CHAPTER FIVE

MANAGEMENT
ACCOUNTING: Basic
Framework
BY Dr Takele Fufa. Wednesday, July 21, 2021 1
MODERN MANAGEMENT ACCOUNTING

•Managerial accounting has undergone

several changes
•The early industrial revolution era
•The stagnation and ‘relevance lost’
•1990s ‘relevance regained’
•The current trend
The Role of Management Accounting
 Mechanized production.
 Industrial Revolution.
 More people and required larger sums of capital to finance
machinery.
 Separation of ownership from control caused the attention
of cost accounting to shift from determining cost to
exercising control by absent owners over their managers.
 Divisional performance evaluation and Budgeting.
 Concerned with evaluating the efficiency of internal
processes, rather than measuring organizational
profitability.
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 Johnson and Kaplan (1987) argued that by 1925
‘virtually all management accounting practices used
today had been developed’(p. 12).
 Johnson and Kaplan (1987) described how
 A management accounting system must provide
timely and accurate information to facilitate efforts to
control costs, to measure and improve productivity,
and to devise improved production processes. The
management accounting system must also report
accurate product costs so that pricing decisions,
introduction of new products, abandonment of
obsolete products, and response to rival products can
be made. (p. 4)
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Four Functions of management
 Strategic management
 Cost management information needed to make sound
strategic decisions, choice of methods, products,
marketing etc
 Planning and decision making
 Cost management information needed, for recurring
decisions, replacement, cash flow, budgeting,
production scheduling, pricing etc.
 Management and operational control
 Measurement of performance, leading to reward and
motivation
 Cont’d
 Preparation of financial
statements
 Inventory information
 Asset values etc.
The Chartered Institute of Management Accountants’
definition of the core activities of management
accounting includes:
 Participation in the planning process at both strategic
and operational levels, involving the establishment of
policies and the formulation of budgets;
 The initiation of and provision of guidance for
management decisions, involving the generation,
analysis, presentation and interpretation of relevant
information;
 Contributing to the monitoring and control of
performance through the provision of reports
including comparisons of actual with budgeted
performance, and their analysis and interpretation.
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Recent Developments in Management Accounting
 Value-Based Management(VBM approaches
include total shareholder return, market value
added, shareholder value added and economic
value added). Total shareholder return (TSR) compares
the dividends received by shareholders and the increase
in the share price with the original shareholder
investment, expressing the TSR as a percentage of the
initial investment. Market value added (MVA) is the
difference between total market capitalization (number
of shares issued times share price plus the market value
of debt) and the total capital invested in the business by
debt and equity providers. This is a measure of the value
generated by managers for shareholders.
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 Shareholder value added (SVA) to refer to the
increase in shareholder value over time. Discount
forecast future cash flows into present values.
 Economic Value Added (EVA) is a financial
performance measure developed by consultants
Stern Stewart & Co. EVA is net operating profit after
deducting a charge to cover the opportunity cost of
the capital invested in the business

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 Non-Financial performance measurement systems;
 Quality Management Approaches: the need to improve
performance by reducing waste have led to management
tools such as total quality management (TQM), just-in-
time (JIT), business process re-engineering (BPR) and
continuous improvement(CI) processes such as Six
Sigma( a process improvement method that relies on
customer feedback and fact based data gathering and
analysis techniques to drive process improvement) The
most common framework used to guide Six Sigma
process improvement efforts is known as DMAIC
(pronounced: du-may-ik), which stands for Define,
Measure, Analyze, Improve, and Control and the Business
Excellence model.
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 Activity-Based Management
 is an approach that emphasizes the
underlying business processes that
are required to produce goods and
services and the need to identify the
drivers or causes of those activities
in order to be able to budget for and
control costs more effectively(; and

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 Strategic Management Accounting.(an attempt
to shift the perceptions of accountants
and non-financial managers from an
inward-looking to an outward-looking
one, recognizing the need to look
beyond the business along the value
chain to its suppliers and customers and
to seek ways of achieving and
maintaining competitive advantage).

