Ebook Diploma in business management: Managerial accounting - Part 1

Business Management
Study Manuals

Diploma in
Business Management

MANAGERIAL
ACCOUNTING

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Diploma in Business Management

MANAGERIAL ACCOUNTING
Contents

Unit

Title

Page

1

Management Accounting and Information
Introduction
Management Accounting
Information
Collection and Measurement of Information
Information for Strategic, Operational and Management Control
Information for Decision Making

1
2
2
4
6
11
14

2

Cost Categorisation and Classification
Introduction
Accounting Concepts and Classifications
Categorising Cost to Aid Decision Making and Control

Management Responsibility Levels
Cost Units
Cost Codes
Patterns of Cost Behaviour
Influences on Activity Levels
Numerical Example of Cost Behaviour

17
19
20
23
32
33
34
35
39
39

3

Direct and Indirect Costs
Introduction
Material Costs
Labour Costs
Decision Making and Direct Costs
Overhead and Overhead C

41
42
42

45
50
51

4

Absorption Costing
Introduction
Definition and Mechanics of Absorption Costing
Cost Allocation
Cost Apportionment
Overhead Absorption
Under and Over Absorption of Overheads
Treatment of Administration and Selling and Distribution Overhead
Uses of Absorption Costing

53
54
54
55
56
60
65
67
69

5

Marginal Costing
Introduction

Definitions of Marginal Costing and Contribution
Marginal Versus Absorption Costing
Limitation of Absorption Costing
Application of Marginal and Absorption Costing

75
76
76
79
82
85


Unit

Title

Page

6

Activity-Based and Other Modern Costing Methods
Introduction
Activity-Based Costing (ABC)
Just-in-Time (JIT) Manufacturing

99
100
100
114

7

Product Costing
Introduction
Costing Techniques and Costing Methods
Job Costing
Batch Costing
Contract Costing
Process Costing
Treatment of Process Losses
Work-In-Progress Valuation
Joint Products and By-Products
Other Process Costing Considerations

119
121
121
122
126
127
129
132
135
138
142

8

Cost-Volume-Profit Analysis

Introduction
The Concept of Break-Even Analysis
Break-Even Charts (Cost-Volume-Profit Charts)
The Profit/Volume Graph (or Profit Graph)
Sensitivity Analysis

143
144
144
149
157
160

9

Planning and Decision Making
Introduction
The Principles of Decision Making
Decision-Making Criteria
Costing and Decision Making

167
168
168
173
175

10

Pricing Policies

Introduction
Fixing the Price
Pricing Decisions
Practical Pricing Strategies
Further Aspects of Pricing Policy

183
184
184
184
187
195

11

Budgetary Control
Introduction
Definitions and Principles
The Budgetary Process
Budgetary Procedure
Changes to the Budget
Flexible Budgets
Budgeting With Uncertainty
Budget Problems and Methods to Overcome Them

199
201
201
205
210

221
222
226
229


Unit

Title

Page

12

Standard Costing
Introduction
Principles of Standard Costing
Setting Standards
The Standard Hour
Measures of Capacity

235
236
236
238
245
246

13

Standard Costing Basic Variance Analysis
Introduction
Purpose of Variance Analysis
Types of Variance
Investigation of Variances
Variance Interpretation
Interdependence between Variances

249
250
250
253
257
263
264

14

Management of Working Capital
Principles of Working Capital
Management of Working Capital Components
Dangers of Overtrading
Preparation of Cash Budgets
Cash Operating Cycle
Practical Examples

267
268
269
272

272
273
276

15

Capital Investment Appraisal
Introduction – The Investment Decision
Payback Method
Return on Investment Method
Introduction to Discounted Cash Flow Methods
The Two Basic DCF Methods
Appendix: Present Values Tables

281
282
283
284
285
288
296

16

Presentation of Management Information
Introduction
Information for Management – General Principles
Using Diagrams and Charts
Using Ratios

301
302
302
306
310



1

Study Unit 1
Management Accounting and Information
Contents

Page

Introduction

2

A.

Management Accounting
Some Introductory Definitions
Objectives of Management Accounting
Setting Up a Management Accounting System
The Effect of Management Style and Structure

2
2

3
4
4

B.

Information
Information and Data
Users of Information
Characteristics of Useful Information

4
4
5
5

C.

