STUDY

MANUAL

Foundation level

Management Accounting
2012


Second edition January 2012
First edition 2010
ISBN 9781 4453 8013 1
Previous ISBN 9780 7517 8151 9
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.
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
©
BPP Learning Media Ltd 2012

ii

Welcome to the next step in your career –
CPA Program
Today’s CPA Program is a globally recognised education program available around the world. All candidates
of CPA Australia are required to attain a predetermined level of technical competence before the CPA
designation can be awarded. The CPA Program foundation level is designed to provide you with an
opportunity to demonstrate knowledge and skills in the core areas of accounting, business and finance.
A pass for each exam is based on a determination of the minimum level of knowledge and skills that
candidates must acquire to have a good chance at success in the professional level of the CPA Program.
In 2012 you have more opportunities to sit foundation level exams, allowing you to progress through to the
professional level of the CPA Program at your own pace.
The material in this study manual has been prepared based upon standards and legislation in effect as at
1 September 2011. Candidates are advised that they should confirm effective dates of standards or
legislation when using additional study resources. Exams for 2012 will be based on the content of this study
manual.

Additional Learning Support
A range of quality learning products will be available in the market for you to purchase to further aid your
core study program and preparation for exams.
These products will appeal to candidates looking to invest in additional resources other than those
provided in this study manual. More information is available on CPA Australia’s website
www.cpaaustralia.com.au/learningsupport
You will also be able to source face-to-face and online tuition for CPA Program foundation level exams
from registered tuition providers. The tuition provided by these registered parties is based on current
CPA Program foundation level learning objectives. A list of current registered providers can be found on
CPA Australia’s website. If you are interested you will need to liaise directly with the chosen provider to
purchase and enrol in your tuition program.

iii



iv


Contents

Page

Introduction
Welcome to CPA Australia

iii

Chapter features

vi

Chapter summary

viii

Answering multiple choice questions

x

Learning objectives

xi


Chapter
1

The nature and purpose of management accounting

1

2

Decision making and relevant costing

39

3

Budgeting

63

4

Cost behaviour and CVP analysis

97

5

Overheads, absorption and marginal costing

131


6

Overhead costing – activity-based costing

167

7

Process and job costing

187

8

Standard costing

229

9

Variance analysis

243

10

Capital expenditure

267


11

Inventory and pricing decisions

289

12

Performance measurement and evaluation

317

Revision questions

347

Answers to revision questions

371

Before you begin questions: answers and commentary

387

Glossary of terms

407

Index


415

Introduction

v


Chapter features
Each chapter contains a number of helpful features to guide you through each topic.
Learning
objectives

Show the referenced CPA Australia learning objectives.

Topic list

Tells you what you will be studying in this chapter.

Introduction

Presents a general idea of what is covered in this chapter.

Chapter summary
diagram

Summarises the content of the chapter, helping to set the scene so that you can
gain the bigger picture.

Before you begin


This is a small bank of questions to test any pre-existing knowledge that you may
have of the chapter content. If you get them all correct then you may be able to
reduce the time you need to spend on the particular chapter. There is a
commentary section at the end of the Study Manual called Before you begin: answers
and commentary.

Section overview

This summarises the key content of the particular section that you are about to
start.

Learning objective
reference

This box indicates the learning objective covered by the section or paragraph to
which it relates.

LO
1.2

vi

Definition

Definitions of important concepts. You really need to know and understand these
before the exam.

Exam comments


These 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 Level
study manual.)

Worked example

This is an illustration of a particular technique or concept with a solution or
explanation provided.

Question

This is a question that enables you to practise a technique or test your
understanding. You will find the solution at the end of the chapter.

Key chapter points

Review the key areas covered in the chapter.

Management Accounting


Quick revision
questions

A quick test of your knowledge of the main topics in this chapter.

Revision
questions

The revision questions are not a representation of the difficulty of the questions

which will be in the examination. The revision MCQs provide you with an
opportunity to revise and assess your knowledge of the key concepts covered in
the materials so far. Use these questions as a means to reflect on key concepts
and not as the sole revision for the examination.

Case study

This is a practical example or illustration, usually involving a real world scenario.

Formula to learn

These are formulae or equations that you need to learn as you may need to apply
them in the exam.

Bold text

Throughout the Study Manual 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.

The quick revision questions are not a representation of the difficulty of the
questions which will be in the examination. The quick revision MCQs provide you
with an opportunity to revise and assess your knowledge of the key concepts
covered in the materials so far. Use these questions as a means to reflect on key
concepts and not as the sole revision for the examination.

