Foundation Exams Management Accounting Study Guide 2018 PDF

FOUNDATION EXAMS MANAGEMENT ACCOUNTING  STUDY GUIDE Foundation exam Management Accounting ii Seventh edition 2018 First edition 2010 ISBN 9781 5097 1390 5...

FOUNDATION EXAMS MANAGEMENT ACCOUNTING  STUDY GUIDE Foundation exam Management Accounting ii Seventh edition 2018 First edition 2010 ISBN 9781 5097 1390 5 Previous ISBN 9781 4727 3898 1 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. Published by BPP Learning Media Ltd All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means or stored in any retrieval system, electronic, mechanical, photocopying, recording or otherwise without the prior permission of the publisher. The contents of this book are intended as a guide and not professional advice. Although every effort has been made to ensure that the contents of this book are correct at the time of going to press, BPP Learning Media, the Editor and the Author make no warranty that the information in this book is accurate or complete and accept no liability for any loss or damage suffered by any person acting or refraining from acting as a result of the material in this book. Every effort has been made to contact the copyright holders of any material reproduced within this publication. If any have been inadvertently overlooked, BPP Learning Media will be pleased to make the appropriate credits in any subsequent reprints or editions. We are grateful to CPA Australia for permission to reproduce the Learning Objectives, the copyright of which is owned by CPA Australia. Printed in Australia This is printed on FSC accredited stock by an FSC accredited printer. © BPP Learning Media Ltd 2018  MANAGEMENT ACCOUNTING | iii CONTENTS Page INTRODUCTION Foundation exams iv Module features v Preparing for your foundation exam vii Module summary ix Learning objectives xi MODULES 1 The nature and purpose of management accounting 1 2 Cost classification 31 3 Types of product costing 63 4 Budgeting and variance analysis 133 5 Performance measurement 205 6 Short-term and long-term decision making 229 7 Inventory and pricing decisions 285 Revision questions 311 Answers to revision questions 331 Before you begin questions: Answers and commentary 347 Glossary of terms 367 Index 375 iv | INTRODUCTION FOUNDATION EXAMS International Education Standards CPA Australia is a member of the International Federation of Accountants (IFAC). All foundation exams education materials are developed in line with IFAC’s International Education Standards. These standards provide guidance in establishing the content of professional accounting education programs together with the associated assessment. The standards also assist in developing the required passing standard for accounting education and competence of a professional accountant. The foundation exams provide you with the opportunity to demonstrate your competence in areas required for Associate membership of CPA Australia. By demonstrating this entry level knowledge you will be well positioned to succeed at the CPA Program and ultimately attaining the CPA designation. YOU AND YOUR STUDY PLAN This Study Guide is designed to give you an understanding of what to expect in your exam as well as covering the fundamentals that you need to know. Exams will be based on the contents of the current Study Guide. You will need to check My Online Learning to confirm which version you should use based on your exam date. There are no specifically recommended hours of study. Each candidate brings their own level of experience and knowledge to the foundation exams. The number of study hours required is entirely dependent on your prior knowledge of the subject. You will need to develop your own study plan. Refer to Preparing for your foundation exam on page viii. ADDITIONAL LEARNING SUPPORT If you feel you have gaps in your knowledge after reviewing the Study Guide, there is a range of optional additional support to assist in your exam preparation. Additional learning support caters for different learning styles and budgets. Please check the CPA Australia website for more information https://www.cpaaustralia.com.au/cpa- program/cpa-program-candidates/your-in-semester-support/learning-resources/foundation STANDARDS AND LEGISLATION The material in this Study Guide has been prepared based upon standards and legislation in effect as at 1 September 2017. Candidates are advised that they should confirm effective dates of standards and legislation when using additional study resources. Exams are based on the learning objectives outlined within this Study Guide.  MANAGEMENT ACCOUNTING | v MODULE FEATURES Each module contains a number of helpful features to guide you through each topic. Learning Show the referenced CPA Australia learning objectives. objectives Topic list Tells you what you will be studying in this module. Module outline Presents a general idea of what is covered in this module. Module summary Summarises the content of the module, helping to set the scene so that you diagram can understand the bigger picture. Before you begin A small bank of questions to test any pre-existing knowledge that you may have of the module content. If you get them all correct then you may be able to reduce the time you need to spend on the particular module. There is a commentary section at the end of the Study Guide called Before you begin questions: Answers and commentary. Section overview Summarises the key content of the particular section that you are about to start. Learning objective Indicates the learning objective covered by the section or paragraph to reference which it relates. LO 1.2 Definition Definitions of important concepts. You really need to know and understand these before the exam. Exam comments Highlight points that are likely to be particularly important or relevant to the exam. (Please note that this feature does not apply in every foundation exam exam Study Guide.) Worked Example An illustration of a particular technique or concept with a solution or explanation provided. Question A question that enables you to practise a technique or test your understanding. You will find the solution at the end of the module. Key module points Reviews the key areas covered in the module. vi | INTRODUCTION Quick revision A quick test of your knowledge of the main topics in this module. questions The quick revision questions are not a representation of the difficulty or style of questions which will be in the exam. They provide you with an opportunity to revise and assess your knowledge of the key concepts covered in the materials so far. They are not a practice exam, but rather a means to reflect on key concepts and not as the sole revision for the exam. Revision questions The revision questions are not a representation of the difficulty or style of questions which will be in the exam. They provide you with an opportunity to revise and assess your knowledge of the key concepts covered in the materials so far. They are not a practice exam but rather a means to reflect on key concepts and not as the sole revision for the exam. Case study A practical example or illustration, usually involving a real world scenario. Formula to learn Formulae or equations that you need to learn as you may need to apply them in the exam. Bold text Throughout the Study Guide you will see that some of the text is in bold type. This is to add emphasis and to help you to grasp the key elements within a sentence and paragraph.  MANAGEMENT ACCOUNTING | vii PREPARING FOR YOUR FOUNDATION EXAM STUDY PLAN  Review all the learning objectives thoroughly. Use the weightings provided in the learning objectives table (see Learning Objectives section) to develop a study plan to ensure you provide yourself with enough time to revise each learning objective.  Don’t leave your study to the last minute. You may need more time to explore learning objectives in greater detail than initially expected.  Be confident that you understand each learning objective. If you find that you are still unsure after reading the Study Guide, seek additional information from other resources such as text books, supplementary learning materials or tuition providers. STUDY TECHNIQUES  In addition to being able to complete the revision and self-assessment questions in the Study Guide, ensure you can apply the concepts of the learning objectives rather than just memorising responses.  Some exams have formulae and discount tables available to candidates throughout the exams. My Online Learning lists the tools available for each exam.  Check My Online Learning on a weekly basis to keep track of announcements or updates to the Study Guide. TIPS FOR EXAMS  Plan to arrive at the exam centre at least 15 minutes before your exam. Allow for possible delays with public transport or traffic.  You have three hours and fifteen minutes to complete the exam. As soon as you commence the exam your exam clock in the top right hand corner of the screen begins to count down. Watch your time carefully. ANSWERING MULTIPLE CHOICE QUESTIONS Foundation exams are a series of 100 multiple choice questions. Each question will contain four possible options. Step 1 Attempt every question. Read the question thoroughly. You may prefer to work out the answer before looking at the options, or you may prefer to look at the options at the beginning. Adopt the method that works best for you. Step 2 Read the four options and see if one matches your own answer. Be careful with numerical questions, as some options are designed to match answers that incorporate common errors. Check that your calculation is correct. Have you followed the requirement exactly? Have you included every step of the calculation? Step 3 You may find that none of the options matches your answer.  