Management accounting for decision makers fifth edition by peter atrill and eddie mclaney

Management Accounting
for Decision Makers

Fifth Edition

Fifth Edition

‘...friendly, accessible and engaging.
It is easy to read and draws the reader in.’
Ellis Jenkins, University of Glamorgan

Designed to help you study, Management Accounting for Decision Makers is praised for its clear, accessible and
uncluttered style. It provides a comprehensive introduction to the main principles of management accounting, with a
strong practical emphasis avoiding excessive technical detail. It has a clear and unequivocal focus on how accounting
information can be used to improve the quality of decision making by managers, providing the perfect grounding for
the decision makers of the future.

Audience

Features

Suitable for those studying an introductory course in
management accounting, who are seeking an understanding of basic principles and underlying concepts
without detailed technical knowledge.




Numerous activities and exercises enable you
to constantly test your understanding and
reinforce learning.

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Authors



Peter Atrill is a freelance academic and author
working with leading institutions in the UK, Europe
and SE Asia. He was previously Head of Business
and Management at the University of Plymouth
Business School.
Eddie McLaney is Visiting Fellow in Accounting and
Finance at the University of Plymouth.

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Interactive ‘open-learning’ style is ideal
for self study.
Decision-making focus on the use of
accounting information rather than the
preparation is highly appropriate for
business managers.
Full range of topical examples from the service
sector, public sector and manufacturing
industry.
Key terms, glossary and bulleted summaries
are excellent revision aids.

ISBN 0-273-71044-3

Fifth Edition

Management Accounting
for Decision Makers
Peter Atrill
Eddie McLaney

Peter Atrill
Eddie McLaney

Visit the companion website at
www.pearsoned.co.uk/atrillmclaney

Lively and relevant examples from the real
world demonstrate the practical application
and value of concepts and techniques learnt.

Management Accounting for Decision Makers

Peter Atrill Eddie McLaney

9 780273 710448
an imprint of

0273710443_05_COVER.indd 1

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Management Accounting

for Decision Makers
Visit the Management Accounting for Decision Makers,
fifth edition Companion Website with Grade Tracker at
www.pearsoned.co.uk/atrillmclaney to find valuable student
learning material including:
n

n
n

n
n

Self assessment questions with Grade Tracker function to
test your learning and monitor your progress
A study guide to aid self-learning
Revision questions and exercises to help you check your
understanding
Extensive links to valuable resources on the web
Comments on case studies to aid interpretative and
analytical skills


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We work with leading authors to develop the
strongest educational materials in accounting,
bringing cutting-edge thinking and best
learning practice to a global market.
Under a range of well-known imprints, including
Financial Times Prentice Hall, we craft high-quality print and
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5th
Edition

Management Accounting
for Decision Makers
Peter Atrill
and

Eddie McLaney


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Pearson Education Limited
Edinburgh Gate
Harlow
Essex CM20 2JE
England
and Associated Companies throughout the world
Visit us on the World Wide Web at:
www.pearsoned.co.uk

First published 1995 by Prentice Hall Europe
Second edition published 1999 by Prentice Hall Europe
Third edition published 2002 by Pearson Education Limited
Fourth edition published 2005
Fifth edition published 2007
© Prentice Hall Europe 1995, 1999
© Pearson Education Limited 2002, 2007
The rights of Peter Atrill and Edward John McLaney to be identified as authors of this work have
been asserted by them in accordance with the Copyright, Designs and Patents Act 1988.
All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted in any form or by any means, electronic, mechanical,
photocopying, recording or otherwise, without either the prior written permission of the
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Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS.
All trademarks used herein are the property of their respective owners. The use of any
trademark in this text does not vest in the author or publisher any trademark ownership rights
in such trademarks, nor does the use of such trademarks imply any affiliation with or
endorsement of this book by such owners.
ISBN: 978-0-273-71044-8
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging-in-Publication Data
A catalog record for this book is available from the Library of Congress
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Typeset in 9.5/12.5pt Stone Serif by 35
Printed and bound by Mateu Cromo Artes Graficas, Madrid, Spain
The publisher’s policy is to use paper manufactured from sustainable forests.


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Contents

Guided tour of the book
Guided tour of the Companion Website
Preface
How to use this book
Acknowledgements
1

xiv
xvi
xviii
xx
xxii

Introduction to management accounting

1

Introduction
Learning outcomes

1
1

What is the purpose of a business?
How are businesses organised?
How are businesses managed?
1 Establish mission and objectives
2 Undertake a position analysis
3 Identify and assess the strategic options
4 Select strategic options and formulate plans

5 Perform, review and control

2
2
5
6
7
8
8
9

The changing business landscape
Setting financial aims and objectives
Enhancing the owners’ wealth
Balancing risk and return

10
11
11
12

What is management accounting?
How useful is management accounting information?
Providing a service
But . . . is it material?
Weighing up the costs and benefits
Management accounting as an information system
It’s just a phase . . .
What information do managers need?
Reporting non-financial information

Influencing managers’ behaviour
Reaping the benefits of IT
From bean counter to team member
Reasons to be ethical
Management and financial accounting
Not-for-profit organisations

13
14
15
16
16
18
19
20
22
23
24
24
25
26
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CONTENTS

2

3

Summary
Key terms
Further reading
References
Review questions
Exercises

29
31
31
31
32
32

Relevant costs for decision making

34

Introduction
Learning outcomes

34
34

What is meant by ‘cost’?
A definition of cost

35
36

Relevant costs: opportunity and outlay costs
Sunk costs and committed costs
Qualitative factors of decisions
Self-assessment question 2.1