Collection and Measurement of Information
Sources of Information
Relevancy
Measuring Information
Communicating Information
Value of Information
Quantitative and Qualitative Information
Accuracy of Information
Financial and Non-Financial Information

6
6

7
7
8
9
10
10
10

D.

Information for Strategic, Operational and Management Control
Elements of Control
Feedback
Control Information

11
11
12
12

E.

Information for Decision Making

14

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INTRODUCTION
We begin our study of this module with some definitions which will make clear what
managerial or management accounting is, what it involves and what its objectives are.
A number of factors must be considered when setting up a management accounting system
and the management style and structure of an organisation will affect the system which it
creates.
Information is an important part of any such system and the study unit will go on to examine
its various types and sources.

A. MANAGEMENT ACCOUNTING
Some Introductory Definitions
The Chartered Institute of Management Accountants (CIMA) in its Official Terminology
describes accounts as follows:


The classification and recording of actual transactions in monetary terms, and



The presentation and interpretation of these transactions in order to assess
performance over a period and the financial position at a given date.

The American Accounting Association (AAA) supplies a slightly more succinct definition of
accounting:
"....the process of identifying, measuring and communicating economic

information to permit informed judgements and decisions by users of
information."
Another way of saying this is that accounting provides information for managers to help
them make good decisions.
Cost accounting is referred to in the CIMA Terminology as:
"That part of management accounting which establishes budgets and standard
costs and actual costs of operations, processes, departments or products and
the analysis of variances, profitability or social use of funds. The use of the term
costing is not recommended."
Management accounting is defined as:
"The provision of information required by management for such purposes as:
(1)

formulation of policies;

(2)

planning and controlling the activities of the enterprise;

(3)

decision taking on alternative courses of action;

(4)

disclosure to those external to the entity (shareholders and others);

(5)

disclosure to employees;

(6)

safeguarding assets.

The above involves participation in management to ensure that there is effective:
(a)

formulation of plans to meet objectives (long-term planning);

(b)

formulation of short-term operation plans (budgeting/profit planning);

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(c) recording of actual transactions (financial accounting and cost
accounting);
(d) corrective action to bring future actual transactions into line (financial
control);
(e)

obtaining and controlling finance (treasurership);

(f)

reviewing and reporting on systems and operations (internal audit,
management audit)."

Financial accounting is referred to as:
"That part of accounting which covers the classification and recording of actual
transactions of an entity in monetary terms in accordance with established
concepts, principles, accounting standards and legal requirements and presents
as accurate a view as possible of the effect of those transactions over a period
of time and at the end of that time."
All three branches of accounting should be integrated into the company's reporting system.


Financial accounting maintains a record of each transaction and helps control the
company's assets and liabilities such as plant, equipment, stock, debtors and
creditors. It satisfies the legal and taxation requirements and also provides a direct
input into the costing systems.



Cost accounting analyses the financial data into more detail and provides a lot of the
information used for control. It also provides key data such as stock valuations and
cost of sales which are fed back into the financial accounting system so that accounts
can be finalised.



Management accounting draws from the financial and cost accounting systems. It

uses all available information in order to advise management on matters such as cost
control, pricing, investment decisions and planning.

Users of financial accounting are usually external – shareholders, the tax authorities etc.
Management Accounting users are internal – the managers at different levels.

Objectives of Management Accounting
(a)

Planning: all organisations should plan ahead in order that they can set objectives
and decide how they should meet them. Planning can be short- or long-term and it is
the role of the management accounting system to provide the information for what to
sell, where and at what price. Management accounting is also central to the
budgetary process which we shall look at in more detail later.

(b)

Control: production of the company's internal accounts, its management accounts,
enables the firm to concentrate on achieving its objectives by identifying which areas
are performing and which are not. The use of management by exception reports
enables control to be exercised where it is most useful.

(c)

Organisation: there is a direct relationship between the organisational structure and
the management accounting system. It is often difficult to determine which has the
greater effect on the other, but it is necessary that the management accounting
system should produce the right information at the right cost at the right time, and the
organisational structure should be such that immediate use is made of it.

(d)

Communication: the existence of a budgetary and management accounting system
is an important part of the communication process; plans are outlined to managers so
that they are fully aware of what is required of them and the management accounts tell
them whether or not the desired results are being achieved.

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(e)

Motivation: more will be said about the motivational aspects of budgeting later, but
suffice to say here that the targets included in any system should be set at such a
level that managers and the people who work for them are motivated to achieve them.