Introduction

vii



Chapter summary
This summary provides a snapshot of each of the chapters, to help you to put the Study Manual into
perspective.

Chapter 1 – The nature and purpose of management accounting
This introductory chapter 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 also introduces two key activities of the management accountant: decision making and performance
measurement and evaluation.

Chapter 2 – Decision making and relevant costing
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. The chapter goes on to consider choice of product
(product mix) decisions, make or buy decisions and outsourcing.

Chapter 3 – Budgeting
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 chapter explains the background of budgeting and then teaches you
how to prepare and operations budget and a cash budget.

Chapter 4 – Cost behaviour and CVP analysis
This chapter introduces the different types of cost and also discusses cost behaviour. 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.


Chapter 5 – Overheads, absorption and marginal 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 chapter examines the different types of overheads and
introduces two methods of accounting for them: absorption and marginal costing. It ends with a comparison
between the two.

Chapter 6 – Overhead costing – activity-based costing
Activity-based costing (ABC) has been developed relatively recently to suit modern business and accounting
practices. It provides a modern alternative to traditional methods such as absorption costing, which tend 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.

Chapter 7 – Process and job costing
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.

viii

Management Accounting


Chapter 8 – Standard costing
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.

Chapter 9 – Variance analysis

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 (ie positive) variance on one aspect of production
will be cancelled out by an adverse (ie 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.

Chapter 10 – Capital expenditure
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 chapter introduces the different means
of assessing the value of capital expenditure.

Chapter 11 – Inventory and pricing decisions
Manufacturing businesses in particular are very concerned to retain the right amount of stock, or inventory.
They do not want to tie too much cash up in the purchase and holding of stocks of goods or components,
but 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 stock or cannot get it quickly enough. This chapter examines systems for maintaining
inventory and controlling its levels, and also looks at different approaches to pricing.

Chapter 12 – Performance measurement and evaluation
This chapter 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.

Introduction

ix



Answering multiple choice questions
The questions in your exam will each contain four possible answers. You have to choose the option that
best answers the question. The three incorrect options are called distractors. There is a skill in
answering MCQs quickly and correctly. By practising MCQs you can develop this skill, giving you a better
chance of passing the exam.
You may wish to follow the approach outlined below, or you may prefer to adapt it.

x

Step 1

Attempt each question – starting with the easier questions which will be those at the start of
the exam. 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 the distractors 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 stage 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

Step 4

If you are still unsure make a note 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.

Step 5

Revisit unanswered questions. When you come back to a question after a break you often
find you are able to answer it correctly straight away. If you are still unsure have a guess. You
are not penalised for incorrect answers, so never leave a question unanswered!

Management Accounting


Learning objectives
CPA Australia's learning objectives for this Study Manual are set out below. They are cross-referenced to
the chapter in the Study Manual where they are covered.

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.
Topics
Chapter where
covered

LO1. Conceptual issues and behavioural implications
LO1.1

Explain the historical development of management accounting

1

LO1.2

Analyse the key differences between financial, cost and management
accounting

1

LO1.3

Analyse the current influences on management accounting

1

LO1.4


Explain the range of theories that underpin management accounting and
how they have an influence on practice

1

LO1.5

Outline the core parts of management accounting systems and how they
enable strategic management

1

LO1.6

Analyse the roles of management accountants in cross-functional teams

1

LO1.7

Identify and explain appropriate internal controls for management and
accounting systems in a range of situations

12

LO1.8

Explain how organisational behaviour can impact the creation of
organisational value


1

LO1.9

Describe the increasing awareness of sustainability and its relationship to
management accounting

1

LO2. Decision making
LO2.1

Apply the steps in the decision making process

1

2.1.1 define the problem
2.1.2 identify the decision making criteria
2.1.3 develop alternatives
2.1.4 analyse alternatives
2.1.5 select an alternative
LO2.2

Apply relevant information guidelines for short-term alternative choice
operating decisions

2

LO2.3


Identify the quantitative and qualitative criteria involved in accepting a
project

10

LO2.4

Analyse the challenges posed by differences between a project and an
organisation’s risk profiles

