6202: Advanced Cost and
Management Accounting
Introduction
DEFINITION OF ACCOUNTING
 Accounting is the process of
identifying, measuring and
communicating economic
information about an entity to
permit informed judgments and
decisions by users of the
information (Anthony et al,
1995)
 What economic information?
Examples
•
Assets of the entity
 Liabilities of the entity
 Expenses & income of the entity
 Performance of the entity
 Financial position of the entity
economic information
users of the information
 Liquidity position of the entity
Users of accounting information
 Management
 Investors: Shareholders/owners &
lenders
 Creditors/ suppliers
 Debtors/customers
 Government
 The public/ Community
 Financial analysts
 Employees
Branches of Accounting
 Financial Accounting
 Cost Accounting
 Management Accounting
Accounting:
Financial Accounting: (Stewardship
Accounting)
limits its activities in recording business
transaction and determining financial results
and position.
Cost Accounting: (Control Accounting)
takes the responsibility of determining cost of
products and services and controlling costs
with a view to maximizing profit.
Management Accounting: (Decision
making Accounting)
takes the duty of helping management in
planning and decision making.
Relationship of Financial,
Management, and Cost Accounting
Product
Costs
FINANCIAL
COST
MANAGEMENT
ACCOUNTING ACCOUNTIG ACCOUNTING
Definition
“Cost Accounting is the identification,
•
“It is the process of identifying,
accumulation, assignment and analysis
of production and activity cost data to
measuring, accumulating, analyzing,
provide information for external
preparing,
reporting, internal planning and control
communicating
interpreting,
information
and
that
of ongoing operations and special
decisions.”
managers use to fulfill organizational
objectives.”
Comparison of Financial and
Managerial Accounting
Financial Accounting
Managerial Accounting
External persons who
make financial decisions
Managers who plan for
and control an organization
Historical perspective
Future emphasis
3. Verifiability
versus relevance
Emphasis on
verifiability
Emphasis on relevance
for planning and control
4. Precision versus
timeliness
Emphasis on
precision
Emphasis on
timeliness
5. Subject
Primary focus is on
the whole organization
Focuses on segments
of an organization
6. GAAP
Must follow GAAP
and prescribed formats
Need not follow GAAP
or any prescribed format
Mandatory for
external reports
Not
Mandatory
1. Users
2. Time focus
7. Requirement
Difference Between Cost Accounting and Managerial Accounting
Base
Cost Accounting
Managerial Accounting
Meaning
Cost Accounting is
ascertaining the cost
of
Managerial accounting is one which enables
management in doing its functions efficiently.
Objects
The primary object of Cost accounting is
Managerial accounting is aims at representation of
cost data or accounting information for
management use.
a
process
to determine the records, cost of products
and services.
Scope
The scope of Cost accounting is not wide,
it is apart of Managerial accounting
Managerial accounting has wider scope. It includes
Financial accounting, Cost accounting an
statistics etc.
Principles
Under this system of cost accounting
certain principles are followed.
No principles is followed under the system of
managerial accounting.
Parties
Both parties, internal and external have
interested in costing
Managerial accounting is specially designed for
management or internal use.
Principles
and formats
Cost accountancy have some established
and set accounting principles and formats
it is not so in the case
accounting
of the management
Historical Perspective
 Cost and management information was considered to be of great
importance in supporting the growth of large transportation,
production and distribution enterprises during the 1850-1925 period in
US. Historians have found examples of cost management information
in records of 19th century manufacturers of textiles, machine tools,
steel, nails and petroleum products.
Textile Industry: the demand for the
information can be traced back to the early stages of
the industrial revolution in textile mills. Records of early
19th century textile mills show that textile mill
managers received information about the hourly cost
of converting raw material (cotton) into intermediate
product (threads & yarn) & finished products (fabric)
& the cost per pound of output by department and
for each worker.The owner used such information for
two different purposes:
=>To control & improve efficiency
=>For pricing & product mix decisions
Railroad Industry: Due to the emergence of
Railroad industry in the mid 19th century, new measures
such as cost per gross ton mile, cost per passenger mile
& the operating ratio were developed to help to
evaluate the efficiency of their operating processes.
