the division makes on the amount that
it has invested.
The performance of an investment centre might be measured by calculating the
profit as a percentage of the amount invested (the return on investment or ROI).
An investment centre might include a number of different profit centres. For
example, a company manufacturing cars and trucks might have two investment
centres, (1) car-making and (2) truck-making. Within the truck-making division,
there might be several profit centres, each of these a separate location or factory
at which trucks are manufactured and assembled.
Revenue centres. A revenue centre is a department or division within the
organisation for which revenues are established. In a revenue centre there is no
measurement of cost or profit. Revenue centre managers will only need to have
information relating to revenues and will be accountable for revenues only. For
example, the income accountant in a hospital is only responsible for recording
and controlling the different incomes that are received from funding bodies or
other sources (for example, private patients, fundraising and so on).
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Example
A media company has several divisions. One is a magazine publishing division. This
division is divided into three operating units: fashion magazines, sports magazines
and business magazines, which operate from different offices. The fashion
magazines unit has three main functions: commissioning, editing and printing, and
marketing and sales.
The media company might organise its cost and management system as follows:
Each of the divisions in the media company, including the magazines division,
might be an investment centre. The senior manager of the magazines division
might have the authority to incur capital expenditure to acquire new assets for
the division. The performance of the magazines division might be measured by
its annual return on investment (ROI).
Within the magazines division, the fashion magazines unit, sports magazines
unit and business magazines unit might be profit centres. The manager of each
unit might be responsible for the revenues and costs of the unit, and the
performance of each unit would be measured by the profit that it makes.
Within the fashions magazine unit, each of the operating functions
(commissioning, editing and printing, and marketing and sales) might be a cost
unit. The manager in charge of each unit is responsible for costs, and the
performance of the cost unit might be measured by comparing the actual costs of
the cost centre with its budgeted costs.
The differing information needs of cost, revenue, profit and investment centre
management
Managers of responsibility centres are responsible for the performance of their part
of the organisation and its activities. The performance of an organisation is often
measured financially, in terms of:
keeping expenditure under control
earning a sufficient amount of revenue
making a profit
making a suitable return on investment.
Managers therefore need information about the costs of operations for which they
are responsible. They will often also need information about revenues and profit. In
some cases, they will also need information about the amount of property, plant and
equipment, and other ‘assets’ for which they are responsible. The information they
need to make decisions within their area of responsibility depends on the scope of
their management authority and responsibilities.
Managers also need financial information to help them make decisions. For
example, they might need information about expected costs to make a decision
about how much to charge for a job for a customer. Similarly, they might need
information about costs and revenues to decide whether to invest money in a new
project.
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Management accounting is concerned with providing information to management
to help them with planning and control, and for making other decisions.
The accounting information provided to managers should help them to make
decisions, and the information provided should be relevant for the decisions they
have to make. Clearly, the nature and content of the accounting information
required depends on the nature of the manager’s responsibilities (i.e. on the type of
responsibility centre).
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Cost and management accounting versus financial accounting
Purpose and role of cost and management accounting
Comparison of financial accounting and cost and management accounting
2 Cost and management accounting versus financial
accounting
2.1 Purpose and role of cost and management accounting
Cost accounting
Cost accounting is concerned with gathering data about the costs of products or
services and the cost of activities. There may be a formal costing system in which
data about operational activities is recorded in a ‘double entry’ system of cost
accounts in a ‘cost ledger’. The cost accounting data is captured, stored and
subsequently analysed to provide management information about costs.
Information provided by cost accounting systems is financial in nature, and
analysed in detail. It may be forward-looking, and used to provide information
about expected costs and profits in the future. More usually, cost accounting
information is historical in nature, and provides information about the actual costs
of items and activities that have been incurred.
Management accounting
Management accounting is concerned with providing information to management
about costs, sales revenue and profits, so that managers are able to make well-
informed decisions. Management accounting information is often prepared from an
analysis of cost accounting data, although cost estimates and revenue estimates may
be obtained from sources other than the cost accounting system.
The purpose of management accounting is to provide detailed financial information
to management, so that they can plan and control the activities or operations for
which they are responsible. Management accounting information is also provided to
help managers make other decisions. In other words, management accounting
provides management information to assist with planning, control and ‘one-off’
decisions.
Management control systems
A management accounting system may be described as a management control
system. This is an information system, largely at a tactical information level for
middle management that helps managers to plan and control the activities of the
organisation.
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A management control system can be described as a system for:
identifying the objectives of the organisation: these may be long-term objectives,
or may be budget objectives for the next financial year
setting quantified targets for achieving those objectives
measuring actual results throughout the planning period, and comparing actual
performance with the objectives and targets
taking control action where necessary when actual results are below target, or
taking control action where appropriate to sustain performance when this is
better than target.