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 Changes in the New Business
Environment
 Total quality management (With no defects and
the reduction of non-value adding activities)
 Just-in-time manufacturing (Elimination of non-
value added activities)
 Time based competition (Reduction in the
amount of time)
 Flexible manufacturing (Ability to shift from one
product to another with out significant costs or
delay)
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Effects of the new business Environment on
Managerial accounting
 The development of managerial accounting
techniques to meet information needs in the new
business Environment.
 Value chain analysis
 Strategic positioning analysis
 Activity- based management
 Activity- based Costing
 Strategic Cost management

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Changes in the business environment
 These changes include;
 (1) an increase in global competition;
 (2) lean manufacturing;
 (3) advances in information technologies, the
Internet, and enterprise resource management;
 (4) a greater focus on the customer;
 (5) new forms of management organization; and
 (6) changes in the social, political, and cultural
environment of business

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 Management accountants have responded to the
above six changes in the contemporary business
environment with 13 methods that are useful in
implementing strategy in these dynamic times. The first
six methods focus directly on strategy implementation
the balanced scorecard/strategy map, value chain,
activity-based costing, business intelligence, target
costing, and life-cycle costing. The next seven methods
focus on strategy implementation through a focus on
process improvement—benchmarking, business
process improvement, total quality management, lean
accounting, the theory of constraints, enterprise
sustainability, and enterprise risk management
2021 Fufa, P.hD.16
Wednesday, July 21, Takele
 BSC: Financial and Nonfinancial
Measures of Success
Financial Measures of Success
 Sales growth Customer
 Earnings growth Market share and growth in market share
 Dividend growth Customer service (e.g., based on number of complaints)
 Bond and credit ratings On-time delivery
 Increase in stock price Brand recognition (growth in market share)
Nonfinancial Measures of Success
 Internal Processes
 High product quality
 High manufacturing productivity
 Cycle time
 Product yield and reduction in waste
 Learning and Growth
 Competence of managers (education attained)
 Morale and firm wide culture (employee survey)
 Education and training (training hours
 Strategy map
 The strategy map is a method, based on
the balanced scorecard, which links the four
perspectives in a cause and- effect diagram.
 High achievement in the learning and
growth perspective contributes directly to
higher achievement in the internal
perspective, which in turn causes greater
achievement in the customer satisfaction
perspective, which then produces the
desired financial performances.
The BSC Translates Strategy to a Series of Cause and
Effect Relationships
Long-Term
Long-Term
Strategy
Strategy
How do shareholders
view organization?
Financial
Financial
Perspective
Perspective
How do customers
view organization?
Customer
Customer
Perspective
Perspective
How do employees
view organization?
Performance
Performancemeasurements
measurementsfor for Internal
Internal
each
eachperspective
perspectivecan
canbe
beused
usedtoto Perspective
Perspective
determine
determineappropriate
appropriate
operational
operationaland
andstrategic
strategic
changes.
changes. Learning
Learning&&
Growth
Growth
How can organization grow and improve?
© John Wiley & Sons, 2005
Cont’d
 Business Intelligence (BI): Business intelligence
(also called business analytics or predictive
analytics) is an approach to strategy
implementation in which the management
accountant uses data to understand and analyze
business performance.
 Business intelligence (BI) often uses statistical
methods such as Regression or Correlation
analysis to predict consumer behavior, to measure
customer satisfaction, or to develop models for
setting prices, among other uses
 Cont’d
 Target Costing: is a method that has resulted
directly from the intensely competitive
markets in many industries.
 Target costing determines the desired cost
for a product on the basis of a given
competitive price, such that the product will
earn a desired profit. TC=Selling price -Desired profit margin.
 Life-cycle costing is a method used to
identify and monitor the costs of a product
throughout its life cycle.
 Cont’d
 Benchmarking: is a process by which a firm identifies its
critical success factors, studies the best practices of other
firms (or other business units within a firm) for achieving
these critical success factors, and then implements
improvements in the firm’s processes to match or beat the
performance of those competitors.
 Business process improvement is a management method
by which managers and workers commit to a program of
continuous improvement in quality and other critical success
factors.
 Total quality management (TQM) is a technique by which
management develops policies and practices to ensure that
the firm’s products and services exceed customers’
expectations.
 Lean accounting uses value streams to measure the
financial benefits of a firm’s progress in implementing
lean manufacturing.
 The Theory of Constraints: The theory of constraints
(TOC) is used to help firms effectively improve a very
important critical success factor: cycle time, the rate
at which raw materials are converted to finished
products. The TOC helps identify and eliminate
bottlenecks—places where partially completed
products tend to accumulate as they wait to be
processed in the production process. In the
competitive global marketplace common to most
industries, the ability to be faster than competitors is
often a critical success factor.
 Enterprise Sustainability : the
balancing of the organization’s short-
and long-term goals in all three
dimensions of performance—social,
environmental, and financial.
 In the broad sense to include identifying
and implementing ways to reduce cost
and increase revenue as well as to
maintain compliance with social and
environmental regulations and
expectations.
Management Control, Management Accounting
and its Rational-Economic Assumptions
 Management accounting needs to be understood as part
of the broader context of management control systems.
 Inhis seminal work on the subject, Anthony(1965)
defined Management control as:
 The process by which managers assure that resources
are obtained and used effectively and efficiently in the
accomplishment of the organization’s objectives.
 Management control encompasses both financial and
non-financial performance measurement.
 Strategy formulation, Management control & Task
control.
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Hierarchy of controls