(f)

Decision Making: all businesses have to make decisions, may of which are short
term like whether a component should be made or bought from an outside supplier,
pricing and eliminating loss making activities.

Setting Up a Management Accounting System
There are several factors which should be borne in mind when a system is being set up:



What information is required?



Who requires it?



How often is it required?

Further thought will need to be given to such matters as:


What data is required to produce the information?



What are the sources of this data?



How should it be converted?



How often should it be converted?

Finally, factors such as organisational structure, management style, cost and accuracy (and

the trade-off between them) should also be taken into account.

The Effect of Management Style and Structure
Theories of management style range from the autocratic at one end of the spectrum to the
democratic at the other. Which style a particular organisation uses very much affects the
management accounts system. With a democratic style for instance, it is likely that decision
making is devolved further down the management structure and information provided will
need to reflect this. An autocratic style, by contrast, means that decision making is
exercised at a higher level and therefore the necessary information to enable the function to
be carried out will similarly be provided at this level also.
In addition, the management structure will also have an impact, a flat management structure
will mean that a particular manager will need to be provided with a greater range of reports
(e.g. on sales, marketing, production matters, etc.) than in a company with a functional
structure where reports are only required by a manager for his or her own function, such as
sales.
Note that management structure is much more formalised than management style; it is
possible for instance to have both democratic and autocratic managers within a particular
management structure.

B. INFORMATION
Information and Data
You need to read the following as background information to inform your study. This section
is not Management Accounting as such, but will give you a context for it's study.
Information can be distinguished from data in that the latter can be looked upon as facts and
figures which do not add to the ability to solve a problem or make a decision, whilst the
former adds to knowledge. If, for instance, a memo appears on a manager's desk with the
figure "10,000" written on it, this is most certainly data but it is hardly information.

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Information has to be more specific. If the memo had said "sales increased this month by
10,000 units" then this is information as it adds to the manager's knowledge. The way in
which data or information is provided is also affected by the Management Information
System (MIS) which is in use. Taking our example in a slightly different context, the figure of
10,000 may be input to the system as an item of data which, at some stage, will be
converted and detailed in a report giving the information that sales have increased by
10,000 units.

Users of Information
The Corporate Report of 1975 set out to identify the objectives of financial statements and
identified the user groups which it considered were legitimate users of them. The following
list is important in that once we define whom a report is for, it can be tailored specifically to
their needs.
Users of information and the uses to which that information can be applied are as follows:


Managers – to help in decision making.



Shareholders and investors – to analyse the past and potential performance of an
enterprise and to assess the likely return on investments.



Employees – to assess the likely wage rate and the possibility of redundancy and to
look at promotion prospects.



Creditors – to assess whether the enterprise can meet its obligations.



Government – the Office for National Statistics collects a range of accounting
information to help government in its formulation of policy.



HM Revenue and Customs – to assess taxation.

Non-profit-making (or not-for-profit) organisations also need accounting information. For
example, a squash club has to establish its costs in order to fix its subscription level. A local
authority needs accounting information in order to make decisions about future expenditure
and to fix the level of contribution by local residents via the Council Tax. Churches need to
keep records of accounting information to satisfy the local diocese and to show parishioners
how the church's money has been spent.

Characteristics of Useful Information
There are certain characteristics which relate to information:
(a)

Purpose – if information does not have a purpose then it is useless and there is no

point in it being produced. To be useful for its purpose it should enable the recipient to
do his or her job adequately. The ability of information to achieve its purpose depends
on the following:


The level of confidence that the recipient has in the information.



The clarity of the information.



Completeness.



How accurate it is.



How clear it is to the user.

(b)

The recipients of the information must be clearly identified; for information to be useful
it is necessary to know who needs it.

(c)

Timeliness – information must be communicated when it is required. A monthly report
which details a problem must be produced as quickly as possible in order that

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corrective action can be taken. If it takes a month to produce then this may be too
long a time-scale for it to be useful.
(d)

Channel of communication – information should be transmitted through the
appropriate channel; this could be in the form of a written report, graphs, informal
decisions, etc.

(e)

Cost – as data and information cost money to produce, it is necessary that their value
outweighs their costs.

To summarise, having looked at the general qualities of information, the characteristics of
good information are:


It should be relevant for its purpose.



It should be complete for its purpose.



It should be sufficiently accurate for its purpose.



It should be understandable to the user.



The user should have confidence in it.



The volume should not be excessive.