36
40
41
42

Summary
Key terms
Further reading
Review questions
Exercises

44
44
45
46

46

Cost–volume–profit analysis

52

Introduction
Learning outcomes

52
52

The behaviour of costs
Fixed costs
Variable costs
Semi-fixed (semi-variable) costs
Estimating semi-fixed (semi-variable) costs
Finding the break-even point
Contribution
Margin of safety
Operating gearing
Operating gearing and its effect on profit

53
53
55
56
57
58
62

63
66
66

Profit–volume charts
The economist’s view of the break-even chart
Failing to break even
Weaknesses of break-even analysis
Using contribution to make decisions – marginal analysis
Accepting/rejecting special contracts
The most efficient use of scarce resources
Make-or-buy decisions
Closing or continuation decisions

68
68
70
70
72
73
74
76
78

Self-assessment question 3.1

79

Summary
Key terms

80
81


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CONTENTS

4

5

Further reading
Review questions
Exercises

81
82
82

Full costing

87

Introduction
Learning outcomes

87
87

Why do managers need to know the full cost?
What is full costing?
Single-product businesses
Multi-product businesses
Direct and indirect costs
Job costing
Full (absorption) costing and the behaviour of costs
The problem of indirect costs
Job costing: a worked example
Selecting a basis for charging overheads
Segmenting the overheads
Dealing with overheads on a departmental basis
Batch costing
Full (absorption) cost as the break-even price
The forward-looking nature of full (absorption) costing

88
89
89
90
90
92
93

94
95
98
101
102
112
113
113

Self-assessment question 4.1
Using full (absorption)-cost information
Criticisms of full (absorption) costing
Full (absorption) costing versus variable costing
Which method is better?

113
114
116
116
117

Summary
Key terms
Further reading
References
Review questions
Exercises

118
119

120
120
121
121

Costing and pricing in a competitive
environment

126

Introduction
Learning outcomes

126
126

Cost determination in the changed business environment
Costing and pricing products in the traditional way
Costing and pricing products in the new environment
Cost management systems

127
127
127
128

Activity-based costing
An alternative approach to full costing
What drives the costs?
Cost pools

ABC and service industries
Criticisms of ABC

128
129
129
130
131
135

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CONTENTS

6

Self-assessment question 5.1
Other approaches to cost management in the modern environment
Total (or whole) life-cycle costing

Target costing
Costing quality control
Kaizen costing
Benchmarking

138
139
139
142
143
144
144

Pricing
Economic theory
Some practical considerations
Full cost (cost-plus) pricing
Pricing on the basis of relevant/marginal cost
Target pricing
Pricing strategies

146
146
154
155
158
160
160

Summary

Key terms
Further reading
References
Review questions
Exercises

161
162
162
163
164
164

Budgeting

168

Introduction
Learning outcomes

168
168

How budgets link with strategic plans and objectives
Collecting information on performance and exercising control

169
170

Time horizons of plans and budgets

Limiting factors
Budgets and forecasts
Periodic and continual budgets
How budgets link to one another
How budgets help managers
The budget-setting process
Step 1: Establish who will take responsibility
Step 2: Communicate budget guidelines to relevant managers
Step 3: Identify the key, or limiting, factor
Step 4: Prepare the budget for the area of the limiting factor
Step 5: Prepare draft budgets for all other areas
Step 6: Review and co-ordinate budgets
Step 7: Prepare the master budgets
Step 8: Communicate the budgets to all interested parties
Step 9: Monitor performance relative to the budget

170
172
172
172
173
175
178
178
179
179
179
180
181
181

181
181

Using budgets in practice
Incremental and zero-base budgeting
Preparing the cash budget
Preparing other budgets
Activity-based budgeting
Non-financial measures in budgeting

183
184
186
189
193
193


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CONTENTS

7

Budgets and management behaviour
Self-assessment question 6.1
Who needs budgets?
Beyond conventional budgeting
Long live budgets!

194
194
195
196
199

Summary
Key terms
Further reading
References
Review questions
Exercises

200
201
201
201
202
202

Accounting for control

209

Introduction
Learning outcomes

209
209

Budgeting for control
Types of control
Variances from budget
Flexing the budget
Sales volume variance
Sales price variance
Materials variances
Labour variances
Fixed overhead variance

210
211
212
213
213
216
216
218
219

Reasons for adverse variances
Non-operating profit variances
Investigating variances
Compensating variances

Making budgetary control effective
Behavioural issues
The impact of management style
Reservations about the Hopwood study
Failing to meet the budget

222
224
224
227
228
228
229
230
230

Self-assessment question 7.1
Standard quantities and costs
Setting standards
What kind of standards should be used?
Information gathering
The learning-curve effect

231
232
232
232
233
234

Other uses for standard costing
Some problems . . .
. . . and some more problems

235
235
236

Summary
Key terms
Further reading
References
Review questions
Exercises

237
238
239
239
240
240

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CONTENTS

8

Making capital investment decisions
Introduction
Learning outcomes
The nature of investment decisions
Investment appraisal methods
Accounting rate of return (ARR)
ARR and ROCE
Problems with ARR
Payback period (PP)
Problems with PP
Net present value (NPV)
Interest lost
Risk
Inflation
What will a logical investor do?
Using discount tables
The discount rate and the cost of capital
Why NPV is better
NPV’s wider application
Internal rate of return (IRR)
Problems with IRR

Some practical points
Investment appraisal in practice
Self-assessment question 8.1
Dealing with risk
Assessing the level of risk
Reacting to the level of risk
Managing investment projects
Stage 1: Determine investment funds available
Stage 2: Identify profitable project opportunities
Stage 3: Evaluate the proposed project
Stage 4: Approve the project
Stage 5: Monitor and control the project
Summary
Key terms
Further reading
References
Review questions
Exercises