10

LO2.5

Explain the impact of cash flows and risks on project decision making

2, 10

Introduction

xi


Chapter where
covered

LO3. Budgeting
LO3.1

Identify and analyse the human behavioural challenges to the budgeting

process in organisations

3

LO3.2

Explain the nature of budgets and the reasons that organisations use budgets

3

LO3.3

Prepare an operations budget

3

LO3.4

Prepare a cash budget

3

LO4. Cost behaviour
LO4.1

Apply the techniques to separate costs into their fixed and variable
components

4


LO5. Overhead costing – product and service costing
LO5.1

Explain three methods of departmental overhead allocation

5

LO5.2

Explain the concepts underpinning product costing in organisations

5

LO5.3

Develop different product costing statements involving production resource
costs

5

LO5.4

Evaluate the difference between direct production costs and indirect
overhead costs

5

LO5.5

Apply the principles of absorption and variable costing to product costing

analysis

5

LO6. Overhead costing – activity-based costing
LO6.1

Identify and apply the principles of activity-based costing to allocate
overheads in organisations

6

LO7. Process and job costing
LO7.1

Explain the differences between job and process costing techniques

7

LO7.2

Apply costing principles to job costing and process costing organisations

7

LO8. Standard costing
LO8.1

Explain how standard costing can be used to assist in cost control and
efficient resource allocation


8

LO9. Variance analysis
LO9.1

Calculate and explain the causes of variances and associated corrective
actions

9

LO10. Capital expenditure
LO10.1

xii

Analyse capital expenditure decisions in organisations and apply related
tools and techniques
LO10.2
Apply capital expenditure analysis to project planning and managing
uncertain scenarios through scenario analysis
LO11. Inventory, pricing decisions, and cost-volume-profit analysis

10

LO11.1

Evaluate the principles of just-in-time

11


LO11.2

11

LO11.3

Apply the economic order quantity formula to determine order quantities
for inventory management
Establish and apply the appropriate approach for long-term pricing decisions

LO11.4

Apply the principles of cost-volume-profit analysis in organisations

4

Management Accounting

10

11


Chapter where
covered

LO12. Performance measurement and evaluation
LO12.1


Describe how management accounting creates value

1

LO12.2

Explain the characteristics and purpose of performance measurement
systems

12

LO12.3

Analyse the different types of financial performance measures and their
limitations

12

LO12.4

Describe the key characteristics of the Balanced Scorecard and its
advantages over traditional performance measurement systems

12

LO12.5

Outline the characteristics of reward systems and the circumstances in
which they can be tied to performance measures


12

Topic exam weightings
1

Conceptual issues and behavioural implications

7%

2

Decision making

13%

3

Budgeting

10%

4

Cost behaviour

12%

5

Overhead costing – product and service costing


13%

6

Overhead costing – activity-based costing

5%

7

Process and job costing

5%

8

Standard costing

5%

9

Variance analysis

5%

10

Capital expenditure


5%

11

Inventory, pricing decisions, and cost-volume-profit analysis

8%

12

Performance measurement and evaluation

12%

TOTAL

100%

Introduction

xiii


xiv

Management Accounting


Chapter 1


The nature and purpose of
management accounting
Learning objectives

Reference

Conceptual issues and behavioural implications

LO1

Explain the historical development of management accounting

LO1.1

Analyse the key differences between financial, cost and management accounting

LO1.2

Analyse the current influences on management accounting

LO1.3

Explain the range of theories that underpin management accounting and how they
have an influence on practice

LO1.4

Outline the core parts of management accounting systems and how they enable
strategic management


LO1.5

Analyse the roles of management accountants in cross-functional teams

LO1.6

Explain how organisational behaviour can impact the creation of organisational
value.

LO1.8

Describe the increasing awareness of sustainability and its relationship to
management accounting

LO1.9

Decision making

LO2

Apply the steps in the decision making process
define the problem

LO2.1
LO 2.1.1

identify the decision making criteria

LO 2.1.2


develop alternatives

LO 2.1.3

analyse alternatives

LO 2.1.4

select an alternative

LO 2.1.5

Performance measurement and evaluation

LO12

Describe how management accounting creates value

LO12.1

Topic list

1
2
3
4
5
6
7

8
9

The management accounting function
Financial accounting and management and cost accounting
Planning, control and decision-making
Information
Presentation of information to management
Management accounting systems
Design of management accounting systems
Developments in management accounting
Sustainability and management accounting
1


Introduction
This chapter provides an introduction to Management Accounting.
We commence this first chapter by looking at the role of the management accounting function.
We then examine the differences between management accounting and financial accounting and introducing
cost accounting.
The chapter goes on to look at the importance of information provided by the management
accountant in planning, control and decision making
We also briefly look at how management accounting systems have developed and the design of management
accounting systems.
This chapter 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.
Finally we examine the management accountant’s role in the creation of organisational value and the
relationship between sustainability and management accounting.