It should be timely.



It should be communicated through the appropriate channels of communication.



It should be provided at a cost which is less than its value.

C. COLLECTION AND MEASUREMENT OF INFORMATION
Sources of Information
The information used in decision making is usually data at source and has to be processed
to become information. The main sources of information can be categorised as internal or
external.
(a)

Internal
The main sources and types of internal information, and the systems from which such
information derives, are summarised in the following table.
Source

System

Information

Sales invoices

Sales ledger

Total sales
Debtor levels
Aged debtors
Sales analysis by category

Purchase
orders/Invoices

Purchase ledger

Creditor levels
Aged creditors
Total purchases by category

Wage slips

Wages and salaries Total wages and salaries
Salaries by individual/department
Employee analysis (i.e. total
number, number by department)

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(b)

7

External
There is a wealth of information available outside of the organisation and the following
table provides just a few examples:
Source

Information

Market research

Customer analysis, competitor analysis, product
information, market information.

Business statistics

Exchange rates, interest rates, productivity statistics,
social statistics (i.e. population projections, family
expenditure surveys, etc.), price indices, wage levels
and labour statistics.

Government

Legislation covering all aspects of corporate
governance such as insider dealing, health and safety
requirements, etc.

Specialist publications

Economic data, foreign market information.

Some of the above overlap and there are certainly many more sources of information that
you may be able to think of, both internal and external. The uses that the information can
be put to are greater than the sources and will depend on whom the information is for. The
sales department, for instance, may wish to have details of a customer in order to market a
new product to them, whilst the credit control department may wish to have information
which may lead them to decide that no more credit should be given to the customer.

Again, a few moments' reflection should provide you with many more examples of the uses
to which information can be put and the potential conflicts that can arise.

Relevancy
For information to be useful it has to be relevant and an accounting system is designed to
be a filter similar to the brain, providing only relevant information to management. Obviously
the system must be designed to comply with the wishes or needs of management.
Consider a manager who has to decide on a course of action in a situation where he plans
to purchase a machine, and has an operating team which can perform two distinct functions
with the machine. It would be irrelevant for him to consider the cost of the machine in his
decision-making process as, irrespective of which course of action he decides upon the cost
of the machine remains the same.
Relevance is thus at the heart of any accounting or management information system. The
accountant must be familiar with the needs of the enterprise, since if information has no
relevance it has no value.
The inclusion of non-relevant data should be avoided wherever possible, since its inclusion
may increase the complexity of the decision-making process and potentially lead to the
wrong decision being taken.

Measuring Information
Accountants are used to expressing information in the form of quantified data.
Accountants are not unique in this approach; in the world of sport we record the
performance of an athlete in the time he takes to run a certain distance, or how far he
throws the javelin, or how high he jumps. Even in gymnastics the performance of the
gymnast is reduced to numbers by the judges.

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Not all decisions can be reduced to numbers and although accounting information is usually
expressed in monetary terms, a management accountant must be prepared to provide
accounting information in non-monetary terms.
If management decides that it wishes to adopt a policy to improve employee morale and to
foster employee loyalty in order to achieve a lower labour turnover rate, the benefit in lower
training costs may be expressed in monetary terms, but the morale and loyalty cannot be
directly measured in such terms. Other quantitative and qualitative measures will be
needed to evaluate alternative courses of action.
In order to measure information the unit of measurement should remain stable, but this is
not always possible. Inflation and deflation affect the value of a monetary measure and we
shall discuss how we can allow for such changes when we consider ratios in a later study
unit.
Finally, when considering measurement within an information system we must always be
aware of the cost of such a system. The value of measuring information must be greater
than the costs involved in setting-up the system.
Figure 1.1 illustrates the point that above a certain level of information the cost of providing
it rises out of all proportion to the value.

Figure 1.1

Communicating Information
A communication system must have the following elements:


transmitting device



communication channel



receiving device.

