Management Accounting:
A Road of Discovery
Management Accounting:
A Road of Discovery
James T. Mackey
Michael F. Thomas
Presentations by:
Roderick S. Barclay
Texas A&M University - Commerce
James T. Mackey
California State University - Sacramento
© 2000 South-Western College Publishing
Chapter 2
How do companies create
value?
Why we can’t use financial
accounting to manage the
firm
Key Learning Objectives
• Define economic value and
explain the factors that
influence it..
• Demonstrate how value chains,
product differentiation, and cost
management are used to create
value..
• Explain why financial
accounting does not report
economic value.
• Give examples of the three
manufacturing inventories.
• Describe the three traditional
manufacturing resources and
prepare a cost of goods
manufactured schedule.
• List the six steps in strategic
planning and discuss the role of
management accounting in this
process.
How Do Companies Create Value?
The objective of good management is to
maintain and create value!!
Street Talk: Know your business!
Why we can’t use financial accounting
alone to manage the firm.
What is Economic Value?

Making money now and in the future


Financial Accounting Data = past cash
transactions + current cash transactions
Economic Value = current cash transactions
+ future cashflows
Factors That Influence Value

Value is influenced by

Which Means

Risk


Effort


Time


Opportunities

The likelihood of
receiving cash
How easy or hard it is to
collect the cash
How long it takes to
collect the cash
Other investments we
can make instead of this
one
Businesses are Money-Making Machines
Dollars-to-Dollars Cycle:
Buy resources
Make
products
Collect cash
Sell products
How do We Create Value?

Manage Activities


Buy something then do something with it
and sell it for more than it costs!
Value chains — see Exhibit 2-3




A series of value adding activities
The activities spanned define a company
Activities from cradle to grave define an
industry
We must position ourselves on the
industry value chain
The Home Building Industry’s Value Chain
Cultivate forests
Buy land
Harvest trees
Saw lumber
Zone and subdivide land
Install underground utilities
Clear and grade land
Build roads, curbs, sidewalks, etc.
Purchase and deliver other materials and equipment
Build houses
Sell houses
Deliver lumber
Contract labor
Provide customer and
warranty service
Creating Value through Product
Differentiation and Image
Brand Name Image
Band Aid
Xerox
Ben & Jerry’s Ice Cream
Coca-Cola
Customer Service
Federal Express
Sears Roebuck & Co.
State Farm Insurance
Hilton Hotels
Product Features
Cadillac
Burger King
Canon
Boeing
Technological leadership
IBM
Hewlett Packard
Maytag
Intel
Multree Homes Value Chain
1.
2.
3.
Customer order-taking
1.1 Sales
1.2 Credit check
Materials acquisition (inbound logistics)
2.1 Scheduling
2.2 Purchasing
2.3 Receiving, inspecting, and storage
2.4 Deliver to factory
Manufacturing
3.1 Lumber sawing
3.2 Wall assembly
3.3 Rough wiring
3.4 Rough plumbing
Continued
3.
4.
Manufacturing (Continued)
3.5 Wall finishing
3.6 Roof construction
3.7 Finish carpentry
3.8 Top-off plumbing
3.9 Finish electric
3.10 Carpeting
3.11 Inspection
Shipping (outbound logistics)
4.1 Packing
4.2 Shipping
4.3 Set up at retail dealer, customer lot
Continued
5.
6.

Close sales
5.1 Customer walk-through and inspection
5.2 Bill customer
5.3 Collect and deposit cash
After customer services
6.1 Provide warranty work
6.2 Survey customer satisfaction
6.3 New product and service advertising
We increase value by increasing value to
the customer by more than it costs us!
Creating Value Through Cost Management
of Processes

Another way to increase value is by reducing costs.
Processes are sets of activities needed to provide
goods or services.
The objective is to minimize the cost of each process

Economic Value and the Service Sector


Will All Companies Become Service
Companies?
Financial Accounting Does Not Measure
Economic Value

Historical Costs: Look Backwards






They do not measure all the things that determine
economic value, I.e. future cashflows.
Financial accounting measures the past not future value.
Financial accounting requires arm’s length transactions.
Financial reports must be audited to have wide acceptance.
Hard (verifiable, countable) data is necessary.
What does financial accounting information
tell us about value?

Unless we can exactly predict the future, nothing. Past
accounting (statistical) information does not predict the
future. It can only be used to estimate trends and
likelihood.
Balance Sheet Information



Assets = Liabilities + Assets
Assets — Resources we Have
Current Assets




Cash
Promises for Cash (Accounts Receivable)
The cost of merchandise we own (Inventory)
Long Term Assets

The cost of resources we own that will provide
economic benefits in the future
Balance Sheet Information (Continued)


Liabilities — How much we owe outsiders
Current Liabilities


Long-Term Liabilities



How much we owe in the future (after this year)
Equity — How much we owe investors
Contributed Capital


How much we owe now (accounts payable)
How much the owners invested in the business
Retained Earnings

How much we have left from previous earnings
Income Statement Information




Revenue — Sales of products or services
Cost of Sales — Cost of products or services sold to
generate revenue
Gross Profit — Profit from basic activity
Expenses




Net profit from operations


Sales function costs
General and administrative costs
Financing costs
Income taxes
Net Profit — Profit from operating the business
Different Businesses Function Differently

Service Businesses


Merchandise Businesses


Have no inventories. Value is added from services
provided.
Hold inventories for sale. The add value by
purchasing products and reselling them to
customers.
Manufacturing Businesses

Hold inventories of raw materials, work in process,
and finished goods. They add value by converting
raw materials (or purchased parts and materials)
into products desired by customers (or other
businesses).
Manufacturing Cost of Goods Sold

Traditional Resource Categories



Direct Materials
Direct Labor
Manufacturing Overhead (Indirect)



Indirect Materials
Indirect Labor
Manufacturing Overhead
The Relationship Between Accounting and
Economic Value





The accounting system measures the results of past
transactions.
Economic value measures the economic value of the
company now and in the future.
Information is the key to understanding economic
value.
Financial measures relate to economic value.
Managers must understand what causes economic
value to increase and how the financial accounting
measures help provide the necessary information.
Strategic Planning to Create Value






Create a vision or mission statement.
Identify relevant objectives.
Translate our objectives into measurable
goals.
Analyze our environments to facilitate
accomplishing our goals.
Determine how to accomplish our goals.
Develop appropriate and relevant
performance measures.
Management Accounting’s Role in
Strategic Planning



The management accountant needs to be a
‘process controller’.
The management accounting system should
provide information for the strategic
planning process.
The management accountant needs to be
‘the copy on the block’ to develop and
enforce performance measures.