9

Strategic management accounting
Introduction
Learning outcomes
What is strategic management accounting?
Facing outwards
Competitor analysis
Customer profitability analysis

244

244
244
245
246
248
249
250
252
254
256
257
258
258
259
262
263
264
265
265
268
269
272
275
275
276
285
287
287
288
288

289
289
290
292
292
292
293
293
299
299
300
300
301
301
304


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CONTENTS

Competitive advantage through cost leadership
Total life-cycle costing
Target costing

Kaizen costing
Value chain analysis
An alternative view

308
308
309
309
310
311

Translating strategy into action
The Balanced Scorecard

313
314

Measuring shareholder value
The quest for shareholder value
How can shareholder value be created?
The need for new measures
Net present value (NPV) analysis
Extending NPV analysis: shareholder value analysis
Measuring free cash flows
Business value and shareholder value
Managing with SVA
The implications of SVA
Economic value added (EVA®)
EVA® and SVA
EVA® or SVA?

318
318
319
319
322
322
323
324
327
328
329
334
335

Just another fad?
Self-assessment question 9.1

337
338

Summary
Key terms
Further reading
References
Review questions
Exercises

338
339

339
340
341
341

10 Measuring performance

345

Introduction
Learning outcomes

345
345

Why do businesses divisionalise?
Types of divisions
Divisional structures
Is divisionalisation a good idea?

346
346
346
347

Measuring divisional profit
Contribution
Controllable profit
Divisional profit before common expenses
Divisional net profit

351
352
352
353
353

ROI and RI
Return on investment (ROI)
Residual income (RI)
Looking to the longer term
Comparing performance

355
355
358
359
361

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CONTENTS

EVA® revisited
Self-assessment question 10.1
Transfer pricing
Transfer pricing policies
Market prices
Variable cost
Full cost
Negotiated prices
Differential transfer prices
Transfer pricing and service industries

362
363
364
367
367
368
368
369
370
371

Non-financial measures of performance
What is measured?
Choosing non-financial measures
Who should report?

371
372
375
375

Summary
Key terms
Further reading
Review questions
Exercises

376
378
378
379
379

11 Managing working capital

384

Introduction
Learning outcomes

384
384

What is working capital?
Managing working capital

385
386

The scale of working capital
Managing inventories
Budgeting future demand
Financial ratios
Recording and reordering systems
Levels of control
Inventories management models
Materials requirement planning systems
Just-in-time inventories management

386
388
390
390
391
392
393
396
396

Managing receivables
Which customers should receive credit?
Length of credit period
An alternative approach to evaluating the credit decision
Cash discounts

398
399
400
402
403

Self-assessment question 11.1
Debt factoring and invoice discounting
Collection policies

403
403
404

Managing cash
Why hold cash?
How much cash should be held?
Controlling the cash balance
Cash budgets and managing cash

406
406
407
407
409


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CONTENTS

Operating cash cycle
Cash transmission
Bank overdrafts
Managing trade payables
Controlling trade payables

409
412
413
413
415

Summary
Key terms
Further reading
Review questions
Exercises

415
417
417
418
418

Appendix
Appendix
Appendix
Appendix
Appendix

A: Glossary of key terms
B: Solutions to self-assessment questions
C: Solutions to review questions
D: Solutions to selected exercises
E: Present value table

Index

425
434
444
454
495
497

Supporting resources
Visit www.pearsoned.co.uk/atrillmclaney to find valuable online resources
Companion Website for students
n Self assessment questions with Grade Tracker function to test your learning
and monitor your progress
n A study guide to aid self-learning
n Revision questions and exercises to help you check your understanding
n Extensive links to valuable resources on the web

n Comments on case studies to aid interpretative and analytical skills
For instructors
n Complete, downloadable Instructor’s Manual
n PowerPoint slides that can be downloaded and used for presentations
n Progress tests, consisting of various questions and exercise material with
solutions
n Additional international case studies
n Tutorial/seminar questions and solutions
n Solutions to individual chapter exercises

Also: The Companion Website with Grade Tracker provides the following features:
n
n

Search tool to help locate specific items of content
Online help and support to assist with website usage and troubleshooting

For more information please contact your local Pearson Education sales
representative or visit www.pearsoned.co.uk/atrillmclaney

xiii


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Guided tour of the book
Guided tour of the book
WHAT IS MEANT BY ‘COST’?

2

35

What is meant by ‘cost’?
‘

Relevant costs for
decision making

Let us begin by asking ‘what is meant by cost?’ The answer to this question may seem,
at first sight, very obvious. Many people might say that cost is how much was paid for
an item of goods being supplied or a service being provided. However, the following
activity illustrates that the definition of ‘cost’ is not always as obvious as might first be
thought.

Activity 2.1
You own a motor car, for which you paid a purchase price of £5,000 – much below the
list price – at a recent car auction. You have just been offered £6,000 for this car.
What is the cost to you of keeping the car for your own use? Note: Ignore running
costs and so on; just consider the ‘capital’ cost of the car.

INTRODUCTION

By retaining the car, you are forgoing a cash receipt of £6,000. Thus, the real sacrifice, or

cost, incurred by keeping the car for your own use is £6,000. Any decision that you make
with respect to the car’s future should logically take account of this figure. This cost is known
as the ‘opportunity cost’ since it is the value of the opportunity forgone in order to pursue
the other course of action. (In this case, the other course of action is to retain the car.)

This chapter considers the identification and use of costs in making management
decisions. These decisions should be made in a way that will promote the
business’s achievement of its strategic objective. We shall see that not all of the
costs that appear to be linked to a particular business decision are relevant to it.
So, it is important to distinguish carefully between costs (and revenues) that are
relevant and those that are not. Failure to do this could well lead to bad decisions
being made. The principles outlined here will provide the basis for much of the
rest of the book.