These elements are required in order to communicate information from its source to the
person who will take action on this information. We can illustrate the process
diagrammatically as follows:

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SOURCE OF
INFORMATION

TRANSMITTER

Communication
Channel

RECEIVER

9

ACTION
TAKEN

NOISE

Figure 1.2
So let us look at the various elements in the communication system as they apply to an
accounting or management information system. We have already considered the sources
of information.
The accountant is the transmitter and he or she prepares an accounting statement to cover
the economic event. The accounting statement is the communication channel and the
manager is the receiver. The manager then interprets or decodes the accounting
statement and either directly or through a subordinate action is taken.
In a perfect system this should ensure that accountancy information has a significant
influence on the actions of management. However, noise can, by its nature, render a
system imperfect.
Noise is the term used for interference which causes the message to become distorted. In
accounting terms this can be the transposition of figures or the loss of a digit in
transmission. The minimisation of noise in an accounting system can be achieved by
building in self-checking devices and other checks for errors.
Noise can also result from information overload, where the quantity of information is so
great that important items of information are overlooked or misinterpreted. Remember the
importance of relevance: too much irrelevant information will lead to information overload
and the failure of the receiver to identify essential information.
We must also consider the human factor in information. We shall mention this in a later
study unit, but for now it is important for you to note that the human factor can affect how
managers use or fail to use accounting information.

Value of Information
Any accounting system should operate in such a way that it provides the right information to
the right people in the right quantity at the right time.
We have already discussed the cost of providing information and the fact that the value of
the information should exceed the cost of providing it.
Consider the situation where a company is offered an order to the value of £500,000. The
customer would not be adversely affected if the company declined the order so there is no
knock-on effect whether the order is accepted or rejected. The cost of producing the order
is estimated to be either £375,000 or £525,000.
The weighted average cost of production is thus:
£375,000  £525,000
 £450,000
2

giving an expected profit of £50,000.

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If we assume that there is a 50% chance that costs will be £375,000, leading to a profit of
£125,000, and a 50% chance that costs will be £525,000 in which case the order would be
rejected and no profit and no loss would be made, the expected value of possible outcomes
is:
£125,000  0

 £62,500
2

In order to make a decision it would be necessary to obtain further information. Using the
above two profit figures of £50,000 and £62,500 we can establish that the gross value of
information is £12,500 (£62,500 – £50,000). The company could thus spend up to £12,500
on obtaining additional information. If the information needed only cost £10,000 then the net
value of information would be £2,500.
In this example we have assumed that the information that could be obtained was perfect
information. Information that is less than perfect (this applies to most information!) is called
imperfect information. To be perfect information in this case, the information would have to
be such that the cost of production would be known with certainty.

Quantitative and Qualitative Information
Quantitative information can be most simply described as being numerically based, whereas
qualitative information is more likely to be based on subjective judgements. Thus if the
manager concerned with a particular project is told that the potential cost of a contract will
be either £375,000 or £500,000, then this is quantitative information. As we have seen, it is
usually necessary to obtain further information before a proper decision can be made and
this may take the form of qualitative data which will vary according to circumstances. Thus,
the ability of a supplier to meet deadlines and provide materials of a sufficient quality is all
qualitative information.

Accuracy of Information
The level of accuracy inherent in reported information determines the level of confidence
placed in that information by the recipient of it; the more accurate it is the more it will be
trusted.
Accuracy is one of the key features of useful information, for without it incorrect decisions
could easily be made. Returning to our earlier example, if the potential costs of the project
under consideration are assessed at either £275,000 or £375,000, then the average cost

would be £325,000 and the expected profit (£500,000 – £325,000) £175,000. Thus as both
extremes produce a profit, it is unlikely that additional information would be requested which
would have shown that the costs were inaccurate.
There is often, however, a trade-off between getting information 100% correct and receiving
it in time for a decision to be made. In this instance it is usual for an element of accuracy to
be sacrificed in the interests of speed.
The concept of accuracy and related areas such as volume changes and how uncertainty in
relation to accuracy is overcome will be discussed in more detail when we consider
budgeting and variable analysis.

Financial and Non-Financial Information
The most usual way for reporting to be undertaken is through the use of financial
information in terms of turnover, profit, ratio analysis, etc. Another way of defining this would
be to say that performance is cost based and the department being assessed is therefore a
cost centre (which will be more fully defined later). In certain circumstances, however, i.e.
where costs cannot be allocated to a department, then non-financial performance measures
must be considered instead. Non-financial indicators will be described in detail in a later

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study unit, but for now one or two examples should help. For a maintenance department,
these indicators might include:
Actual service time

; or
Total time available

(a)

production time, i.e.

(b)

ratio of planned to emergency (or unplanned) services in terms of time.