2

Management Accounting


Before you begin
If you have studied these topics before, you may wonder whether you need to study this chapter in full. If
this is the case, please attempt the questions below, which cover some of the key subjects in the area.
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 chapter to ensure that you are familiar with everything
covered.
There are references in brackets indicating where in the chapter you can find the information, and you will
also find a commentary at the back of the Study Manual.
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

Identify steps involved in the decision making process.

5

What are the three types of management activity identified by Anthony
(Management Control Systems, 1972)?

(Section 3.7)

6

What are the basic elements of a management control system?

(Section 3.8)

7

What is the difference between data and information?

(Section 4.1)

8

List the qualities of good information.

(Section 4.2)


9

What are the main features of a report?

10

What are the risks of using traditional management accounting methods?

11

What are the components of a management accounting system?

12

Define and explain Just-In-Time (JIT).

(Section 8.1)

13

Define and explain Total Quality Management (TQM).

(Section 8.2)

14

Define and explain Kaizen.

(Section 8.3)


(Section 3.6.1)

(Section 5.1.1)
(Section 6.3)
(Section 6.2/7.1)

1: The nature and purpose of management accounting

3


1 The management accounting function
Section overview
•

LO
1.6

1.1

The role of the management accounting function as an information provider has developed with
advances in technology. In order 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 be looking at what the management accounting function should seek to achieve and how its
performance should be measured.

Role of the management accounting function
The management accounting function exists to provide information to decision-makers, and to provide

advice based on information that is provided. The information provided by management accounting covers
all areas of strategy and operations, and includes information to assist with planning, control and other
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. Developments in technology have also made it easier to provide accounting
information to non-financial managers. At the same time the areas covered by management accounting have
extended and broadened 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 Simons identified three attributes of what could by now be called management
accounting information:
•

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:


1.2

•

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 know what they want the
business to achieve (targets or standards) and what the business is actually achieving.

•

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)

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 cross-functional team is


4

Management Accounting


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 crossfunctional 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 able to
accomplish 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:
•
•
•
•

1.3

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.

Defining management objectives of the accounting function
The objectives of the management accounting function within an organisation should depend on the
information needs of the ‘internal customers’ – the managers who need information to help them to run
the business. The overall objective should be the provision of a quality service, but this broad objective can
be analysed into a number of sub-objectives.
Sub-objective

Detail

The provision of good
information

This requires supplying information that fulfils the following criteria. 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, so that it is better to provide the information sooner rather than later.
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 through a suitable medium. A large amount of
management accounting information should be accessible immediately and on-line to
authorised managers.

The provision of a
value-for-money service

The costs of management accounting should be justified by the benefits that the
function provides to the organisation, and the level of service and the quality of
information provided.

The availability of
informed personnel

Users will expect management accounting staff to be available to answer queries
and resolve problems as and when required.

Flexibility

The management accounting function should be flexible in its response to user
requests for information and reports.

1: The nature and purpose of management accounting

5


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 is required 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 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:
(a)

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,
whether it is timely or provided too late to be of much use, and whether it is reliable.

(b)

Measures relating to value for money. The cost of the function should be measurable, and 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.


(c)

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.

(d)

Measures relating to flexibility, such as number of ad-hoc reports issued within pre-set time
limit.

(e)

Ratings provided from user satisfaction surveys would provide extremely useful measures of
performance. ‘Users’ are the ‘internal customers’ for the management information.

2 Financial accounting and management and cost
accounting
Section overview

6

•

Financial accounting systems ensure that the assets and liabilities of a business are properly
accounted for, and provide information about profits and so on to shareholders and to other
interested parties.

•


Management accounting systems provide information specifically for the use of managers within an
organisation.

•

Cost accounting is part of management accounting. Cost accounting provides a bank of data for the
management accountant to use.

Management Accounting


2.1
LO
1.2

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.
(a)

Financial accounts are prepared for individuals external to an organisation: for example
shareholders, customers, suppliers, regulatory authorities, employees.

(b)


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 is 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
Financial accounts

Management accounts

Financial accounts detail the performance of an
organisation over a defined period and the state of affairs
at the end of that period.

Management accounts are used to aid management
record, plan and control the organisation's activities and
to help the decision-making process.

Limited liability companies must, by law, prepare financial
accounts.

There is no legal requirement to prepare management
accounts.

The format of published financial accounts is determined
by local law, by International Accounting Standards and

International Financial Reporting Standards. In principle
the accounts of different organisations can therefore be
easily compared.

