and Control Systems
|Learning objectives|| |
After you have studied this module, you will be able to:
Chapter 1: Introduction to management accounting
|Read Module Excerpt||Management Accounting and Control Systems|
Why Open School of Management believes that competences in management accounting and control systems are important
According to the Institute of Management Accountants, "Management Accounting is a profession that involves partnering in management decision making, devising planning and performance management systems, and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization's strategy."
Simply put, management accounting is strategic planning and outlining of decisions and systems which implement and control an organization's finances and prospects. In management accounting, managers use accounting information to establish control systems. They use their knowledge to assist in formulating policies and the plans to control operations. With respect to their decisions, management accountants are interested in the company's future success.
A control system, also known as a system of internal control, is a system or plan used to ensure that an organization's resources are used efficiently. This, in turn, helps to minimize and prevent fraudulence from employees and managers within the organization. Several aspects of the organization's data information are used to create a control system. The morality of those in authority, the organization's ability to properly record and protect accounting transactions and records, and the segregation and balancing of duties in order to prevent mistakes, are all important parts of an effective control system.
Without a foundation of principles, professionals in management and accounting have nothing to build new theories of methods for managerial costs upon. With that being said, there are two main principles of management accounting: the principle of causality, and the principle of analogy. The principle of causality provides cause and effect insight. The principle of analogy is the application of those causal insights by management. These principle serve both the customers and management accoutants. They help to govern the practice of management accounting and ensure a better understanding of the profession from the inside to the outside, which help to weed out ineffective and inappropriate principles.
According to the American Institute of Certified Public Accountants (AICPA), the management accounting practice has three extensions. The first extension is called strategic management. In strategic management, the management accountant's role is advanced as a strategic partner in the organization. The second extension is called performance management. In performance management, the performance of the organization is maintained and managed, and the decision-making process of the business is developed. The third extension is called risk management. In risk management, risks are identified, measured, reported and managed. This contributes to the overall achievement of the organization's expectations and goals.
Companies use budgets as a financial plan that map out strategies, objectives and assumptions within that organization. This includes master budgets and annual budgets. In a master budget, all operating budgets are included (i.e., sales budgets, administrative budgets, production budgets, marketing budgets and department budgets). Annual budgets show a profit plan for the upcoming year. They are usually planned and detailed monthly and/or by quarter. These budgets are strictly followed and are not changed, except in the rare event that the business environment of an organization has changed, entirely.
There are several other important techniques when it comes to budgeting in managerial accounting. One of these is called Cost Volume Profit Analysis, or CVP Analysis. Its relevance is in that it is used to estimate and determine how financial decisions will effect a company's operating and net income, which is the main source of a company's success. There are several assumptions made in CVP analysis, such as the consistency in sales per unit, variable costs and fixed costs, that all products are sold, and that any changes in activity will influence changes in costs. In CVP, all costs are required to be categorized as variable or fixed. A variable cost is a cost that changes according to the amount of goods or services produced. A fixed cost is independent of output, usually consisting of cost for rent, buildings, machinery, etc.
There are a few important calculations in utilizing CVP analysis. One of these is known as contribution margin per unit. The contribution margin is the company's sales revenue after subtracting variable costs, and before deducting fixed costs. For example, if a company makes $800,000 in a year in sales, and uses $450,000 in variable costs, the contribution margin is $350,000. To calculate the contribution per unit, the variable cost per unit is subtracted from the sales per unit. So, if the company has sold 200,000 units with the cost of sales per unit being $4.00, and the variable cost per unit being $2.25, the contribution margin per unit will be $1.75.
Another important calculation in CVP analysis is known as the break-even point analysis. The break-even point is the point at which the net income is equal to zero, after all variable and fixed costs have been paid. Sales revenue is equal to the sum of variable costs and fixed costs, and the contribution margin is equal to fixed costs. Therefore, using the previous example, the company has a fixed income of $350,000 as the break-even point shows a net income of $0. The purpose of the break-even point analysis is to establish the minimum amount of output that is needed to make a profit. In doing this, it creates and maintains a dynamic relationship between sales, costs, and profits.
In break-even analysis, the margin of safety is also calculated. The margin of safety is the measure of risk and is the extent by which actual sales exceed break-even sales. It represents what number of drop in sales a company can tolerate. The higher he margin of safety, the more fluctuating sales a company can withstand. The lower the margin of safety, the more net income is lost. This is calculated by subtracting the break-even sales from the actual sales.
CVP analysis is also used to calculate targeted income. The targeted income is a specific amount of income a company aims to acquire through sales. To determine how many sales must be made in order to reach the targeted income, the sum of the fixed costs and targeted income is divided by the contribution margin per unit. So, if the company used in the example above wants to make a targeted income of $70,000, the amount of units that must be sold is 240,000.
Another aspect of management accounting is known as marginal analysis. Marginal analysis is the comparison of various business activities in a manner that is cost vs. benefit. This means that the cost of an activity is measured against incremental changes in volume. Doing this will determine how the changes will effect the business overall. There are several variables to be considered in marginal analysis: the quantity of goods produced, the quantity of purchased products, and the quantity of other added costs such as costs for shipping. One of these variables is to either be the control variable or the variable that is changed. Any changes that are made are done so in increments of one unit until profitability decreases to zero. By doing this, a range of changes can be made at different levels of profitability. Marginal analysis is an important decision making tool because it helps the business owner to determine which activities are most profitable for the company.
Full costing is a method used in management accounting to calculate the total cost, per unit, it takes for the output of products. This is done by adding together the variable costs, fixed costs, and manufacturing costs for every product. Activity-based costing (ABC), another method used in management accounting, is a method used to identify the activities in a business and assign a cost to each activity. Firstly, ABC assigns costs to the acticities that are responsible for the overhead, then it assigns the cost of the activities of products. Using ABC can help to improve cost management and profitability within a company. In terms of cost management, ABC can help set pricing strategies based on the accurate knowledge of costs. In doing this, gaining and maintaining profitability becomes easier. ABC reveals the link between the performance of certain activities and the demand of those activities. This link gives managers a clear view of how products/services generate revenue and, therefore, profitability.
Balanced scorecards is also a technique used for strategic planning and management. It is used to align business activities to the strategies and goals of an organization, enabling managers to execute them.
There are four perspectives of balanced scorecards:
- The Learning and Growth Perspective: This perspective includes employee training. The education of employees is important because it provides ease of communication amongst workers, and problem solving when it is needed.
- Business Process Perspective: This perspective refers to the internal business process. It allows managers to know how well their business is running and if products and/or services are satisfying customers.
- Customer Perspective: This focuses on customer satisfaction. This is important because satisfied customers generate more business, whereas dissatisfied customers seek other suppliers. Customer activity is analyzed. Based off of this analysis, the process of providing products for customers is also analyzed and improved.
- The Financial Perspective: This is the recording of timely and accurate financial data.
Balanced scorecards help to improve internal and external communication, and give managers and executives a more balanced view of the organization's performance.
With these properties and techniques of management accounting, it proves to be a profession of precision and reward. It is an important part of owning a successful business, and maintaing its success.
Return to General Management (MG modules).