D. INFORMATION FOR STRATEGIC, OPERATIONAL AND
MANAGEMENT CONTROL
Elements of Control
A large proportion of the information produced for and used by management is control
information. By having this information, managers will be aware of what is happening within
the organisation and its environment, and be able to use that information in making future
plans and decisions. Control information provides the means of identifying past mistakes
and preventing their reoccurrence.
The diagrammatic representation of this is as follows:
ACTUAL RESULTS

Feedback
SENSOR
COMPARATOR
Standards
Variances
INVESTIGATOR

EFFECTOR

Figure 1.3: Single Loop Control System
The operation of the model is as follows:
(a)

Results are measured via the sensor.

(b)

These are compared with the original objectives or standards by the comparator.

(c)

The process by which the information is collected and compared is known as feedback
and this will be looked at in more detail shortly.

(d)

Corrective action is identified using variance analysis.

(e)

The corrective action is implemented via the effector.

As an example, suppose the planning department of a local authority has a target of
producing a particular planning report within three weeks from the date of the request. The
fact that it takes on average perhaps four weeks to produce such a report may be picked up

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by the internal audit department or through the provision of standard control information
detailing such items as the length and content of the report. Whichever it is, this will be the
sensor and the process of receiving the information is the feedback.
The comparator compares the actual length of time taken to produce the report against the
required or expected time; in this instance four weeks as opposed to three. The operation
of the comparator could be carried out either internally or external to the department
concerned. In the latter instance the task could again fall to the internal audit department
(assuming one exists of course).
The process of variance analysis would investigate the reasons why the time-scales are not
being met. At the basic level this will be either that the standards are set at such a level that
they cannot be met, or the standards are reasonable and it is the methods of achieving
them that are inefficient.
Assume for the purposes of our current example that it is impossible, due to other
circumstances, to achieve a time-scale of three weeks. In this case it is likely that the
standard would be altered to four weeks.
The next time a planning report is produced, the process would be entered into and if the
revised time-scale was not being met, the reasons why would be investigated and
appropriate action taken.

Feedback
Feedback may be described as being positive or negative. When a system is using a
measured scale it is travelling in any one of three directions at any time, i.e. it is travelling
either:
(a)

straight ahead; or

(b)

in an upwards direction; or

(c)

in a downwards direction.

Positive feedback is the term used when the corrective action needed is to move the
system in the direction it is already travelling in, e.g. when a favourable sales volume
variance occurs it means actual sales volume is higher than that budgeted. One course of
action to exploit this favourable variance is to increase production so that increased sales
can be taken advantage of.
Negative feedback is the term used when the corrective action needed is to move the
system in the opposite direction to that in which it is travelling. For example, when the
maximum level of stock for a particular item is exceeded, the corrective action is to reduce
the stock level for that item by reducing production and/or increasing sales.

Control Information
The dividing line between control and decision making is a narrow one; in essence control is
part of the decision-making process which we shall look at in more detail shortly.
Control information systems are part of an organisation's structure; the structure of most
organisations is a pyramid or hierarchy and therefore the control system operates in the
same form. The diagram of this is as follows:

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STRATEGIC
CONTROL

MANAGEMENT
CONTROL

OPERATIONAL
CONTROL

Figure 1.4: Flow of Control Information
The information flows are:


between the levels, and



within the same level.

Control information can be classified as follows:
(a)

Strategic Control Information

This will be about the whole organisation and its environment. The main source of this
information will be from the organisation's objectives, plans and budgets. It would also
include information on items such as interest and exchange rates, population trends,
economic trends and so on.

(b)

Management Control Information
The information in this category will be about each division or department within the
organisation. It will specifically depend upon the way the organisation is structured
and the type of organisation it is. For instance, in an organisation structured by
function, information will be about each function such as manpower (personnel), sales
(marketing), production and finance for each division.

(c)

Operating Control Information
This will be much more detailed and specialised than the previous two categories. It
usually relates to each operating department within the organisation, e.g. stock
control, credit control, etc.

To illustrate the differences a little more clearly, operating information could be the sales
value for a particular product, management control information the total sales value for the
division concerned and finally the total sales for the company an input to the strategic
planning process.
Large organisations are frequently split into these smaller divisional units. In such
organisations it is essential that the top level of the organisation's control system covers
every division, as it is only through the control system that top management can know what
is happening in the whole organisation.