Managers used these measures both for
=> operational control (to evaluate the efficiency of
operations of local managers)
=> product costing (to measure the profitability of
various types of business)
Other Companies: Steel Mills measured daily
the cost of materials. Labors & energy inputs used to
produce steel & rails. They used the information:
=> to evaluate the performance of dept. managers,
foreman & workers & to check the quality & mix of raw
materials.
=> to evaluate investments that offered
improvements for processes & products
=> for non-standardized products this information was
the basis for pricing decisions
20th Century Developments
 During 20th century the large, diversified & complex companies
required or demand more information to help them allocate
physical, financial & human resources among their operating
divisions & to monitor & control their diverse operations.
Du Pont Company: A vertically integrated
manufacturing organization using advanced techniques
to generate and collect information to:
=> coordinate operations
=> monitor production & sales efficiencies
=> plan the growth among the company’s diverse
activities
=> evaluate & control the performance of the
company’s three main functional operating dept.
manufacturing, distribution & purchasing.
General Motors: the guiding operating
philosophy of GE - “centralized control with
decentralized responsibility ”
Centralized control is accomplished by having
periodic financial information about divisional
operations & profitability.
Characteristics of early centuries
manufacturing environment &
information requirements
 Mass production of few standardize products.
 Widely accepted the concepts of ‘economies of
scale’.
 Developing measures to motivate & assess the
efficiency of only the internal operating
processes.
 There was little concern with measuring the costs
of different products or even the periodic profit
of the enterprise.
 One common characteristic was that all the
companies measured the efficiency by
which input resources were converted to
finished products or sales revenue
 The organizations had a narrow product
focus that enabled them to use simple
summaries of output.
 Focused on directly measured cost
 The narrow product line created little
demand to attempt to assign indirect costs
to output product.
Changing Manufacturing Environment
 Automation & cost concepts
 Flexible manufacturing systems
 Total quality management
 Value added activities
 Just-in-time concepts
 Activity based management
 Life cycle costing
 Target costing
Management Accounting
 Management accounting, which is a more elaborate
version of cost accounting needs to take a
multidimensional focus in order to better serve the
various and complex needs facing the management
accountant. As a result, management accounting rests
not only in accounting but also on organizational,
behavioral, decisional, strategic and other foundations
and dimensions.
The Multidimensional Scope of
Management Accounting
Management accounting is generally understood
as a process or as referring to the use of techniques.
It has been defined as “the application of
appropriate techniques and concepts in processing
the historical and projected economic data of an
entity to assist management in establishing a plan
for reasonable economic objectives and in the
making of rational decisions with a view towards
achieving these objectives.”
 the emergent conceptual framework of management accounting started
by the National Association of Accountants (NAA) defines it as:
 “the process of identification, measurement, accumulation, analysis,
preparation, interpretation and communication of financial information
used by management to plan, evaluate, and control within an
organization and to assure the appropriate use of and accountability
for its resources.”
 In fact, the 1961 AAA Management Accounting Committee, charged with
determining the relevance of financial accounting concepts to
management accounting, concluded that
 1. the concepts underlying internal reporting differ in several important
respects from those of external public reporting;
 2. these differences are due to differences in the objectives of both
areas; and
 3. it is justified to develop a separate body of concepts applicable to
internal reporting
 The objectives of management accounting are the first
and essential steps to understand and interpret
management accounting techniques. The management
accounting concepts become true because they are
based on accepted objectives. In spite of the importance
of management accounting objectives, there has never
been a formal attempt to accomplish this task.
AAA committee 1972:
 Related to the planning functions of the managers.
 Related to organizational problem areas.
 Related to management control functions.
 Related to operating systems management by function,
product, project or other segmentation of operations.
 More specifically the true objectives are defined as providing information and
participating in the management process.
Qualitative Characteristics of Management
Accounting Information
 Management accounting information should have
certain desirable properties so that benefits are
achievable. In 1974 AAA Committee on Concepts and
Standards—Internal Planning and Control offered
certain closely related properties as representatives of
the benefits of information or information systems:
 1. Relevance/mutuality of objectives
 2. Accuracy/precision/reliability
 3. Consistency/comparability/uniformity
 4. Verifiability/objectivity/neutrality/traceability
 5. Aggregation
 6. Flexibility/adaptability
 7. Timeliness
 8. Understandability/acceptability/motivation/fairness
Management accounting concepts
 Management accounting concepts based on
both the objectives and qualitative
characteristics of management accounting
process. In 1972, AAA identified measurement,
communication, information, system, planning,
feedback, control, and cost behavior as some of
the management accounting concepts “which
represent a necessary, if not minimum,
foundation for the body of knowledge contained
within the structure.”
measurement has been defined as “an assignment of
numerals to an entity’s past, present, or future economic
phenomena, on the basis of past or present observation
and according to rules.” This concept is very essential to
management accounting.
communication encompasses “the procedures by
means of which one mechanism affects another
mechanism.”