‘

LEARNING OUTCOMES

‘

When you have completed this chapter, you should be able to:
l

Define and distinguish between relevant costs, outlay costs and opportunity
costs.

l

Identify and quantify the costs that are relevant to a particular decision.

l

Use the relevant costs to make decisions.

l

Set out the analysis in a logical form so that the conclusion may be
communicated to managers.

‘

We can see that the cost of retaining the car is not the same as the purchase price.
In one sense, of course, the cost of the car in Activity 2.1 is £5,000 because that is how
much was paid for it. However, this cost, which for obvious reasons is known as the
historic cost, is only of academic interest. It cannot logically ever be used to make a
decision on the car’s future. If we disagree with this point, we should ask ourselves how
we should assess an offer of £5,500, from another person, for the car. The answer is that
we should compare the offer price of £5,500 with the opportunity cost of £6,000. This
should lead us to reject the offer as it is less than the £6,000 opportunity cost. In these
circumstances, it would not be logical to accept the offer of £5,500 on the basis that
it was more than the £5,000 that we originally paid. (The only other figure that should
concern us is the value to us, in terms of pleasure, usefulness, and so on of retaining
the car. If we valued this more highly than the £6,000 opportunity cost, we should
reject both offers.)
We may still feel, however, that the £5,000 is relevant here because it will help us
in assessing the profitability of the decision. If we sold the car, we will make a profit
of either £500 (£5,500 − £5,000) or £1,000 (£6,000 − £5,000) depending on which
offer we accept. Since we should seek to make the higher profit, the right decision is
to sell the car for £6,000. However, we do not need to know the historic cost of the
car to make the right decision. What decision should we make if the car cost us

£4,000 to buy? Clearly we should still sell the car for £6,000 rather than for £5,500 as
the important comparison is between the offer price and the opportunity cost. We
should reach the same conclusion whatever the historic cost of the car.
To emphasise the above point, let us assume that the car cost £10,000. Even in this
case the historic cost would still be irrelevant. Had we just bought a car for £10,000
and found that shortly after it is only worth £6,000, we may well be fuming with rage
at our mistake, but this does not make the £10,000 a relevant cost. The only relevant
factors, in a decision on whether to sell the car or to keep it, are the £6,000 opportunity

Learning outcomes Bullet points at the start of each chapter show what
you can expect to learn from that chapter, and highlight the core coverage.

OTHER APPROACHES TO COST MANAGEMENT IN THE MODERN ENVIRONMENT

There needs to be a review of the product or service over its entire life cycle,
which could be a period of 20 or more years. Traditional management accounting,
however, tends to be concerned with assessing performance over periods of just one
year or less.
Real World 5.3 provides some idea of the extent to which total life-cycle costing is
used in practice.

141

78

CHAPTER 3

Total (whole) life-cycle costing in practice
A survey of management accounting practice in the US was conducted in 2003. Nearly
2,000 businesses replied to the survey. These tended to be larger businesses, of which

about 40 per cent were manufacturers and about 16 per cent financial services; the
remainder were across a range of other industries.
The survey revealed that 22 per cent extensively use a total life-cycle approach to cost
control, with a further 37 per cent considering using the technique in the future.
Though the survey relates to the US, in the absence of UK evidence, it provides some
insight to what is likely also to be practised in the UK and elsewhere in the developed
world.
Source: Ernst and Young (see reference 5 at the end of the chapter).

Real World 5.4 shows how a well-known international carmaker uses total life-cycle
costing.

COST–VOLUME–PROFIT ANALYSIS

It is quite common for businesses to produce separate financial statements for each
department or section, to try to assess the relative effectiveness of each one.

Goodsports Ltd is a retail shop that operates through three departments, all in
the same premises. The three departments occupy roughly equal-sized areas of the
premises. The trading results for the year just finished showed the following:

Total

Sales revenue
Costs
Profit/(loss)

(
5

REAL WORLD 5.4

design: Creating a vehicle
manufacturing: Extracting and producing materials, manufacturing and assembling
the components, and then the whole vehicle
distribution: Transition between the vehicle’s departure from the production plant and
its purchase by a customer
vehicle service life: The use by the motorist, the longest phase
recycling.
These phases make up the life cycle. Why the word ‘cycle’? Because the end of a
vehicle’s service life is factored in right from the design phase.’
Source: www.renault.com.

£000

Sports
equipment
£000

Sports
clothes
£000

General
clothes
£000

534
482)
2

254
(213)
41

183
(163)
20

97
(106)
(9)

It would appear that if the general clothes department were to close, the business
would be more profitable, by £9,000 a year, assuming last year’s performance to
be a reasonable indication of future performance.
When the costs are analysed between those that are variable and those that
are fixed, however, the contribution of each department can be deduced and the
following results obtained:

Total

Total life-cycle costing at Renault
According to Renault, the French motor vehicle manufacturer;
‘The life of a vehicle is long and comprises several phases:

Key terms The key
concepts and techniques
in each chapter are
highlighted in colour where

they are first introduced,
with an adjacent icon in
the margin to help you
refer back to the most
important points.

Closing or continuation decisions

Example 3.4
REAL WORLD 5.3

Activities These short
questions, integrated
throughout each chapter,
allow you to check your
understanding as you
progress through the text.
They comprise either a
narrative question requiring
you to review or critically
consider topics, or a
numerical problem requiring
you to deduce a solution.
A suggested answer is
given immediately after
each activity.