Strategy formulation Goals strategies and polices

Management control Implementation of strategies

systems

Efficient and effective

Task control performance of individual tasks

Dr Takele Fufa 2010 modified 2012 26

 Daft and Macintosh (1984) described six components
of management control systems:
1. Strategic plan,
2. Long-range plan,
3. Annual operating budget,
4. Periodic statistical reports,
5. performance appraisal, and
6. policies and procedures.

Takele Fufa, P.hD. Wednesday, July 21, 2021 27

Management control System and Strategic Planning

Strategic planning Management Control system

 Focus on single aspect of  Focus all operations of different
corporate life units of organization
 Unstructured and
unperformed decisions  Rhythmic and regular
 Information required tailor
made, external, future  Integrated, largely internal,
oriented, less accurate historic and accurate
 information
Use of SWOT analysis
 Use of budgets
 Creative and analytical
 Administrative and persuasive
 Covers longer time horizon  One year, semi-annual, quarter

 Easily evaluated
 Difficult for appraisal

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MCS and Operational/task Control
Management control Operational control
system
 Focus on organizational sub unit  Focus on single task
 Grater judgment and objective
decision making
 Involves little judgment,
greater reliance on rules
 Uses integrated, financial
futuristic and historical  Often tailor-made to the
information operation, non- financial
 Works with weekly, monthly,  Time horizon tend to be
quarterly, yearly time frame day to day
 Diverse information generated  Techniques of OR widely
through MIS, DSS, KBS applied, programmable

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Takele Fufa, P.hD. Wednesday, July 21, 2021 31
A Budget:
– is a financial or nonfinancial expression of a plan of
action for a specified period.

– identifies the resources and commitments required

to achieve the organization’s goals for an upcoming
period.

Budgeting:
– The process of preparing a budget is called
budgeting.
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Strategic Goals and Long-term
Objectives.
 The starting point in the budget-preparation process is
specification of the organization’s strategy.

 An organization expresses its strategic goals and long-

term objectives in its capital and master budgets.

 Long-range planning often entails capital budgeting,

which is a process for evaluating, selecting, and
financing major projects, such as purchases of new
factory equipment and construction of a new factory
etc.
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The Master Budget.
– Represents the “grand plan of action” for an
upcoming period.

– Translates the organization’s short-term objectives

into action steps.