 Information represents significant data upon
which action is based. It refers to those data
that reduce the uncertainty on the part of the
user. Thus, data produced by management
accounting should be evaluated in terms of
their informational content. Although not
exhaustive, management accounting
information includes the following categories:
 financial information resulting from the flow of
financial resources within the organization,
 production information resulting from the physical
flow of resources within the organization,
 personnel information resulting from the flow of
people within the organization, and
 marketing information resulting from the interaction
with the market for the organization’s products.
System refers to an entity consisting of two or more
interacting components or sub- systems intended to
achieve a goal. Management accounting is generally
a subsystem of the accounting information system,
which is itself a subsystem of the total management
information system within the organization. A
management accounting system may be defined as
the set of human and capital resources within an
organization that is responsible for the production and
dissemination of information deemed relevant for
internal decision making.
Planning refers to the management function of setting
objectives, establishing policies, and choosing means of
accomplishment. Planning may be practiced at
different levels in the organization, from strategic to
operational, and may have behavioral implications.
Feedback refers to the output of a process that returns
to become an input to the process in order to initiate
control. It is basically a revision of the planning process
to accommodate new environmental events.
Control refers to monitoring and evaluation of
performance to determine the degree of conformance
of actions to plans. Ideally, planning precedes control,
which is followed by a feedback corrective action or a
feed-forward preventive action.
Cost behavior cost results from the use of an asset for
the generation of revenues. The identification,
classification, and estimation of costs are essential to
any evaluation of courses of action.
DECISIONAL DIMENSIONS
 Anthony Framework - The decision systems are
categorized as strategic planning, management
control, and operational control.
 Simon Framework - Simon’s framework focuses on
the question of problem solving by individuals
regardless of their position within an organization.
Simon maintains that all problem solving can be
broken down into three distinct phases: intelligence,
design, and choice. Simon’s framework also makes
the distinction between programmed and nonprogrammed decisions
 Gorry–Scott Morton Framework - The Gorry–Scott Morton
framework provides a combination of both Anthony and
Simon’s frameworks in the form of a matrix that classifies
decisions on both a structured-to-unstructured
dimension and an operational-to-strategic dimension.
This implies that the design of a management
accounting support system is flexible enough to cope
with the various complex demands.
 Forrester Framework - As developed by Professor Jay
Forrester, the essence of industrial dynamics is that social
systems such as business organizations can be
understood through nonlinear feedback systems
concepts.
 Decisions are made at multiple points throughout the
system. Each resulting action generates information that
can be used at several but not all decision points. This
structure of cascaded and interconnected informationfeedback loops, when taken together, describes the
industrial system. Forrester viewed management in terms
of the sequence information-decision-action, with the
decision-making process as a response to the gap
between the objectives of the organization and its actual
progress toward the accomplishment of these objectives.
Thus, industrial dynamics views organizations from a
control perspective. It is intended mostly as a method of
designing organizational policies. Nevertheless, industrial
dynamics is a useful framework for management
accounting in several ways:
 1. It places information as an explicit and integral part of
organizational decision making.
 2. The information’s function is to represent the physical
values of the levels of various activities and entities in the
organization.
 3. It emphasizes the identification of decision points,
objectives, and information requirements
 Dearden Framework - John Dearden observes
that the concept of a single information system
is “too large and all-encompassing to be a
meaningful and useful classification.” He
suggests to break down the systems and dataprocessing activities both horizontally and
vertically. Horizontally, systems activities can be
classified by the type of work performed;
vertically, systems activities can be classified by
the kind of information handled. The horizontal
classification includes three stages: systems
specification, data processing implementation,
and programming. The vertical classification is
based on the presence of three major
information systems include financial, personnel,
and logistics.
THE BEHAVIORAL DIMENSION
 Management accounting is built on behavioral
foundations. Its explicit aim is to affect the
behavior of individuals in a desirable direction.