Re-read the question to ensure that you understand it and are answering the requirement  Eliminate any obviously wrong answers  Consider which of the remaining answers is the most likely to be correct and select the option viii | INTRODUCTION Step 4 If you are still unsure, you can flag the question and continue to the next question. Some questions will take you longer to answer than others. Try to reduce the average time per question, to allow yourself to revisit problem questions at the end of the exam. Revisit unanswered questions. A review tool is available at the end of the exam, which allows you to Review Incomplete or Review Flagged questions. When you come back to a question after a break you often find you are able to answer it correctly straight away. You are not penalised for incorrect answers, so never leave a question unanswered! COMPUTER-BASED EXAM NAVIGATION Your computer-based exam has the following functions: Navigation – You can select your answer by: clicking on the circle to the left of the option, or typing the letter corresponding to the option. – To move through the exam, you use the 'Next' or 'Previous' buttons on the bottom of the screen. The function of each button is selected by your mouse, or with a combination of keyboard keys. For example, you can select the 'Next' button by clicking it with the mouse, or by typing ALT + N. – The 'Next' button moves you from one screen to the next screen. If you wish to go back and view the screen you just viewed, click the 'Previous' button or type ALT + P. – There is also a ‘Navigator’ button on the bottom of the screen which allows you to click ahead to any question in the exam. This button can be accessed using your mouse or ALT + V. ‘Navigator’ allows you to see a list of all questions and their status including ‘Incomplete’/ ‘Complete’ and ‘Unseen’. Any questions you have flagged for review will also be shown in this view. Select for review – There is a flag in the upper right corner of your exam screen labelled 'Flag for Review'. Alternatively you can use ALT + F to flag a question. You mark an exam question to review at a later time by clicking on this flag. The flag will appear filled-in once it is selected. You may mark any exam question for later review, whether you select an answer or not. Review Screen – After finishing the last exam question, you will see a review screen. This lists every exam question. If you clicked the 'Flag for Review' flag on a question screen, that question appears on the Review screen marked with the flag filled in. – If you skipped any exam questions, these will be labelled as 'Incomplete' even if you did not select them for review. – From the Review screen you can choose to: 1. review all of the questions in the exam by clicking 'Review All'; 2. individually select questions for review (click on the question number) or choose more questions for review (click on the flags corresponding to the questions); 3. review all questions marked as incomplete by clicking 'Review Incomplete'; 4. begin reviewing the selected review questions by clicking 'Review Flagged'; or 5. exit by clicking 'End Review' – this will also end your exam.  MANAGEMENT ACCOUNTING | ix MODULE SUMMARY This summary provides a snapshot of each of the modules, to help you to put the syllabus as a whole, and the Study Guide itself, into perspective. MODULE 1 – THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING This introductory module sets the scene for your forthcoming studies of Management Accounting. It explains the differences between financial, cost and management accounting and explains the role of the management accountant. It highlights the importance of management information for planning, control and decision making. It also introduces you to sustainability and management accounting systems. MODULE 2 – COST CLASSIFICATION One of the most important things that a management accountant does is to provide the information that enables a business to make decisions about its activities. This involves ascertaining the relevant costs of the business, which are its future costs and cash flows. This module also introduces the different types of cost such as fixed and variable costs, their behaviour, and to split mixed costs into their fixed and variable elements. Understanding cost behaviour is very useful for forecasting future costs. MODULE 3 – TYPES OF PRODUCT COSTING There are some costs incurred by organisations that have to be allocated out to the various units produced, so that a cost per unit can be produced. This module begins by examining the different types of overheads and several methods of accounting for them: absorption and marginal costing and activity based costing (ABC). Absorption costing and marginal costing are quite different whereas ABC is a form of absorption costing. ABC was developed relatively recently to suit modern business and accounting practices. It provides a modern alternative to absorption costing as absorption costing tends to allocate too great a proportion of overheads to high volume products. ABC involves the identification of those factors, known as cost drivers, which cause the costs of an organisation’s major activities. The module then moves on to some other costing systems. Costing systems are used to cost goods or services, and the method used depends on the way in which the goods or services are produced. Within the context of your syllabus, the two most important are process costing, used when it is not possible to identify separate units of production, and job costing, where work is undertaken to a particular customer’s specific requirements. MODULE 4 – BUDGETING AND VARIANCE ANALYSIS A budget is a quantitative statement, for a defined period of time (often a year) which usually includes planned revenues, expenses, assets, liabilities and cash flows. When organisations draw up budgets they have stated objectives and intentions, and the actual results can then be compared with the budget and differences identified and analysed. This module explains the background of budgeting and then teaches you how to prepare and operations budget and a cash budget. In business, standards are applied to the costs of products and services. An organisation will expect the standards that it sets (for example for the amount of materials to be used in production, or for the amount of workforce time involved) to be met. If they are not, a variance analysis will be carried out, which identifies where they have not been met. The actual results achieved by an organisation during the reporting period are frequently different from those expected. Variance analysis identifies where these differences from the expected occur. It is important to realise that in some situations a favourable (i.e. positive) variance on one aspect of x | INTRODUCTION production will be cancelled out by an adverse (i.e. negative) variance on another aspect. Hence businesses produce operating statements, which reconcile the expected and the actual results, by means of all the variances, so management can see the complete picture. MODULE 5 – PERFORMANCE MEASUREMENT This module is concerned with performance indicators, i.e. the ways of assessing how a business, or a division, or a particular product within a catalogue, is performing. The central theme here is responsibility accounting, the system of accounting that divides revenue and costs into area of personal responsibility in order to monitor and assess the performance of each part of an organisation. MODULE 6 – SHORT-TERM AND LONG-TERM DECISION MAKING This module begins by looking at the decision making process. It then goes on to consider a choice of product (product mix) decisions, make or buy decisions and outsourcing. It then moves on to cost-volume-profit analysis, which is based on cost behaviour principles; this is necessary so that the appropriate decision-making information can be provided to management. Long term decisions involving capital expenditure are then considered. Decisions about capital expenditure require different thought processes from those about revenue expenditure. Capital expenditure often involves the expenditure of larger sums of money, and this usually happens over a longer period of time. Because of this, there are sometimes elements of uncertainty, such as interest rates or the revenue to be gained from a project, and this module looks at the different means of assessing the value of capital expenditure. MODULE 7 – INVENTORY AND PRICING DECISIONS Manufacturing businesses in particular are very concerned about retaining the right amount of inventory. They do not want to tie too much cash up in the purchase and holding of inventory of goods or components. Nor do they want to run the risk of not being able to fulfil an order from a customer because they do not have the inventory or cannot get it quickly enough. This module examines systems for maintaining inventory and controlling its levels, and also looks at different approaches to pricing.  MANAGEMENT ACCOUNTING | xi LEARNING OBJECTIVES CPA Australia's learning objectives for this Study Guide are set out below. They are cross-referenced to the module in the Study Guide where they are covered. GENERAL OVERVIEW This exam covers an understanding of developments in management accounting and the tools management accountants use to cost products and services, and to develop and manage budgets. It also covers performance management and control; planning and assessment of project alternatives; and an understanding of the nature, functions, structures and operations of management. These are the Learning Objectives that will be covered in the exam. Module Learning Objectives (LO) Weighting Module 1 LO1.1 Explain the role and objectives of management accounting 7% The nature LO1.2 Describe the key differences between financial, cost and and purpose management accounting of management LO1.3 Describe how management accounting provides information accounting and creates value LO1.4 Outline the core parts of management accounting systems and how they enable strategic management Module 2 LO2.1 Describe different cost classifications and their characteristics 15% Cost LO2.2 Apply relevant techniques to separate costs into their fixed and classification variable components Module 3 LO3.1 Explain the concepts underpinning product costing and the 23% Types of need for absorption costing product LO3.2 Apply overhead allocation and apportionment techniques costing LO3.3 Apply overhead absorption and marginal costing techniques LO3.4 Apply the principles of activity-based costing to and contrast it to other costing techniques LO3.5 Explain the differences between job and process costing techniques LO3.6 Apply costing principles to job costing and process costing Module 4 LO4.1 Explain the nature of budgets and the reasons that 20% Budgeting organisations use budgets and variance LO4.2 Prepare an operations budget, cash budget and budgeted analysis financial statements LO4.3 Explain incremental and zero-based budgeting approaches LO4.4 Identify and analyse the human behavioural challenges to the budgeting process in organisations LO4.5 Explain how standard costing can be used to assist in cost control and efficient resource allocation LO4.6 Calculate and analyse various variances and identify possible corrective actions xii | INTRODUCTION