The format of management accounts is entirely at
management discretion: no strict rules govern the way
they are prepared or presented. Each organisation can
devise its own management accounting system and
format of reports.

Financial accounts concentrate on the business as a
whole, aggregating revenues and costs from different
operations, and are an end in themselves.

Management accounts can focus on specific areas of an
organisation's activities. Information may be produced
to aid a decision rather than as the end product of a
decision.

Most financial accounting information is of a monetary
nature.

Management accounts incorporate non-monetary
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 picture
of past operations.


Management accounts are both an historical record and
a future planning tool.

Question 1: Management accounts
Which of the following statements about management accounts is/are true?
I
II
III

There is a legal requirement to prepare management accounts
The format of management accounts is largely determined by law
They serve as a future planning tool and are not used as a historical record

A
B
C
D

I and II
II and III
III only
none of the statements are correct
(The answer is at the end of the chapter)

1: The nature and purpose of management accounting

7


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 the following:
•
•
•

Preparing statements (e.g. the construction of budgets and costing statements)
Cost data collection
Measuring inventory costs, and the costs and profitability of products and services.

Management accounting on the other hand is concerned with the following:
•

2.3.1

Interpretation and assessment of financial and accounting data, and communicating it as information
to users, for example as financial targets or performance measurements.

Aims of cost accounts
Cost accounting is used to measure:
(a)

The cost of goods produced or services provided.

(b)


The cost of a department or business unit.

(c)

The revenues earned from a product, service, department or business unit, or the organisation in
total.

(d)

The profitability of a product, a service, a department, or the organisation in total.

(e)

Selling prices with some regard for the costs of sale.

(f)

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.

(g)

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.

(h)

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 can 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 revealed by these differences between budgeted
and actual results. This system of control is often referred to as budgetary control or variance
analysis.

It would be wrong to suppose that cost accounting systems are 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 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.

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Management Accounting


3 Planning, control and decision-making
Section overview

3.1
LOs
1.7
1.8

•

Information for management is likely to be used for planning, control and decision making.

•


Long-term planning, also known as corporate or strategic planning, involves selecting appropriate
strategies so as to prepare a long-term plan to attain the organisation’s objectives.

•

Robert N Anthony (Management Control Systems, 1972) has categorised management activities and
decision-making into strategic planning, management control and operational control.

•

A management control system is a system which measures and corrects the performance of
activities of subordinates.

•

Information within an organisation can be analysed into the three levels of Anthony's hierarchy:
strategic; tactical; and operational information.

Planning
Planning forces management to think ahead systematically in both the short term and the long term. An
organisation should never be surprised by developments that occur gradually over an extended period of
time because the organisation should have implemented a planning process. 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.
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.

1: The nature and purpose of management accounting

9


The two main types of organisation that you are likely to come across in practice are as follows:
•
•

Profit making.
Non-profit making.

It is often assumed that the main objective of profit making organisations is to maximise profits. A
secondary objective of profit making organisations might be growth, for example by increasing the output
and sales of its goods/services. Instead of maximising profit, an organisation may seek to maximise the
wealth of its shareholders. Unfortunately, the aim of profit maximisation may encourage short-termism and
excessive risk-taking by management in order to increase profits ‘now’, regardless of the consequences of
their decisions for the longer term.
The main objective of non-profit making organisations is usually to provide goods and services. A
secondary objective of non-profit making organisations might be to minimise the costs involved in providing
the goods/services.
In conclusion, 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 are often based on one of these assumptions 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 plan or 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 2, 5, 7
or 10 years although longer planning periods may be used.
Long-term strategic planning is a detailed, lengthy process, consisting 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 longterm planning.

3.4

Short-term tactical planning
The corporate or strategic plan serves as the long-term framework for the organisation as a whole,
but for operational purposes it is necessary to convert the corporate (strategic) plan into a series of shortterm 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 as 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.
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 shortterm plan is based, such as growth rates, costs, efficiency savings, cost inflation, and so on.

10

Management Accounting


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.
(a)

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.


(b)

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 as
necessary before any serious damage to the organisation's future success occurs.

Effective control is not practical without planning, and planning without control is pointless,
because 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.

3.6
LO
2.1

Decision-making
A function of management is decision-making. Managers at all levels within an organisation make
decisions. Decisions may be taken within the routine planning and control processes. In addition, there are
many other decisions, both long term and short term, and routine and occasional, that managers have to
make at all levels within the management hierarchy. Decision making always involves a choice between

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