– Culminates in the preparation of a set of pro-forma

financial statements.
– Communicates to employees and managers alike the
expectations of top management.
– Helps coordinate subunit activities.
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The master budget is made up of operating and financial
budgets:

 Operating budgets are plans that identify resources

needed to carry out the budgeted activities, such as
sales and services or production
 Operating budgets include production, purchase,
personnel, and marketing budgets
 Financial budgets identify sources and uses of funds for
the budgeted operations
 Financial budgets include the cash budget, budgeted
statement of cash flows, the budgeted balance sheet,
and the capital expenditures budget
36
Sales Budget

The sales budget is often referred to as the

cornerstone of the entire master budget
The sales budget has two components:
 Forecasted sales volume
 Budgeted selling prices

37
Sales Budget illustrated
Kerry Industrial Company
Sales Budget
For the Quarter Ended June 30, 2007

April May June Quarter

Sales in units 20,000 25,000 35,000 80,000

Selling price
per unit x $30 x $30 x $30 x $30
Total sales $600,000 $750,000 $1,050,000 $2,400,000

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Production budget
 After the sales budget, we prepare a production
budget, which shows planned production for a
given period
 Budgeted production can be calculated through
use of the following formula:

Budgeted
Budgeted Budgeted
Budgeted Desired
Desired Beginning
Beginning
Production
Production = Sales
Sales + Ending
Ending __ Inventory
Inventory
(in
(in units)
units) (in
(in units)
units) Inventory
Inventory (in
(in units)
units)
(in
(in units)
units)

39
 Production Budget cont’d)
 Kerry example:

(1) Beginning inventory (April 1) =

5,000 units
(2) Desired ending inventory (April
30th) = 30% of the following month’s
projected unit sales
(3) The sales budget has total sales for
May at 25,000 units.
40
 Computation of production budget for April
 desired ending inventory on April 30=
30% x 25,000 units (May sales)= 7 500
units
 Budgeted production for April= budgeted
sales unit+ desired ending inventory-
beginning inventory
= 20,000 + 7,500 -5000(April 1
inventory) = 22,500 units

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Production Budget (continued)

July sales are budgeted at 40,000 units: 30% ×

40,000 = 12,000 units

Production Budget
For the Quarter Ended June 30,2007
April May e June Quarter
Budgeted sales in units 20,000 25,000 35,000 80,000
Desired ending inventory 7,500 10,500 12,000 12,000
Units needed 27,500 35,500 47,000 92,000
Beginning inventory 5,000 7,500 10,500 5,000
Budgeted production 22,500 28,000 36,500 87,000

30%
30% of
of June’s
June’s
budgeted
budgeted sales
sales

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 Direct materials budget
The direct materials usage budget:
– Shows the amount (and cost) of direct
materials required for budgeted
production
– The last line of the production budget
= first line of the direct materials
usage budget

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 Direct Materials Budgets (continued)
The direct materials purchases budget:
– Contains budgeted purchases, in units and dollars, of
direct materials for the upcoming period
– Is needed to complete the direct materials usage
budget (i.e., provides unit cost data)
– Is a function of: materials required for production
(from materials usage budget), target ending
inventory of materials, beginning-of-period materials
inventory, budgeted purchase price per unit of raw
material

44
Materials Purchases Budget: Kerry Company

45
 Direct Labor Budget

 Enables the personnel department to plan for

hiring & repositioning of employees, based on
production needs
 Is prepared for each class (type) of labor, e.g.,
skilled and semi-skilled
 Is a function of:
– Budgeted output (from production budget)
– Standard labor hours per unit of output
– Standard wage rate per hour
46
 Cont’d
 Kerry uses 0.5 hours of semiskilled
labor and 0.2 hours of skilled labor
per unit @ standard wage rates of
birr 8 and birr 12 per hour,
respectively

47
Direct Labor Budget: Kerry Company
Each unit of output requires 0.5 hours of semi-skilled labor @ $8.00/hour, and 0.2
hours of skilled labor @ $12.00/hour