Module Learning Objectives (LO) Weighting Module 5 LO5.1 Explain the characteristics and purpose of performance 12% Performance measurement systems measurement LO5.2 Analyse the different types of financial performance measures and their limitations LO5.3 Describe the key characteristics of the Balanced Scorecard and its advantages over traditional performance measurement systems LO5.4 Outline the characteristics of reward systems and the circumstances in which they can be tied to performance measures Module 6 LO6.1 Explain the steps in the decision-making process 18% Short-term LO6.2 Use relevant information and apply techniques to support short- and long- term operating decisions term decision making LO6.3 Apply tools and techniques to support capital expenditure decisions LO6.4 Explain the impact of risk on capital expenditure decisions Module 7 LO7.1 Evaluate the principles of just-in-time 5% Inventory and LO7.2 Explain the importance of inventory control and apply inventory pricing management techniques decisions LO7.3 Establish and apply the appropriate approach for long-term pricing decisions  1 MODULE 1 THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING Learning objectives Reference Explain the role and objectives of management accounting LO1.1 Describe the key differences between financial, cost and management accounting LO1.2 Describe how management accounting provides information and creates value LO1.3 Outline the core parts of management accounting systems and how they enable LO1.4 strategic management Topic list 1 The management accounting function 2 Financial accounting, cost and management accounting 3 Providing information for planning, control and decision-making 4 Information and value creation 5 Developments in management accounting 6 Sustainability and management accounting 7 Management accounting systems  2 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING MODULE OUTLINE This module provides an introduction to Management Accounting. We begin this first module by looking at the role of the management accounting function. We then examine the differences between management accounting and financial accounting and introduce cost accounting. The module goes on to look at the importance of information provided by the management accountant in planning, control and decision making. We also look at the management accountant's role in the creation of organisational value. This module discusses the limitations of some of the traditional methods of management accounting, and considers how recent developments in management accounting attempt to overcome these limitations. We then examine the management accountant's role in the relationship between sustainability and management accounting and finally finish with a look at management accounting systems. The module content is summarised in the module summary diagram below. The nature and purpose of management accounting Planning, control Management Financial accounting and cost Information and decision accounting and management accounting making systems Presentation of The management value creation to accounting function management Developments in management accounting Sustainability and management accounting Management accounting systems  MANAGEMENT ACCOUNTING | 3 BEFORE YOU BEGIN If you have studied these topics before, you may wonder whether you need to study this module in full. If this is the case, please attempt the questions below, which cover some of the key subjects in the area. MODULE 1 If you answer all these questions successfully, you probably have a reasonably detailed knowledge of the subject matter, but you should still skim through the module to ensure that you are familiar with everything covered. There are references in brackets indicating where in the module you can find the information, and you will also find a commentary at the back of the Study Guide. 1 What are the differences between financial accounts and management accounts? (Section 2.2) 2 What are the differences between cost accounting and management accounting? (Section 2.3) 3 Explain the link between an organisation's objectives and its strategy. (Section 3.2) 4 What are the basic elements of a management control system? (Section 4.1) 5 What is the difference between data and information? (Section 4.3) 6 List the qualities of good information. (Section 4.4) 7 Define and explain Just-in-time (JIT). (Section 5.1) 8 Define and explain Total Quality Management (TQM). (Section 5.2) 9 Define and explain Kaizen. (Section 5.3) 10 What are the components of a management accounting system? (Section 7.1)  4 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING 1 THE MANAGEMENT ACCOUNTING FUNCTION LO 1.1 Section overview  The role of the management accounting function as an information provider has developed with advances in technology. To assess the effectiveness of the management accounting function, a clear understanding is needed of its objectives and activities, so that appropriate measures of performance can be determined. We will now look at the role and objectives of the management accounting function and how its performance should be measured. 1.1 ROLE OF THE MANAGEMENT ACCOUNTING FUNCTION The role of the management accountant is to provide information to decision makers, and to provide advice based on that information. The information provided by management accounting covers all areas of strategy and operations, and includes information to assist with planning, control and decision making by management. The role of the management accountant today is more concerned with providing complex analysis and information to support business management than with providing routine reports, since much routine work is now computerised. At the same time the areas covered by management accounting have extended to include strategic information and non-financial information, and information to support risk management. Developments in technology have also made it easier to provide accounting information to non-financial managers. 1.1.1 THE DEVELOPMENT OF MANAGEMENT ACCOUNTING INFORMATION In the 1950s, three attributes of what could by now be called management accounting information were identified:  It should be useful for scorekeeping to see how well the organisation is doing overall and to monitor performance.  It should be attention-directing to indicate problem areas that need to be investigated.  It should be useful for problem-solving to provide a means of evaluating alternative responses to the situations in which the organisation finds itself. Management accounting information is therefore used by managers for a number of purposes:  To make decisions.  To plan for the future. Managers have to plan and they need information to do this. Much of this is provided by management accounting systems.  To monitor the performance of the business. Managers need to understand how they are performing against goals and targets.  To measure profits and put a value on inventory.  To implement processes and practices that focus on effective and efficient use of organisational resources to support managers to enhance customer and stakeholder value (IFAC 2002).  MANAGEMENT ACCOUNTING | 5 1.2 ROLE OF THE MANAGEMENT ACCOUNTANT IN CROSS- FUNCTIONAL TEAMS In some organisations, the cost and management accounting function may be organised as a functional section or department within the organisation. However, because management accountants provide information to other managers, it has become fairly common to include management accountants within cross-functional teams, or to assign them to work with non-accounting functions. A MODULE 1 cross-functional team is a small group of individuals, with different expertise, taken from many different parts and levels of an organisation, which comes together to work towards a common purpose or goal. The size of each team will vary according to the scale and complexity of the project. Cross-functional teams are typically formed on the assumption that a small group is better for a particular task than either individuals acting alone or in a large, permanently structured group. Benefits of cross-functional teams include:  improved coordination and integration of systems or activities  problem solving across traditional functional or organisational boundaries  facilitate innovation and product/service development In addition to contributing their technical expertise as accounting and finance experts and their functional expertise as information providers, management accountants have a key role to play in helping maximise the potential of a cross-functional team by:  providing, collecting and assessing critical team information  helping establish goals and set priorities  assisting with problem solving and decision making, through the application of decision-making models and other techniques  ensuring the team maintains an organisation-wide perspective. 1.3 DEFINING OBJECTIVES OF THE MANAGEMENT ACCOUNTING FUNCTION The objectives of the management accounting function should depend on the information needs of the 'internal customers' – the managers within an organisation who need information to help them to run the business. The overall objective should be the provision of quality service and decision making information. This broad objective can be analysed into a number of sub-objectives. SUB-OBJECTIVE DETAIL The provision of good This requires supplying information that fulfils the following criteria. information Information must be relevant to the needs of users. This involves identifying the users of information and the reasons why they need it. Information can only ever be relevant if it has a purpose and a use. Information should be reliable. It should be sufficiently accurate for its purpose. For example it should be free from material error and should not be taken from an unreliable source. Unless information is reliable, management will not have sufficient confidence to use it. Information should be timely, which means that it should be provided in time for the purpose for which it is intended. Information has no value if it is provided too late. Some information, such as information provided for control purposes, may lose value with time. Information should be clear, comprehensible and appropriately communicated, since it will lose its value if it is not clearly communicated to the user in a suitable format and medium. A large amount of management accounting information should be accessible immediately and online to authorised managers. The provision of a value-for- The costs of management accounting should be justified by the benefits that money service the function provides to the organisation, and the level of service and the quality of information provided. The availability of informed Users will expect management accounting staff to be available to answer personnel queries and resolve problems as and when required.  