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Management Accounting and Information

E. INFORMATION FOR DECISION MAKING
As we mentioned earlier, the control and decision-making processes are closely interwoven
– study the following diagram:
Identify Objectives

Look for Various Courses of
Action

PLANNING

Gather Information on
Alternatives

Select Course of Action

Implement the Decision

Compare Actual Results with
Plan
CONTROL
Take Action to Correct

Errors
Figure 1.5: Control and Decision Making
You will see from this that the control element we have studied forms an integral part of the
process. Note also the loop to allow us to make changes and see the effect this has on the
system in order to decide if such changes were the right ones. If, for example, we have a
pair of shoes priced at £30 per pair and we decide to reduce the price to £25 in order to shift
some stock, we can then gather information on the impact of the price change on the sales
volume. If volumes remain fairly static, we may decide to put the price back up or lower it
still further and again measure the effect.
Planning is a long-term strategy and as such is determining the long-term view – the
strategic view. Information must be collected on market size, market growth potential, state
of the economy, etc. The implications of long-term strategic decisions will influence
operating or short-term decisions for years to come and it is sometimes necessary to
consider the operating decisions as part of the planning process. Examples of short-term
decisions are:


level of the selling price of each individual item



level of production



type of advertising

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

delivery period



level of after-sales service.

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Be reminded again that this section gives a background or overview of information in a
general sense. Managerial Accounting deals in specific information and utilises many of the
principles discussed. Your work in Managerial Accounting will explore the detail contained in
the generalisations discussed here.

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Study Unit 2
Cost Categorisation and Classification
Contents

Page

Introduction

19

A.

Accounting Concepts and Classifications
Financial Accounting
Management Accounting

20
20
20

B.

Categorising Cost to Aid Decision Making and Control
Fixed and Variable
Relevant and Common Costs

Opportunity Costs
Controllable and Uncontrollable Costs
Incremental Costs
Other Definitions
A Worked Example of Relevant Costing

23
23
23
24
27
27
28
29

C.

Management Responsibility Levels
Cost Centre
Service Cost Centres
Revenue Centres
Profit Centres
Investment Centres

31
31
31
31
31
32

D.

Cost Units

32

E.

Cost Codes

33

F.

Patterns of Cost Behaviour
Fixed Costs
Variable Costs
Stepped Costs
Semi-Variable Costs
Other Cost Behaviour Patterns

34
34
35
36
36
36
(Continued over)

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G.

Influences on Activity Levels

38

H.

Numerical Example of Cost Behaviour

38

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INTRODUCTION
Accounting is a wide term that covers separate disciplines, all are complimentary, but all are
different and each one has it's own procedures, methods and purposes.
Financial Accounting is the area within accounting concerned with recording events and
transactions, and from these records producing accounting statements, like the profit and
loss account and the balance sheet. The constraints of company law often dictate the style,
layout and content of these statements and, therefore, the methods of recording data need
to bear in mind the end product of a set of accounts that are acceptable to the intended
users.
In simple terms, the phrase "stewardship accounting" can be used to describe this form of
accounting, particularly for limited companies or public limited companies. The directors of
the company need to account for the use they have made of the investors' money.
Shareholders need to know how their money has been deployed and the results of this
deployment.
Financial Accounting is required in all businesses not just those owned by shareholders. All
owners need financial information as do the tax authorities and potential investors. These
are users of accounting information.
An additional discipline is taxation and this is a specific subject for study in most accounting
courses. Many lay people assume that if you are in accounting, you must understand
taxation and work to minimise tax liability. This may be true in some cases, but taxation
accounting is a very specific part of accounting.
A further area is auditing. Accounts need to be verified and seen as being true and fair.
Auditors need to be independent to give validity to the accounting function. This is again a
specialised activity.
Management Accounting is the area within accounting concerned with providing relevant
information to managers to enable them to deal with decision making, planning and
controlling. There are many potential users of accounting information, each with specific
interests and specific reasons for needing accounting information. The law in many cases
provides for their needs by demanding accounts are produced in a certain way. Managers'
needs are different to owners' or shareholders' needs and management accounting needs to

be tailored to the requirements of different businesses of varied sizes, structures and
complexities.
Now that we have had an introduction to management accounts and the importance of
information, we can start to look in more detail at how managerial accounting operates in
practice. This study unit will describe the different ways in which costs can be classified in
order to provide meaningful management information. You should always bear in mind that
the ultimate purpose of any management accounting system is to provide information for
management to make decisions.
In addition to cost classification, we shall look further at how costs behave under differing
conditions – an important thing to understand when making decisions based on the
information to hand – as well as how this information is likely to be presented to you.

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