Sales revenue
Variable costs
Contribution

Fixed costs (rent and so on)
Profit/(loss)

(

5

£000

Sports
equipment
£000

Sports
clothes
£000

General
clothes
£000

534
344)
190
(138)
2

254
(167)
87

(46)
41

183
(117)
66
(46)
20

97
(60)
37
(46)
(9)

Now it is obvious that closing the general clothes department, without any
other developments, would make the business worse off by £37,000 (the department’s contribution). The department should not be closed, because it makes
a positive contribution. The fixed costs would continue whether the department were closed or not. As can be seen from the above analysis, distinguishing
between variable and fixed costs, and deducing the contribution, can make the
picture a great deal clearer.

Note that Renault divides the Production phase into two sections: manufacturing
and distribution. It also divides the Post-production phase into vehicle service life and
recycling.

‘Real World’ illustrations Integrated throughout the text, these illustrative examples highlight the
practical application of accounting concepts and techniques by real businesses, including extracts from
company reports and financial statements, survey data and other interesting insights from business.

Examples At frequent

intervals throughout most
chapters, there are
numerical examples that
give you step-by-step
workings to follow through
to the solution.


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GUIDED TOUR OF THE BOOK

xv

Self-assessment questions Towards the end of most chapters you will encounter one of these questions,
allowing you to attempt a comprehensive question before tackling the end-of-chapter assessment material.
To check your understanding and progress, solutions are provided at the end of the book.

138

CHAPTER 5

200

COSTING AND PRICING IN A COMPETITIVE ENVIRONMENT

CHAPTER 6

BUDGETING

SUMMARY

Self-assessment question 5.1
Psilis Ltd makes a product in two qualities, called ‘Basic’ and ‘Super’. The business is able
to sell these products at a price that gives a standard profit mark-up of 25 per cent of full
cost. Management is concerned by the lack of profit.
Full cost for one unit of a product is calculated by charging overheads to each type of
product on the basis of direct labour hours. The costs are as follows:
Basic
£
40
15

Direct labour (all £10/hour)
Direct material

The main points of this chapter may be summarised as follows:
A budget is a short-term business plan, mainly expressed in financial terms.
l Budgets are the short-term means of working towards the business’s objectives.
l They are usually prepared for a one-year period with sub-periods of a month.
l There is usually a separate budget for each key area.

Super
£

60
20

Uses of budgets
l Promote forward thinking.
l Help co-ordinate the various aspects of the business.

The total overheads are £1,000,000.
Based on experience over recent years, in the forthcoming year the business expects
to make and sell 40,000 Basics and 10,000 Supers.
Recently, the business’s management accountant has undertaken an exercise to try to
identify cost drivers in an attempt to be able to deal with the overheads on a more precise
basis than had been possible before. This exercise has revealed the following analysis of
the annual overheads:

l Motivate performance.
l Provide the basis of a system of control.
l Provide a system of authorisation.

The budget-setting process
l Establish who will take responsibility.
l Communicate guidelines.

Activity (and cost driver)

Number of machine set-ups
Number of quality-control inspections
Number of sales orders processed
General production (machine hours)
Total

Cost

l Identify key factor.

Annual number of activities

£000

Total

Basic

Super

280
220
240
260
1,000

100
2,000
5,000
500,000

20
500
1,500
350,000

80
1,500
3,500
150,000

Bullet point chapter
summary Each chapter
ends with a ‘bullet-point’
summary. This highlights
the material covered in the
chapter and can be used
as a quick reminder of the
main issues.

l Prepare budget for key factor area.
l Prepare draft budgets for all other areas.
l Review and co-ordinate.
l Prepare master budgets (income statement and balance sheet).
l Communicate the budgets to interested parties.
l Monitor performance relative to budget.

Preparing budgets
l There is no standard style – practicality and usefulness are the key issues.
l They are usually prepared in columnar form, with a column for each month (or

The management accountant explained the analysis of the £1,000,000 overheads as follows:
l

l

l

similarly short period).
l Each budget must link (co-ordinate) with others.

The two products are made in relatively small batches, so that the amount of the
finished product held in inventories is negligible. The Supers are made in very small
batches because their demand is relatively low. Each time a new batch is produced, the
machines have to be reset by skilled staff. Resetting for Basic production occurs about
20 times a year and for Supers about 80 times: about 100 times in total. The cost of
employing the machine-setting staff is about £280,000 a year. It is clear that the more
set-ups that occur, the higher the total set-up costs; in other words, the number of setups is the factor that drives set-up costs.
All production has to be inspected for quality and this costs about £220,000 a year. The
higher specifications of the Supers mean that there is more chance that there will be
quality problems. Thus the Supers are inspected in total 1,500 times annually, whereas
the Basics only need about 500 inspections. The number of inspections is the factor
that drives these costs.
Sales order processing (dealing with customers’ orders, from receiving the original
order to despatching the products) costs about £240,000 a year. Despite the larger
amount of Basic production, there are only 1,500 sales orders each year because the
Basics are sold to wholesalers in relatively large-sized orders. The Supers are sold
mainly direct to the public by mail order, usually in very small-sized orders. It is believed
that the number of orders drives the costs of processing orders.

Criticisms of budgets
l Cannot deal with rapid change.
l Focus on short-term financial targets, rather than value creation.
l Encourage a ‘top-down’ management style.
l Time-consuming.

l Based around traditional business functions and do not cross boundaries.
l Encourage incremental thinking (last year’s figure, plus x per cent).
l Protect rather than lower costs.
l Promote ‘sharp’ practice among managers.
l Budgeting is very widely regarded as useful and extensively practised despite the

criticisms.

Key terms summary At the end of each chapter, there is a listing (with page reference)
of all the key terms, allowing you to refer back easily to the most important points.