6 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING 1.4 MANAGEMENT ACCOUNTING FUNCTION – ESTABLISHING ACTIVITIES Once the objectives have been defined, the activities that the function should carry out to achieve its objectives must be established. This is why it is necessary to answer the question: 'What information do we want, or might we want?' The specific information that a management accounting system needs to provide (and the timing or accessibility of this information) will vary between organisations, according to factors such as the nature of their business and their size. The management accounting function should be organised and staffed so that it is able to provide the information expected from it. A follow-up question is: 'What type and size of function do we need to provide this information, and what will it cost?' Management, as users of information, should therefore understand what information they are getting, and what it is costing to get it. 1.5 MANAGEMENT ACCOUNTING FUNCTION – IDENTIFYING PERFORMANCE MEASURES The performance of the management accounting function should be measured according to its objectives and its specified activities. Suitable specific performance measures might be as follows:  Measures relating to the quality of the information provided. Quality measures may be based on the judgement of users, such as opinions about whether the information provided is useful, timely and reliable.  Measures relating to value for money. The cost of the function should be measurable. It may be possible to compare the cost with other information provision services within the organisation or in different organisations. The benefits are not so easy to assess, but management need to be satisfied that they are getting value for money.  Measures relating to the availability of accounting staff to assist management, such as the amount of time the accounting staff spend with managers in other functions, and the speed of their response to requests for information, advice or assistance.  Measures relating to flexibility, such as delivery in accordance with the service levels agreed with business units to meet needs for ad-hoc reporting.  Ratings provided from user satisfaction surveys would provide extremely useful measures of performance. 'Users' are the 'internal customers' for the management information.  Measure of management accounting service: – timeliness of reports – attendance/contribution at management meetings/forums – management accounting involvement in strategic projects  MANAGEMENT ACCOUNTING | 7 2 FINANCIAL ACCOUNTING, COST AND MANAGEMENT ACCOUNTING MODULE 1 LO 1.2 Section overview  Financial accounting systems ensure that the assets and liabilities of a business are properly accounted for, and provide information about profits and historical financial performance to shareholders and to external stakeholders such as Australian Taxation Office (ATO) and Australian Securities and Investments Commission (ASIC); and other interested parties including interest groups, potential shareholders, unions and non-governmental organisations (NGOs).  Management accounting systems provide information specifically for the use of managers within an organisation. Corporate Performance Management (CPM) software and Business Intelligence (BI) software are management accounting tools used by management accountants.  Cost accounting is part of management accounting. The purpose of cost accounting is to determine the cost of products and services. 2.1 FINANCIAL ACCOUNTS AND MANAGEMENT ACCOUNTS Financial accounting systems ensure that the assets and liabilities of a business are properly accounted for. They are used to provide information to shareholders and other interested parties in the form of (published) financial statements. Management accounting systems provide information specifically for the use of managers within an organisation. Management information provides a common source from which information for two groups of people is drawn:  Financial accounts are prepared for individuals external to an organisation. For example shareholders, customers, suppliers, regulatory authorities, employees.  Management accounts are prepared for internal use by managers of the organisation. Much of the data used to prepare financial accounts and management accounts are the same but differences between the financial accounts and the management accounts arise because the data are analysed differently. In addition, management accounting systems draw on a wider range of data, including non-financial data, data from external sources and data relating to the future. 2.2 FINANCIAL ACCOUNTS VERSUS MANAGEMENT ACCOUNTS Management accountants and financial accountants perform different parts of the accounting function. The table below shows the differences between the two areas of accounting. FINANCIAL ACCOUNTS MANAGEMENT ACCOUNTS Financial accounts detail the performance of an Management accounts are used to aid management organisation over a defined period and the state of record, plan and control the organisation's activities and affairs at the end of that period. Financial accounts to help the decision-making process. The information in provide information to third parties. management accounts can measure the organisation's activities against its strategic objectives. Limited liability companies must, by law, prepare There is no legal requirement to prepare management financial accounts. accounts. The format of published financial accounts is The format of management accounts is entirely at determined by local law, by International Accounting management discretion: no strict rules govern the way Standards and International Financial Reporting they are prepared or presented. Each organisation can Standards. In principle the accounts of different devise its own management accounting system and organisations can therefore be easily compared. format of reports.  8 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING FINANCIAL ACCOUNTS MANAGEMENT ACCOUNTS Financial accounts concentrate on the business as a Management accounts can focus on specific areas of an whole, aggregating revenues and costs from different organisation's activities. Information may be produced operations, and are an end in themselves. to aid a decision rather than as the end product of a decision. Most financial accounting information is of a Management accounts incorporate non-monetary monetary nature. measures. Management may need to know, for example, tons of aluminium produced, monthly machine hours, or miles travelled by sales staff. Financial accounts present an essentially historic Management accounts are both an historical record and picture of past operations. a future planning tool. Question 1: Management accounts Which of the following statements about management accounts is/are correct? I. There is a legal requirement to prepare management accounts. II. The format of management accounts is largely determined by law. III. They serve as a future planning tool and are not used as a historical record. A III only B I and II only C II and III only D None of the statements are correct. (The answer is at the end of the module.) 2.3 COST ACCOUNTS The terms 'cost accounting' and 'management accounting' are often used interchangeably. It is not correct to do so. Cost accounting is part of management accounting. Cost accounting provides source data for the management accountant to use. Cost accounting is concerned with:  preparing cost estimates of new and current products  cost data collection  measuring inventory costs including raw materials, work-in-progress and finished goods, and the costs and profitability of products and services. Management accounting, on the other hand, is concerned with interpretation and assessment of financial, accounting and operational data, and communicating it as information to users. For example, as financial targets or performance measurements. 2.3.1 USES OF COST ACCOUNTS Cost accounting is used to measure:  The cost of goods produced or services provided.  The cost of a department or business unit.  The revenues earned from a product, service, department or business unit, or the organisation in total.  The profitability of a product, a service, a department, or the organisation in total.  Selling prices with some regard for the costs of sale.  The value of inventories of goods (raw materials, work in progress, finished goods) that are still held in store at the end of a period, thereby aiding the preparation of a statement of financial position of the company's assets and liabilities.  Future costs of goods and services, based on given assumptions about what will happen in the future. Costing is an integral part of budgeting, because budgets are detailed financial plans.  How actual costs compare with budgeted costs. If an organisation plans for its revenues and costs to be a certain amount, but they actually turn out differently, the differences (variances) can  MANAGEMENT ACCOUNTING | 9 be measured and reported. Management can use these reports as a guide to whether corrective action, or 'control' action, is needed to sort out a problem. This system of control is often referred to as budgetary control or variance analysis. Cost accounting systems are not restricted to manufacturing operations, although they are probably more fully developed in this area. Service industries, government departments and non-profit making organisations all make use of cost accounting information. Within a manufacturing organisation, the MODULE 1 cost accounting system should be applied not only to manufacturing but also to administration, selling and distribution, research and development and all other departments and functions. 3 PROVIDING INFORMATION FOR PLANNING, CONTROL AND DECISION MAKING LO 1.3 Section overview  Management information is used for planning, control and decision making.  Long-term planning, also known as corporate or strategic planning, involves selecting appropriate strategies to prepare a long-term plan to attain the organisation's objectives. As we mentioned in section 1, the role of the management accountant is to provide information to assist with planning, control and decision making by management. 