Kerry Industrial Company

Direct Labor Budget
For the Quarter Ended June 30, 2007
April May June Quarter
Budgeted production 22,500 28,000 36,500 87,000
Semi-skilled labor costs $ 90,000 $ 112,000 $ 146,000 $ 348,000
Skilled labor costs 54,000 67,200 87,600 208,800
Total labor costs $ 144,000 $ 179,200 $ 233,600 $ 556,800

22,500 × 0.5 × $8.00 22,500 × 0.2 × $12.00 = $54,000

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 Cost of Goods Manufactured & CGS Budgets

The cost of goods manufactured

and CGS budgets are prepared
after the factory overhead
budget is prepared
The income statement budget
and the balance sheet use
information from this budget
49
Kerry Company:
Cost of Goods Manufactured & CGS Budgets, April
2007

50
The selling and general administrative
expenses
The selling and general administrative expenses
budget is now prepared:

– This budget includes all the planned expenditures for selling

and general administrative activities
– Many of the expenses included in this budget are considered
discretionary and are a likely place for spending cuts
– Managers must be careful not to focus solely on short-term
affects when making cuts in these areas (e.g., customer-service
expenditures)

51
Kerry Company-Cash Receipts Budget: April 2007

D.Duressa 2012 52
Cash Budget

The cash budget brings together the cash effects of all

budgeted activities-to ensure that the firm has
adequate cash on hand:
– This budget generally has three sections:
 Cash available
 Cash disbursements, and
 Financing
– Preparation of this budget involves careful review of
all other budgets to identify cash inflows and
outflows

53
Kerry Company—Cash Budget: April 2007

54
Budgeted I/S and B/S

The budgeted income statement (I/S) and

budgeted balance sheet (B/S) can then be
prepared using all the aforementioned budgets:

– The budgeted I/S describes the expected operating

income for the upcoming period

– The budgeted B/S, the last budget in the budget-

preparation process, incorporates the effects of all
operations and cash flows during the budget period and
shows projected ending balances in asset, liability, and
equity accounts

55
 Alternative Budgeting Approaches
Zero-base budgeting (ZZB) is a budgeting process that
requires managers to prepare budgets from a zero base
 This type of budgeting allows no activities or
functions to be included in the budget
unless managers can justify their needs
 In-depth reviews and analyses of all budget
items make managers aware of activities
and functions that have outlived their
usefulness
 Can be a difficult and time-consuming
process
56
Alternative Budgeting Approaches (continued)
 Activity-based budgeting (ABB) is a budgeting process
based on activities and cost drivers of operations:
 Starts with the budgeted output and segregates costs
required for the budgeted output into homogeneous
cost pools
 Can be a simple extension of a firm’s ABC system
 Kaizen (Continuous improvement) budgeting:
 Incorporates continuous improvement expectations
into the budgets
 Promotes active engagement in reforming and altering
business practices and processes

57
Behavioral Issues in Budgeting

 Budgetary slack, or padding the budget, is the practice of

managers knowingly including a higher amount of
expenditures or a lower amount of revenue in a budget

 Spending the budget is another issue; managers often feel if

they do not use all the resources they receive, next year’s
budget may be cut

 Goal congruence is a term that refers to the degree of

consistency between goals of the firm, its subunits, and its
employees
– Involving employees in the budgeting process fosters goal
congruence

58
Behavioral Issues in Budgeting (continued)
Difficulty level of the budget target?
– An easy budget may fail to encourage employees to
give their best efforts, while a very difficult target can
be discourage managers from even trying
– A “highly achievable target” is suggested with
incentives for exceeding the budgeted figures
Authoritative or participative budgeting?
– Top-down budgeting is referred to as authoritative
budgeting
– Bottom-up budgeting is referred to as participative
budgeting
– Effective budgeting processes often combine the two
types
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END OF CHAPTER FIVE

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Thank
you!
All

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