REFERENCES

‘

201

202

CHAPTER 6

BUDGETING

Key terms

REVIEW QUESTIONS
Mission statement p. 169
Budget p. 169
Control p. 170
Limiting factor p. 172

Forecast p. 172
Periodic budget p. 172
Continual budget p. 172
Rolling budget p. 173
Master budget p. 173

Management by exception p. 176
Budget committee p. 179
Budget officer p. 179
Incremental budgeting p. 184
Budget holder p. 184
Discretionary budget p. 184
Zero-base budgeting (ZBB) p. 185
Activity-based budgeting (ABB)
p. 193

Answers to these questions can be found at the back of the book, starting on p. 448.

6.1

Define a budget. How is a budget different from a forecast?

6.2

What were the five uses of budgets that were identified in the chapter?

6.3

What do budgets have to do with control?

6.4

What is a budget committee? What purpose does it serve?

Further reading

EXERCISES

If you would like to explore the topics covered in this chapter in more depth, we recommend the
following books:

Exercises 6.5 to 6.8 are more advanced than 6.1 to 6.4. Those with coloured numbers have
answers at the back of the book, starting on p. 470. If you wish to try more exercises, visit
the students’ side of the Companion Website at www.pearsoned.co.uk/atrillmclaney.

Management Accounting, Atkinson A., Banker R., Kaplan R. and Young S. M., 3rd edn, Prentice
Hall, 2001, chapter 11.
Management and Cost Accounting, Drury C., 6th edn, Thomson Learning Business Press, 2004,
chapter 15.
Cost Accounting: A managerial emphasis, Horngren C., Datar S. and Foster G.,12th edn, Prentice
Hall International, 2005, chapter 6.

6.1

Daniel Chu Ltd, a new business, will start production on 1 April, but sales will not start until
1 May. Planned sales for the next nine months are as follows:

Managerial Accounting, Hilton, R., 6th edn, McGraw-Hill Irwin, 2005, chapter 9.

References

1 A Survey of Management Accounting Practices in UK Manufacturing Companies, Drury C.,
Braund S., Osborne P. and Tayles M., Chartered Association of Certified Accountants, 1993.
2 Contemporary Management Accounting Practices in UK manufacturing, Dugdale D.,
Jones C. and Green S. CIMA Research Publication, Vol.1, No. 13, 2005.
3 An Empirical Investigation of the Evolution of Management Accounting Practices, AbdelKader M. and Luther R., Working paper No. 04/06 University of Essex, October 2004.

Review questions
These short questions
encourage you to review
and/or critically discuss
your understanding of the
main topics covered in each
chapter, either individually
or in a group. Solutions
to these questions can
be found at the back of the
book in Appendix C.

Sales units
May
June
July
August
September
October
November
December
January

500

600
700
800
900
900
900
800
700

4 2003 Survey of Management Accounting, Ernst and Young, Ernst and Young, 2003.
5 Financial Management and Working Capital Practices in UK SMEs, Chittenden F.,
Poutziouris P. and Michaelas N., Manchester Business School, 1998.
6 Beyond budgeting, www.beyondbudgeting.plus.com.
7 Beyond budgeting, Hope J. and Fraser R., in Management Accounting, January 1999.
8 Better budgeting, The Chartered Institute of Management Accountants and The Faculty
of Finance and Management, Institute of Chartered Accountants in England and Wales,
March 2004.

Further reading This section comprises a
listing of relevant chapters in other textbooks
that you might refer to in order to pursue a topic
in more depth or gain an alternative perspective.
References Provides full details of sources of
information referred to in the chapter.

The selling price of a unit will be a consistent £100 and all sales will be made on one month’s
credit. It is planned that sufficient finished goods inventories for each month’s sales should be
available at the end of the previous month.
Raw materials purchases will be such that there will be sufficient raw materials inventories
available at the end of each month precisely to meet the following month’s planned production.

This planned policy will operate from the end of April. Purchases of raw materials will be on one
month’s credit. The cost of raw material is £40 a unit of finished product.
The direct labour cost, which is variable with the level of production, is planned to be £20
a unit of finished production. Production overheads are planned to be £20,000 each month,
including £3,000 for depreciation. Non-production overheads are planned to be £11,000 a
month, of which £1,000 will be depreciation.
Various non-current (fixed) assets costing £250,000 will be bought and paid for during April.
Except where specified, assume that all payments take place in the same month as the cost
is incurred.
The business will raise £300,000 in cash from a share issue in April.

Exercises These comprehensive questions appear at the end of most
chapters. The more advanced questions are separately identified. Solutions to
five of the questions (those with coloured numbers) are provided at the end of
the book, enabling you to assess your progress. Solutions to the remaining
questions are available online for lecturers only. Additional exercises can be
found on the Companion Website at www.pearsoned.co.uk/atrillmclaney.


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Guided tour of the Companion Website
Extra material has been prepared to help you study using Management Accounting for Decision Makers.
This material can be found on the book’s Companion Website at www.pearsoned.co.uk/atrillmclaney.

Self assessment questions

For each chapter there is
a set of interactive self
assessment questions,
including multiple choice and
fill-in-the-blanks questions.
Test your learning and
get automatic grading on
your answers.


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Revision questions

Sets of questions covering
the whole book are designed
to help you check your overall
learning whilst you are
revising.

Weblinks

A full set of relevant weblinks
allows further study of each
particular topic.