3.1 PLANNING Planning forces management to think ahead systematically in both the short term and the long term. Planning involves the following:  Establishing overall objectives.  Selecting appropriate strategies to achieve those objectives.  Setting targets for each strategy.  Formulating detailed plans for achieving those targets. When expected changes are gradual, planning occurs in a fairly stable environment, and routine budget planning procedures may be used. 3.2 OBJECTIVES OF ORGANISATIONS Definitions A vision is a succinct statement of an organisation's future aspirations. A mission statement sets out an organisation's fundamental purpose. An objective is the aim or goal of an organisation. A strategy is a possible course of action that might enable an organisation to achieve its objectives. Organisations often start by setting out their vision. This is a succinct statement of the organisation's future aspirations (e.g. Microsoft's vision is 'to help people and businesses throughout the world realise their full potential'). A mission statement is then created, setting out the organisation's fundamental purpose and including references to its strategy, standards of behaviour and values.  10 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING The mission sets the overall direction of the organisation and the organisation's goals and more detailed objectives then follow from this. The strategies identified as a result of the planning process are designed to achieve these objectives. Note that in practice, the terms objective, goal and aim are often used interchangeably. The two main types of organisation that you are likely to come across in practice are profit making and non-profit making. It is often assumed that the main objective of profit making organisations is to maximise shareholder wealth. This is also known as creating value for shareholders and is achieved by maximising profits. A secondary objective of profit making organisations might be growth, for example by increasing the output and sales of its goods/services. Unfortunately, the aim of profit maximisation may encourage decisions that compromise the long-term viability (growth) of the business in the attempt to maximise immediate profit outcomes. The main objective of non-profit making organisations is usually to provide goods and services. A secondary objective of these organisations might be to minimise the costs involved in providing the goods/services. The stated objectives of an organisation might include one or more of the following:  maximise profits  maximise revenue  maximise shareholder value  increase market share  minimise costs. Management accounting techniques often assume one of these objectives when recommending a course of action to management. Remember, however, that decisions have consequences for the longer term as well as the short term, and decisions to maximise profit may have high associated risks. 3.3 LONG-TERM STRATEGIC PLANNING Management accounting contributes to long-term strategic planning. Long-term planning, also known as corporate planning, involves selecting appropriate strategies to attain the organisational objective, and integrating these strategies into an overall long-term corporate or strategic business plan. The time span covered by a long-term plan depends on the organisation, the industry in which it operates and the particular environment involved. Typical periods for a strategic business plan are two, five, seven or 10 years, although longer planning periods may be used. Long-term strategic planning consists of four basic elements:  assess the organisation and its environment  determine the corporate objectives  devise strategies for achieving these objectives  create a corporate plan. The diagram below provides an overview of the process and shows the link between short-term and long-term planning. 3.4 SHORT-TERM TACTICAL PLANNING The corporate or strategic plan serves as the long-term framework for the organisation as a whole. For operational purposes it is necessary to convert the corporate (strategic) plan into a series of short- term plans, usually covering one year, which relate to business units, functions or departments. The annual process of short-term planning should be seen as stages in the progressive fulfilment of the corporate plan. Each short-term plan steers the organisation towards its long-term objectives. It is therefore vital that, to obtain the maximum advantage from short-term planning, some form of long- term plan exists.  MANAGEMENT ACCOUNTING | 11 The management accounting function supports the short-term planning process, for example by providing information for setting targets and standards, and helping to establish the assumptions on which the short-term plan is based, such as growth rates, costs, efficiency savings and cost inflation. The planning process Assess the Assess the Assess ASSESSMENT Assess the external MODULE 1 STAGE organisation future expectations environment Evaluate OBJECTIVE corporate STAGE objectives LONG- TERM STRATEGY Consider PLANNING EVALUATION alternative STAGE ways of achieving objectives Agree on a CORPORATE corporate PLAN plan Research and Production Resource Product development planning planning planning planning SHORT- TERM PLANNING Detailed operation plans that implement the corporate plan on a monthly, quarterly or annual basis. Operational plans include short-term budgets, standards and objectives. 3.5 CONTROL As well as providing information for planning, management accounting also provides information to assist with monitoring and control. There are two stages in the control process. 1. The planned performance of the organisation (set out as targets or expectations in the detailed operational plans) is compared with the actual performance of the organisation on a regular and continuous basis. Significant deviations from the plans can then be identified and appropriate corrective action can be taken where possible. 2. The corporate (strategic) plan is reviewed in the light of the comparisons made and any changes in the parameters on which the plan was based (such as new competitors, government instructions and so on), to assess whether the objectives of the plan can be achieved. The plan is modified to ensure the organisation's future success. Effective control is not practical without planning, and planning and control are interrelated. Targets and objectives will not be achieved without monitoring and control measures when needed. An established organisation should have a system of management reporting that produces control information in a specified format at regular intervals. Smaller organisations may rely on informal information flows or ad-hoc reports being produced as required.  12 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING As we said in the section overview, management information is used for planning, control and decision making. We will cover decision making in detail later in the Study Guide but it's important that you understand that planning, implementation and control all require decisions which require information. 4 INFORMATION AND VALUE CREATION LO 1.3 Section overview  A management control system is a system which measures and corrects the performance of activities of subordinates.  Data is the raw material for data processing. Data relates to facts, events and transactions.  Information is data that has been processed so as to be meaningful.  Good information is relevant, complete, accurate and clear. It inspires confidence, is appropriately communicated, its volume is manageable, it is timely to produce and it costs less to produce than the benefits it provides. We have already mentioned that the objective of a profit seeking business is to create value for shareholders and that the management accountant facilitates this by providing management information for planning, control and decision making. 4.1 MANAGEMENT CONTROL SYSTEMS A management control system is a system that measures and corrects the performance of activities of subordinates in order to make sure that the objectives of the organisation are being met and the plans devised to attain them are being carried out. The basic elements of a management control system are as follows:  Planning what to do and identifying the desired results.  Recording the plan which should incorporate standards of efficiency or targets.  Carrying out the plan and measuring actual results achieved.  Comparing actual results against the plans.  Evaluating the comparison, and deciding whether further action is necessary.  Implementing corrective action where necessary. Information to assist with this process is needed for recording the plan, comparing actual results against the plan and evaluating the comparison. The information is often financial or partially financial in nature, although it will include non-financial information too. This is why management accounting, by providing information of both a financial and non-financial nature, should be an integral part of a management control system. 4.2 TYPES OF INFORMATION Author Robert N Anthony (Management Control Systems, 1972) divided management activities into three levels: strategic planning, management control and operational control. This is sometimes known as the Anthony hierarchy. Information within an organisation can be analysed into the three levels assumed in Anthony's hierarchy: strategic; tactical; and operational information. 4.2.1 STRATEGIC INFORMATION Strategic information is used by senior managers to plan the objectives of their organisation (i.e. long-term planning, which we looked at in section 3.3), and to assess whether the objectives are being met in practice (i.e. control, which we looked at in section 3.5). Examples of such information include  MANAGEMENT ACCOUNTING | 13 overall profitability, the profitability of different segments of the business, capital equipment needs and so on. Strategic information therefore has the following features:  It is derived from both internal and external sources.  It is summarised at a high level and is directed at senior management.  It is relevant to the long term. MODULE 1  It deals with the whole organisation.  It is often prepared on an ad-hoc basis.  It is both quantitative and qualitative.  It cannot provide complete certainty, given that the future cannot be predicted. 