An example of a management control system is budgeting with standard costs, and
measuring actual performance against the standard costs using monthly variance
analysis reports. Standard costs and variance analysis are described in a later
chapter.
2.2 Comparison of financial accounting and cost and management
accounting
Financial accounting
A financial accounting system is used to record the financial transactions of the
entity, such as transactions relating to revenue, expenses, assets and liabilities. The
accounting system provides a record of the assets that the company owns, and what
it owes. It also provides a record of the income that the entity has earned, and the
expenditures it has incurred.
The financial accounting system provides the data that is used to prepare the
financial statements of the entity at the end of each financial year (the income
statement, balance sheet, cash flow statement, and so on).
The main purpose of the financial statements of companies is to inform the
company’s shareholders (owners) about the financial performance and financial
position of the company. They are also used as a basis for preparing the ‘tax
accounts’ and calculating the tax that the company should pay on its profits.
Managers might use the information in the financial statements, but the main
purpose of financial reporting is for ‘external purposes’ rather than to provide
management information.
Financial statements are produced at the end of the financial year. Management
need information much more regularly, throughout the year. They also need much
more detailed information than is provided by a company’s financial statements.
They often need forward-looking forecasts, rather than reports of historical
performance and what has happened in the past.
There is a statutory requirement for companies to produce annual financial
statements, and other business entities need to produce financial statements for the
purpose of making tax returns to the tax authorities.
Managers might find financial statements useful, but the main users of the financial
statements of a company should be its shareholders. Other external users, such as
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potential investors, employees, trade unions and banks (lenders to the business)
might also use the financial statements of a company to obtain information.
Cost and management accounting
Whereas financial statements from the financial accounting system are intended
mainly for external users of financial information, management accounting
information (obtained from the cost accounting system) is prepared specifically for
internal use by management.
An entity might have a cost accounting system as well as a financial accounting
system, so that it has two separate accounting systems in operation. A cost
accounting system records the costs and revenues for individual jobs, processes,
activities and products or services.
Like the financial accounting system, a cost accounting system is based on a
double entry system of debits and credits.
However, the accounts in a cost accounting system are different from the
accounts in the financial accounting systems. This is because the two accounting
systems have different purposes, and so record financial transactions in different
ways.
There is no legal requirement for a cost accounting system. Business entities choose
to have a cost accounting system, and will only do so if the perceived benefits of the
system justify the cost of operating it.
(In business entities where there is no formal cost accounting system, managers still
need management accounting information to run their business. Some management
accounting information might be extracted from the financial accounting system,
but in much less detail than a cost accounting system would provide.)
A comparison of financial and cost accounting systems of companies is summarised
in the table below.
Financial accounting system Cost accounting system
Statutory requirement Not a statutory requirement
Used to prepare financial statements
for shareholders and other external
users
Used to prepare information for
management (internal use only)
Might also provide some information
for management
Records revenues, expenditure, assets
and liabilities
Records costs of activities and used to
provide detailed information about
costs, revenues and profits for specific
products, operations and activities
Used mainly to provide a historical
record of performance and financial
position
Provides historical information, but
also used extensively for forecasting
(forward-looking)
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Practice multiple choice questions
1 Information is processed data.
Is this statement TRUE or FALSE?
(1 mark)
2 Which one of the following statements is correct?
A Management accountants are responsible for planning, decision-making and
control.
B The purpose of a cost accounting system is to collect information about costs.
C A management accounting system provides all the strategic and tactical
information required by management.
D Management accounting information should be timely and relevant, but does
not need to be 100% accurate.
(2 marks)
3 A company owns a factory that produces Component X. All units of Component X
are transferred to the company’s processing centre where a final product is
assembled. Decisions about purchasing equipment for the factory are made at the
company’s head office. In the company’s cost and management accounting system,
the factory is likely to be treated as:
A A cost centre.
B A revenue centre
C A profit centre
D An investment centre.
(2 marks)
4 A cost centre manager needs regular information about costs incurred by the centre.
In a cost and management accounting system, which of the following is the most
likely frequency of regular cost reports for the centre?
A Daily
B Weekly
C Monthly
D Annual
(2 marks)
5 A profit centre manager needs information about which of the following?
(1) Costs incurred by the centre
(2) Revenues earned by the centre
(3) Capital investment in the centre
A (1) only
B (1) and (2) only
C (2) only
D (1), (2) and (3)
(2 marks)
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6 A company is preparing a budget for an advertising campaign that the sales director
has just ordered, subject to approval of the costs. The campaign is expected to last
for just over six months. The advertising budget is an example of:
A Strategic planning
B Tactical planning
C Operational planning
(1 mark)