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Page xviii

Preface

Management accounting is concerned with ensuring that managers have the information
they need to plan and control the direction of their organisation. This book is directed
primarily at those following an introductory course in management accounting. Many
readers will be studying at a university or college, perhaps majoring in accounting
or in another area, such as business studies, IT, tourism or engineering. Other readers,
however, may be studying independently, perhaps with no qualification in mind.
The book is written in an ‘open-learning’ style, which has been adopted because we
believe it to be more ‘user friendly’ for readers. Whether they are using the book as part
of a taught course or for personal study, we feel that the open learning approach makes
it easier for readers to learn.
In writing this book, we have been mindful of the fact that most readers will not
have studied management accounting before. We have therefore tried to write in an
accessible style, avoiding technical jargon. Where technical terminology is unavoidable,
we have tried to give clear explanations. At the end of the book (in Appendix A) there is

a glossary of technical terms, which readers can use to refresh their memory if they come
across a term whose meaning is in doubt. We have tried to introduce topics gradually,
explaining everything as we go. We have also included a number of questions and tasks
of various types to try to help readers to understand the subject fully, in much the same
way as a good lecturer would do in lectures and tutorials. More detail of the nature
and use of these questions and tasks is given in the ‘How to use this book’ immediately
following this preface.
The book covers all the areas required to gain a firm foundation in the subject.
Chapter 1 provides a broad introduction to the nature and purpose of management
accounting. Chapters 2, 3, 4 and 5 are concerned with identifying cost information
and using it to make short-term and medium-term decisions. Chapters 6 and 7 deal
with the ways in which management accounting can be used in making plans and
in trying to ensure that those plans are actually achieved. Chapter 8 considers the use
of management accounting information in making investment decisions, typically
long-term ones. Chapter 9 deals with ‘strategic management accounting’. This is an
increasingly important area of management accounting that focuses on factors outside
the organisation but which have a significant effect on its success. Chapter 10 deals
with the problems of measuring performance where the business operates through a
divisional organisation structure, as most large businesses do. It also considers the use
of non-financial measures in measuring performance. Finally, Chapter 11 looks at the
way in which management accounting can help in the control of short-term assets,
such as inventories (stock) and cash.
In this fifth edition, we have taken the opportunity to improve the book. We have
increased the emphasis on the need for businesses to operate within a framework
of strategic planning and decision making. This includes greater focus on the business
environment and, in particular, on the crucial importance of creating and retaining customers. We have continued to highlight the changing role of management


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PREFACE

accountants to enable them to retain their place at the centre of the decision-making
and planning process. We have also added more examples of management accounting
in practice.
We should like to thank those at Pearson Education who were involved with this
book, for their support and encouragement. Without their help it would not have
materialised.
We hope that readers will find the book readable and helpful.
Peter Atrill
Eddie McLaney

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How to use this book

Whether you are using the book as part of a lecture/tutorial-based course or as the
basis for a more independent mode of study, the same approach should be broadly
followed.

Order of dealing with the material
The contents of the book have been ordered in what is meant to be a logical sequence.
For this reason, it is suggested that you work through the book in the order in which
it is presented. Every effort has been made to ensure that earlier chapters do not refer
to concepts or terms which are not explained until a later chapter. If you work through
the chapters in the ‘wrong’ order, you may encounter points that have been explained
in an earlier chapter and which you have not read.

Working through the chapters
You are advised to work through the chapters, from start to finish, but not necessarily
in one sitting. Activities are interspersed within the text. These are meant to be like
the sort of questions which a good lecturer will throw at students during a lecture or
tutorial. Activities seek to serve two purposes:
1 To give you the opportunity to check that you understand what has been covered
so far.
2 To try to encourage you to think beyond the topic that you have just covered, sometimes so that you can see a link between that topic and others with which you are
already familiar. Sometimes, activities are used as a means of linking the topic just
covered to the next one.
You are strongly advised to do all the activities. The answers are provided immediately
after the activity. These answers should be covered up until you have arrived at a
solution, which should then be compared with the suggested answer provided.
Towards the end of Chapters 2–11 there is a ‘self-assessment question’. This is rather
more demanding and comprehensive than any of the activities. It is intended to give
you an opportunity to see whether you understand the main body of material covered
in the chapter. The solutions to the self-assessment questions are provided at the end

of the book. As with the activities, it is very important that you make a thorough
attempt at the question before referring to the solution. If you have real difficulty with
a self-assessment question you should go over the chapter again, since it should be
the case that careful study of the chapter will enable completion of the self-assessment
question.


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HOW TO USE THIS BOOK

End-of-chapter assessment material
At the end of each chapter, there are four ‘review’ questions. These are short questions
requiring a narrative answer and intended to enable you to assess how well you can
recall main points covered in the chapter. Suggested answers to these questions are
included on the student website. Again, a serious attempt should be made to answer
these questions before referring to the solutions.
At the end of each chapter, there are normally eight exercises. These are more
demanding and extensive questions, mostly computational, and should further reinforce your knowledge and understanding. We have attempted to provide questions
of varying complexity.
Answers to five out of the eight exercises in each chapter are provided at the end
of the book. These exercises are marked with a coloured number. Answers to the three
exercises that are not marked with a coloured number are given in a separate teacher’s
manual. Yet again, a thorough attempt should be made to answer these questions

before referring to the answers.

Supplements and website
A comprehensive range of supplementary materials is available to lecturers adopting
this text at www.pearsoned.co.uk/atrillmclaney.

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Acknowledgements
We are grateful to the following for permission to reproduce copyright material:
Figure 5.1 adapted from Activity-Based Costing: A Review With Case Studies, CIMA Publishing (Innes, J. and Mitchell, F. 1990) © 1990 with permission from Elsevier; Figure 6.6
from Financial Management and Working Capital Practices in UK SMEs, Manchester
Business School (Chittenden, F., Poutziouris, P. and Michaelas, N. 1998); Figure 6.7
from www.bbrt.org. Copyright and source Beyond Budgeting Round Table (BBRT)
– www.bbrt.org; Figure 8.2 adapted from Godden, D., Investement appraisal in UK
manufacturing: has it changed since the mid-1990s?, www.cbi.org.uk; Real World 8.6 from
The theory-practice gap in capital budgeting: evidence from the United Kingdom,
Journal of Business Finance and Accounting, June/July, Blackwell Publishing (Arnold,
G.C. and Hatzopoulos, p. 2000); Table in Real World 10.4 from Divisional Performance
Measurement: An Examination of Potential Explanatory Factors, CIMA Research Report
August 2005, p. 30 (Drury et al. 2005). This table has been reproduced from a CIMA