4.2.2 TACTICAL INFORMATION Tactical information is used by middle management to decide how the resources of the business should be employed (i.e. short-term planning, which we covered in section 3.4), and to monitor how they are being and have been employed (i.e. control, which we covered in section 3.5). Such information includes productivity measurements (output per direct labour hour or per machine hour), budgetary control or variance analysis reports, and cash flow forecasts. Tactical information has the following features:  It is primarily generated internally.  It is summarised at a lower level and is directed at middle management as well as more senior management.  It is relevant to the short and medium term.  It describes or analyses activities or departments.  It is prepared routinely and regularly.  It is based largely on quantitative measures.  It allows the monitoring of business performance against goals. 4.2.3 OPERATIONAL INFORMATION Operational information is used by 'front-line' managers, such as foremen and supervisors, to ensure that specific tasks are planned and carried out properly. In the payroll office, for example, information at this level will relate to day-rate labour and will include the hours worked each week by each employee, the rate of pay per hour, details of deductions, and for the purpose of wages analysis, details of the time each person spent on individual jobs during the week. In this example, the information is required weekly, but more urgent operational information, such as the amount of raw materials being input to a production process, may be required daily, hourly, or in the case of automated production, second by second. Operational information has the following features:  It is derived almost entirely from internal sources.  It is highly detailed, being the processing of raw data.  It relates to the immediate term, and is prepared constantly, or very frequently.  It is task-specific and largely quantitative. 4.3 DATA AND INFORMATION Definitions Data is the raw material for data processing. Data relates to facts, events and transactions. Information is data that has been processed so as to be meaningful to the person who receives it. Information is knowledge communicated or received concerning facts or circumstances.  14 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING Information is sometimes referred to as processed data. The terms 'information' and 'data' are often used interchangeably. It is important to understand the difference between these two terms. For example, researchers who conduct market research surveys might ask members of the public to complete questionnaires about a product or a service. These completed questionnaires are data; they are processed and analysed in order to prepare a report on the survey. This resulting report is information and may be used by management for decision-making purposes. Management accounting systems provide information, and the quality of the management accounting system depends on the quality of the information that it provides. 4.4 QUALITIES OF GOOD INFORMATION Good information is relevant, complete, accurate and clear. It inspires confidence, is appropriately communicated and its volume is manageable. It is timely and its cost to produce is less than the benefits it provides. The qualities of good information include the following:  Relevance. Information should have a purpose; otherwise there is unlikely to be sufficient benefit from processing data to justify the cost of providing it. Information must be relevant to the purpose for which a manager wants to use it.  Completeness. Information users should have all the information they need to do the job properly. If they do not have a complete picture of the situation, they might well make bad decisions.  Reliability. Information should be reliable. This means that it should be sufficiently accurate for its purpose. Using incorrect information could have serious and damaging consequences. However, there is no need to go into unnecessary detail. Where there is some uncertainty about the accuracy or reliability, for example when making forecasts about the future, the nature of the uncertainty should be fully understood, so that the information is used and treated with caution.  Clarity. Information must be clear to the user. If the user does not understand it properly they will not be able to use it properly. Lack of clarity is one of the causes of a breakdown in communication. It is therefore important to choose the most appropriate presentation medium or channel of communication.  Confidence. Information must be trusted by the managers who are expected to use it. However not all information is certain. Some information has to be certain, especially operating information, for example, related to a production process. Strategic information, especially relating to the environment, is uncertain. However, if the assumptions underlying it are clearly stated, this might enhance the confidence with which the information is perceived. Having confidence in information depends on other qualities of the information – reliability, relevance and clarity.  Communication. Within any organisation, individuals are given the authority to do certain tasks, and they must be given the information they need to do them. For example, an office manager might be made responsible for controlling expenditure in the office, and given a budget expenditure limit for the year. As the year progresses, they might try to keep expenditure in check but unless they are told throughout the year what current total expenditure is to date, they will find it difficult to judge whether they are keeping within budget or not.  Volume. There are physical and mental limitations to what a person can read, absorb and understand properly before taking action. An inappropriate amount of information, even if it is all relevant, cannot be handled. Reports to management must therefore be clear and concise and in many systems, control action works basically on the 'exception' principle, with reports only being produced if there is an issue that needs to be brought to management attention or investigated further.  Timing. Information should be timely. If it is not available until after a decision is made, it will be useful only for comparisons and longer-term control. Information prepared too frequently can be a serious disadvantage. If, for example, a decision is taken at a monthly meeting about a certain aspect of a company's operations, information to make the decision is only required once a month, and weekly reports would be a time-consuming waste of effort.  MANAGEMENT ACCOUNTING | 15  Channel of communication. Information should be communicated or should be accessible through appropriate channels of communication. There are occasions when using one particular method of communication will be better than others. Some internal memoranda may be better sent by 'electronic mail'. Some information is best communicated informally by telephone or word-of-mouth, whereas other information ought to be formally communicated in writing or figures. Electronic methods of data transmission, data storage and data access are integral parts of most management accounting systems. MODULE 1  Cost. Information should have some value, otherwise it would not be worth the cost of collecting and filing it. The benefits obtainable from the information must also exceed the costs of acquiring it. Whenever management is trying to decide whether or not to produce information for a particular purpose, for example, whether to computerise an operation or to build a financial planning model, a cost/benefit analysis ought to be undertaken.  Comparability. Information needs to be measured and reported in a similar manner so that meaningful comparisons can be made over time. Question 2: Value of information Managers receive a monthly performance report indicating that costs in the previous month were 15 per cent more than expected. Which one of the following would be the most appropriate response by management to this information? A Control action should be taken to deal with the problem and reduce costs by 15 per cent. B The overspend indicates that planning targets will not be met and forecasts should be revised. C The reasons for the overspend may be controllable; therefore they should be investigated with a view to reducing the overspend as much as possible. D The reasons for the overspend may be controllable or uncontrollable; therefore they should be investigated with a view either to reducing the overspend as much as possible or revising forecasts or targets. (The answer is at the end of the module) 4.5 WHY IS INFORMATION IMPORTANT? Information is important for management because it provides awareness and understanding of an issue. By helping management to make better-informed decisions, information should contribute significantly to better-quality decision making. Consider the following problems and what management needs to solve these problems. (a) A company wishes to launch a new product. The company's pricing policy is to charge cost plus 20 per cent. What should the price of the product be? (b) An organisation's widget-making machine has a fault. The organisation has to decide whether to repair the machine, buy a new machine or hire a machine. What does the organisation do if its aim is to control costs? (c) A company is considering offering a discount of 2 per cent to those customers who pay an invoice within seven days of the invoice date and a discount of 1 per cent to those customers who pay an invoice within eight to 14 days of the invoice date. How much will this discount offer cost the company? In solving these and a wide variety of other problems, management needs information. (a) In problem (a) above, management would need information about the cost of the new product. (b) Faced with problem (b), management would need information on the cost of repairing, buying and hiring the machine. (c) To calculate the cost of the discount offer described in (c), information would be required about current sales settlement patterns and expected changes to the pattern if discounts were offered.  16 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING The successful management of any organisation depends on information: organisations in the public sector, such as hospitals and local authorities and other non-profit making organisations such as charities and clubs need information for decision making and for reporting the results of their activities just as multi-nationals do. For example, a local government authority needs to know what resources are being used to deliver services to residents. A tennis club needs to know the cost of undertaking its various activities so that it can determine the amount of annual subscription it should charge its members. 