To accomplish this purpose, management
accounting has to be adapted to the different
characteristics that shape the “cognitive
makeup” of individuals within an organization
and affect their performance. In general, these
characteristics pertain to three factors: (1) the
perception by the individual of what should be
the objective function or goals in the firm; (2)
the various factors likely to motivate the
individual to perform; and (3) the decisionmaking model most relevant to particular
contexts and most preferred by the individual.
 Thus, management accounting requires a good grasp of the
behavioral concepts, namely, the objective function in
management accounting, motivation theories, and models of
decision making. Each of these concepts identifies factors and
situations that influence individual behavior and indicates avenues
for management accounting to adapt its services.
 The Shareholder Wealth Maximization Model - In a
management accounting context, SWM implies an
acceptance by management of budgeting and control
standards, a rejection of slack budgeting or any sub
optimizing behavior, and an adoption of management
accounting techniques that are in the best interests of
the owners of the firm.
 The Managerial Welfare Maximization Model –
management may be tempted for personal benefits
to pursue an objective other than shareholder
welfare maximization. So rather than maximizing
profits, the managers may maximize sales or assets,
the rate of growth, or managerial utility. As a
consequence, managers may engage in sub
optimization schemes as long as they contribute to
their own welfare. In a management accounting
context, MWM implies a lesser acceptance by
management of budgeting and control standards,
a recourse to slack budgeting and any sub
optimization behavior, a manipulation or avoidance
within legality of full disclosure in order to present the
firm’s operation favorably and, finally, adoption of
management accounting techniques that are in the
best interest of managers
 The Social Welfare Maximization Model - Under
SOWM, the firm undertakes all projects that, in
addition to the usual profitability objective, minimize
the social costs and maximize social benefits
created by the productive operations of the firm.
Thus, under SOWM the firm is liable not only to the
shareholders and managers, but also to the society
at large. In adopting a more socially responsible
attitude and responding to the pressures of new
dimensions—social, human, and environmental—
organizations may have to alter their main objective
to include as an additional constraint the welfare of
society at large.
In a management accounting context, SOWM implies
the developing of a social reporting system oriented
toward the measurement of social performance,
including not only social costs but also social benefits.
It suggests the development of a new concept of
organization performance that will be more indicative
of the firm’s social responsibility than is provided by
conventional accounting.
 Motivation Theories
 Need Theory
 Two-Factor Theory
 Value/Expectancy Theory
 Achievement Theory
 Equity Theory
 Models of Decision Making - The identification of
the decision-making models most relevant to
particular contexts and most preferred by particular
individuals allows the management accountant to
adapt the services to offer to the realities of the
decision situation. The literature on decision making
identifies five main perspectives: the “rational”
manager view, the “satisficing” process-oriented
view, the organizational proceedures view, the
political view, and the individual differences view.
THE STRATEGIC DIMENSION
 Management accounting is built on strategic foundations.
First, management accounting provides a framework and
a language of discourse for the three stages of strategy:
preenactment, resolution, and implementation. Second,
the conduct of management accounting differs for
different distinctions in the strategic decision-making
process. Third, it works best when there is a consequence
between the decision of management control systems and
types of control strategies. Finally, the new area of strategic
management accounting requires management
accounting to its competitors and to monitor the firm’s
performance using strategic rather than tactical indicators.
 Accounting plays a role in the three stages of
strategic change: preenactment, resolution, and
implementation. Accounting provides “a framework
for a language of discourse [and] the power to
establish and maintain the credibility of issue
allocations through its authority structures,
accountability measures, and performance
evaluations.” Basically, strategies need to be
framed in an accounting language and supported
by the authority of accounting techniques,
indicators, and reports.
 Strategic accounting will supplant managerial
accounting as a decisional framework because
managerial accounting lacks strategic relevance. While
cost analysis provides an assessment of the financial
impact of managerial decision alternatives, strategic
cost analysis will provide cost data for the development
of the right strategy necessary to gain competitive
advantage.
THE ORGANIZATIONAL DIMENSION
 Organizational Structure - Management accounting
rests not only on accounting but also on
organizational foundations. It is this form of
organizational structure that management often
seeks to change to improve the organization’s
functioning. In turn, elements of the organizational
structure may affect cost accounting—its
techniques, approaches, and role in the firm. The
strongest influences on cost accounting are the
organizational chart, the line and staff relationships,
and the role of the controller in the organization.