Research Report with kind permission from CIMA.
British Sky Broadcasting Group Plc for an extract from the British Sky Broadcasting
Group Plc Annual Report 2005 and their Mission Statement (Real World 1.2); Northern
Foods Plc for an extract from Northern Foods Plc Annual Report 2005 (Real World 1.2);
Cadbury Schweppes Plc for an extract from www.cadburyschweppes.com (Real
World 1.7); Babcock International Plc for an extract from the Babcock International
Group Plc Annual Report 2005 (Real World 6.2); CIMA for an extract from ‘Beyond
Budgeting’ published in Management Accounting, January 1999 (Real World 6.7); Rolls
Royce Plc for an extract from the Rolls Royce Plc Annual Report and Accounts 2004
(Real World 8.9); Jarvis Plc for an extract from the Jarvis Plc Annual Report and Accounts
2005 (Real World 9.6); Hanson Plc for an extract from Hanson Annual Report 2004
(Real World 9.11) and NI Syndication for ‘Dirty Laundry: How companies Judge the
Numbers’ published in The Times, Business, 22 September 2002.
We are grateful to the Financial Times Limited for permission to reprint the following
material:
Real World 1.3 Goodbye to a little bit of history, © Financial Times, 28 May 2003; Real
World 1.5 Profit without honour, © Financial Times Weekend, 29/30 June 2002; Real
World 1.8 Tsunami: Finding the right figures for disaster, © FT.com, 7 March 2005;
Real World 2.2 Monotub Industries in a spin as founder gets Titan for £1, © Financial
Times, 23 January 2003; Real World 3.4 Jaguar struggles over break even, © Financial
Times, 6 May 2005; Real World 5.12 Adapted from: Case Study: Elsevier, © FT.com,
19 June 2002; Real World 8.8 Satellites need space to earn, © Financial Times, 14 July
2003; Real World 11.10 Cash benefit: How big supermarkets fund expansion by using
suppliers as bankers, © Financial Times, 7 December 2005.
In some instances we have been unable to trace the owners of copyright material,
and we would appreciate any information that would enable us to do so.


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1
Introduction to management
accounting

INTRODUCTION
Welcome to the world of management accounting! In this introductory chapter,
we examine the role of management accounting within a business. To understand
the context for management accounting we begin by considering the nature and
purpose of a business. Thus, we first consider what businesses seek to achieve,
how they are organised and how they are managed. Having done this, we go on to
explore how management accounting information can be used within a business to
improve the quality of managers’ decisions. We also identify the characteristics that
management accounting information must possess to fulfil its role. Management
accounting has undergone many changes in response to changes in the business
environment and in business methods. In this chapter we shall discuss some of the
more important changes that have occurred.

LEARNING OUTCOMES
When you have completed this chapter, you should be able to:
l

Identify the purpose of a business and discuss the ways in which a business
may be organised and managed.

l

Discuss the issues to be considered when setting the financial aims and
objectives of a business.

l

Explain the role of management accounting within a business and describe
the key qualities that management accounting information should possess.

l

Explain the changes that have occurred over time in both the role of the
management accountant and the type of information provided by
management accounting systems.


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2

CHAPTER 1

INTRODUCTION TO MANAGEMENT ACCOUNTING

What is the purpose of a business?
Peter Drucker, an eminent management thinker, has argued that ‘The purpose of
business is to create and keep a customer’ (see reference 1 at the end of the chapter).
Drucker defined the purpose of a business in this way in 1967, at a time when most
businesses did not adopt this strong customer focus. His view therefore represented
a radical challenge to the accepted view of what businesses do. Forty years on, however, his approach has become part of the conventional wisdom. It is now widely
recognised that, in order to succeed, businesses must focus on satisfying the needs of
the customer.
Although the customer has always provided the main source of revenue for a business,
this has often been taken for granted. In the past, too many businesses have assumed
that the customer would readily accept whatever services or products were on offer.

When competition was weak and customers were passive, businesses could operate
under this assumption and still make a profit. However, the era of weak competition
has passed. Nowadays, customers have much greater choice and are much more assertive
concerning their needs. They now demand higher quality services and goods at cheaper
prices. They also require that services and goods be delivered faster with an increasing
emphasis on the product being tailored to their individual needs. If a business cannot
meet these needs, a competitor business often can. Thus the business mantra for the
current era is ‘the customer is king’; most businesses now recognise this fact and organise
themselves accordingly.
Real World 1.1 provides an illustration of how one business recognises the supremacy
of the customer.

REAL WORLD 1.1

Customers are top of the apex
Medrad, a US-based leading worldwide provider of medical devices and services, recently
won a prestigious award for quality, which was presented by President Bush at the White
House. The business’s chief executive officer (CEO) explaining the business’s success said
that at Medrad the customer was placed at the top of the business’s organisation chart.
(An organisation chart is a diagram showing the hierarchy of importance of managers and
staff and usually has the CEO at the top.) Why the customer? ‘Because the customer can
fire (or sack) the whole company at any time,’ said the CEO.
Source: Cohen, C. A. ‘CEO at bottom of award-winning firm’s organisation chart’, post-gazette.com Business News, 13 July 2004.

How are businesses organised?
Nearly all businesses that involve more than a few owners and/or employees are set up
as limited companies. This means that the finance will come from the owners (shareholders) both in the form of a direct cash investment to buy shares (in the ownership
of the business) and through the shareholders allowing past profits, which belong to