4.6 WHAT TYPE OF INFORMATION IS NEEDED? Managers require a mixture of financial and non-financial information. Worked Example: Financial and non-financial information Assume that the management of ABC Co. have decided to provide a cafeteria for their employees.  The financial information required by management might include cafeteria staff costs, costs of subsidising meals, capital costs, costs of gas and electricity and so on.  The non-financial information might include comment on the effect on employee morale of the provision of cafeteria facilities, details of the number of meals served each day, meter readings for gas and electricity and attendance records for cafeteria employees. ABC Co. could now combine financial and non-financial information to calculate the average cost to the company of each meal served, thereby enabling them to predict total costs depending on the number of employees in the work force. 4.6.1 NON-FINANCIAL INFORMATION Management accounting is mainly concerned with the provision of financial information to aid planning, control and decision making. However, the management accountant cannot ignore non- financial influences and should qualify the information provided with non-financial matters as appropriate. Non-financial information may relate to matters such as quality, speed, flexibility, creativity, motivation, customer satisfaction and competitive advantage. 4.7 MEETING MANAGEMENT'S NEEDS In general, developments in information technology (IT) have had a positive impact on organisations. However, in looking at the impact of technology it is also worth considering the potential dangers of information overload. Nowadays, where mobile phones, computers and tablets and the internet have become such an intrinsic part of our social and working lives, we have numerous potential sources of information all fighting to be heard at once, including websites, emails, Twitter feeds and social networking updates. However, the volume of potential information available means that people may be unable to assimilate information effectively. Consequently, if information is not presented clearly and coherently within organisations, there is a danger that managers and staff will overlook it, with the related danger that they will subsequently be ill-informed about important issues. This has important implications for the way management information is presented: the key points need to be presented in such a way that they are clearly communicated to their audience and do not get overlooked. A related consequence of information overload is that people's attention spans appear to have shortened. This again has important implications for the way management information is presented and distributed. Rather than presenting long, detailed reports, users are now more likely to value shorter reports, indicating key points of interest. Reports also need to be produced more frequently because of the speed of change in today's business world.  MANAGEMENT ACCOUNTING | 17 Another issue that has arisen as a result of IT developments is the need for security of information. Measures need to be implemented to safeguard business information from viruses, spyware, trojans, data leaks, theft and so on. An information security management system (ISMS) is a set of procedures for managing sensitive data. One of the main objectives of an ISMS is to ensure that staff are fully aware of information security. Management's needs can also be met by using self-service business intelligence (SSBI). Business MODULE 1 intelligence software allows users without a statistical background to turn raw data into usable information. Another problem for management is the need to combine information from one system, such as the accounting software, with information from another system such as an operations system. Reporting and analysing across multiple systems like this can be a challenge but data integration software can be used to combine data into meaningful information. 4.8 ROLE OF THE MANAGEMENT ACCOUNTANT IN CREATING VALUE Earlier in this module we examined the role of the management accounting function and the contribution of management accounting to strategic management. Management accounting is a value added process. This value added process:  guides management action  motivates behaviour  supports and creates the cultural values required to achieve the organisation's objectives. The management accountant plays a key role in providing relevant and timely information to the management of the organisation, explaining the impact of that information and participating in the managerial decision-making process. The information provided by management accountants and the management accounting system:  supports the strategic planning process which ensures the organisation adapts to its competitive environment (planning)  helps senior management to evaluate performance (control)  provides timely and accurate information about activities required for success (decision making) and  helps maximise the effective use of resources over time. Thus the management accountant helps create organisational value by:  providing relevant information for planning and decision making  assisting management in direction and control activities  motivating managers and other employees towards organisational objectives  measuring the performance of the activities of managers and other employees  assessing the organisation's competitive position. 5 DEVELOPMENTS IN MANAGEMENT ACCOUNTING LO 1.3 Section overview  Management accountants have responded to developments such as Just-in-time (JIT), total quality management (TQM) and lean management accounting by using techniques such as target costing, life cycle costing and Kaizen.  18 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING Many of the 'modern' manufacturing methods are grouped around the concept of World-class Manufacturing (WCM), which sets as its objective achieving and sustaining competitive advantage in an environment of strategic cost reduction. 5.1 JUST-IN-TIME (JIT) Definition Just-in-time (JIT) is a system whose objective is to produce or to procure products or components as they are required by a customer or for use, rather than for inventory. A JIT system is a 'pull' system, which responds to demand, in contrast to a 'push' system, in which stocks act as buffers between the different elements of the system, such as purchasing, production and sales. JIT production is a system which is driven by demand for finished products whereby each component on a production line is produced only when needed for the next stage. JIT purchasing is a system in which material purchases are contracted so that the receipt and usage of material, to the maximum extent possible, coincide. JIT is considered in more detail in Module 7. 5.2 TOTAL QUALITY MANAGEMENT (TQM) Definition Total quality management (TQM) is a culture of management and operations, rather than a specific technique. The culture is one of achieving continuous improvements, no matter how small each individual improvement may be, so that customer needs and expectations are met with increasing success. The approach (like JIT) has a zero defects philosophy and operations should be 'right first time'. 5.3 KAIZEN Definition Kaizen is a Japanese term for continuous improvement in all aspects of an entity's performance at every level. Kaizen is a feature of TQM. 5.4 LEAN MANAGEMENT ACCOUNTING Lean management accounting has a lot in common with the other techniques outlined above. Its emphasis is on the elimination of waste and continuous improvement. Customer demand determines the flow of products or services, and emphasis is on processes and value streams rather than departments. In a lean system, management accounting systems need to be refocused to provide the information necessary to drive improvement, and highlight waste. Distortions such as reduced unit costs arising from producing large batches at a time need to be removed. 5.5 LIFE CYCLE COSTING Life cycle costing is based on the view that the costs and profitability of products should be planned and monitored over the entire life cycle of the products, from the design stage to the end of its commercial life. Life cycle costing tracks and accumulates actual costs and revenues attributable to each product or project over the entire product/project life cycle. The total profitability of any given product / project can therefore be determined.  MANAGEMENT ACCOUNTING | 19 5.6 TARGET COSTING Target costing requires managers to change the way they think about the relationship between cost, price and profit.  The traditional approach is to develop a product, determine the expected standard production cost of that product and then set a selling price with a resulting profit or loss. Costs are controlled through variance analysis at monthly intervals. MODULE 1  The target costing approach is to develop a product concept and the primary specifications for performance and design and then to determine the price customers would be willing to pay for that concept. The desired profit margin is deducted from the price leaving a figure that represents total cost. This is the target cost and the product must be capable of being produced for this amount otherwise the product will not be manufactured. 6 SUSTAINABILITY AND MANAGEMENT ACCOUNTING LO 1.3 Section overview  Sustainability is about considering the future as well as the present. Management accountants have a role in ensuring that this aim is recognised, relevant objectives are set, performance measured and corrective action taken. In this section we examine one of the newer concepts in management accounting, that of sustainability and sustainability accounting. In recent years there has been an increasing awareness of sustainability. The section begins by looking at what is meant by sustainability both on a global scale and at an organisational level. The objectives of sustainability are then considered and its relationship to management accounting. Definition In relation to the development of the world's resources, sustainability has been defined as ensuring that development meets the needs of the present without compromising the ability of future generations to meet their own needs. For organisations, sustainability involves developing strategies so that the organisation only uses resources at a rate that allows them to be replenished (in order to ensure that they will continue to be available). At the same time emissions of waste are confined to levels that do not exceed the capacity of the environment to absorb them. (Brundtland report) The concept of sustainability should not be confused with environmental protection and the scarcity of natural resources, although for many industries there is a direct connection between these. The concept of sustainable business applies to all types of business – banks and retail businesses as well as mining and oil companies. 6.1 THE OBJECTIVES OF SUSTAINABILITY Sustainability is about ensuring that an industry will be able to continue into the foreseeable future. To do this, it needs to identify any risks that may exist to its continued existence, and develop strategic objectives to protect itself against those risks. For many companies, sustainability involves considering how to achieve a sustainable business that does not deplete natural resources below a sustainable level, and does not create excessive pollution that endangers the future well-being of society. It may be argued that sustainability is concerned with ensuring a better quality of life for everyone, now and for generations to come, whilst meeting the following four objectives:  20 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING  Social progress that recognises the needs of everyone  Effective protection of the environment  Prudent use of natural resources  Maintenance of high and stable levels of economic growth or employment However, it is important to recognise that business organisations do not exist primarily to benefit society as a whole. It is all too easy to become naïve and unrealistic when thinking about sustainability! 6.2 SUSTAINABILITY AND MANAGEMENT ACCOUNTING There is clearly a growing interest in providing information to management that will help to support decision-making within the context of setting and achieving sustainability objectives. Many organisations now produce social and environmental reports or sustainability reports. There is also a growing understanding that accountants have an important role to play, demonstrated by the work that is being done by the leading accountancy bodies to engage the profession in sustainability issues. Definition The term 'sustainability accounting' encompasses a range of new accounting and reporting tools and approaches which are part of a transition towards a different kind of organisational decision making, focused not just on economic rationality, but consistent with ecological and social sustainability. The role of the management accountant in sustainability accounting includes:  producing public reports of an organisation's carbon emissions, energy use, and impact on the local economy (sometimes called physical, environmental or social accounting)  the use of such reports as part of an environmental or sustainability management system  the reporting of initiatives which demonstrate that an organisation is taking its social and environmental impacts into account in its decisions (such as in corporate social responsibility (CSR) reporting)  the reporting of such initiatives together with an organisation's financial accounts  the reporting of information within key performance indicator criteria, reflecting progress towards the sustainability of an organisation  the reporting of costs organisations incur to prevent, monitor and report environmental impacts. According to the International federation of Accountants (IFAC), 'a sustainability or (environmental) management system can help an organisation:  define its sustainability objectives, and ensure their alignment to business objectives;  identify sustainability challenges, risks, and opportunities; and  ensure that management and operational practices respond to these challenges, risks, and opportunities.' 6.3 SUSTAINABILITY REPORTING The term 'sustainability reporting' refers to the concept of organisations reporting to stakeholders not only on their economic performance, but also on their performance in relation to the environment and society. This has led to the emergence of frameworks to encompass reporting on social and environmental performance. 6.3.1 GLOBAL REPORTING INITIATIVE (GRI) The Global Reporting Initiative (GRI), founded in 1997, is an international not-for-profit organisation. It is the world-wide standard setter in sustainability reporting, providing a framework for organisations to measure their economic, environmental and social performance. Reporting on these three aspects of performance is sometimes called 'triple bottom line reporting'.  MANAGEMENT ACCOUNTING | 21 Economic performance concerns the organisation's impacts on the economic conditions of its stakeholders and on economic systems at local, national, and global levels. Environmental performance concerns an organisation's impacts on living and non-living natural systems, including ecosystems, land, air, and water. Social performance concerns the impacts an organisation has on the social systems within which it operates. MODULE 1 GRI launched the global standards for sustainability reporting in 2016 to enable organisations to report on their economic, environmental and social impacts. From July 2018 these new standards will be mandatory for a report to be 'in accordance' with GRI standards. These standards will replace the GRI's G4 guidelines published in 2013 which are currently the most widely used in the world. Many organisations around the world have declared their use of the GRI Guidelines as the basis for sustainability reporting, including companies such as Coca Cola, Bayer, British American Tobacco, Dell, and MTR Corporation. Case study 2017 Annual Review of the State of CSR in Australia and New Zealand - published by the Australian Centre for Corporate Social Responsibilty (ACCSR) The ninth annual review found that 53 per cent of Australian respondents were in favour of having mandatory sustainability reporting for all organisations of a certain size. ACCSR managing director Dr Leeora Black said This issue around sustainability reporting is one of the big messages to come out of this year. I was surprised by the high level of support for mandatory reporting especially when you compare it to where we were a decade ago when [a] couple of federal government inquiries canvassed that question and there was a resounding lack of support for mandatory sustainability reporting from business in particular. The current top 10 CSR businesses in Australia are Abergeldie, Arup, Deloitte, Ebmpapst, LexisNexis, PWC, Tata Consultancy Services, Transurban, WaterAid and Yarra Valley Water. https://probonoaustralia.com.au/news/2017/05/business-supports-mandatory-sustainability-reporting- csr-survey/ 7 MANAGEMENT ACCOUNTING SYSTEMS LO 1.4 Section overview  Management accounting systems developed from cost accounting systems. They are used for scorekeeping, directing management attention and problem solving.  A management accounting system comprises people with accounting knowledge, technology, records, processes, mathematical techniques, reports and the users for whom those reports are prepared. The key components of the system are: inputs, processes and outputs. It is used for strategic decision making, performance measurement, operational control and costing. We start this section by briefly looking at what management accounting systems are and the risks of using them. We then focus on the factors determining the design of management accounting systems, and assessing the adequacy of existing management accounting systems. The most important factor is for the output to meet the needs of management, for various decision-making purposes.  22 | THE NATURE AND PURPOSE OF MANAGEMENT ACCOUNTING 7.1 WHAT IS A MANAGEMENT ACCOUNTING SYSTEM (MAS)? A management accounting system (MAS) can be defined by its tangible components:  people with accounting knowledge (management accountants)  the technology they use  paper or computer records of financial transactions  the cost accounting system on which it is based  the management accounting techniques that are used to provide information: there are a wide variety of simple and complex mathematical techniques for analysing data  the reports that are produced by the system, or the nature of the information that is accessible online  the users of the information – the managers for whom the reports are prepared In summary, a MAS is an information system that produces information required by managers to manage resources and create value for customers and shareholders. Strategic management involves planning, controlling and decision making and a MAS enables all of these. 7.2 RISKS IN USING MANAGEMENT ACCOUNTING SYSTEMS In practice, MASs may not provide information of sufficient quality, and this will affect the quality of decision making within the organisation. Typical weaknesses in some MASs are explained briefly below. 7.2.1 EXCESSIVE EMPHASIS ON FINANCIAL MEASURES Management information may be unduly focused on financial costs and short-term profits that can easily be measured. Non-financial information may be overlooked. At a strategic level, for example, the objective of a company may be to increase profitability, but in order to grow the business and its profits, it may be necessary to consider factors such as quality, flexibility, customer satisfaction and employee skills. 7.2.2 INTERNAL ORIENTATION MASs may use data and information from internal sources, and fail to make use of external sources. A business needs an external orientation. It operates in a competitive and regulated environment, and management cannot ignore what is happening in the business environment. There should be some focus on customers and competitors, suppliers and perhaps other stakeholders. 7.2.3 LACK OF GOAL CONGRUENCE MASs may encourage a lack of goal congruence within the organisation (i.e. managers may be encouraged to concentrate on their own part of the company operations, without regard for other aspects of the business). Managers may pursue targets that are in their departmental interests but not in the best interests of the organisation as a whole. Often this may reflect poor overall design of the system, with potential conflicts between short and long-term objectives being ignored and incompatible targets being set for different parts of the organisation. 7.2.4 LACK OF FUTURE PERSPECTIVE The MASs may highlight historical financial costs and report on past performance. There is a requirem