managerial accounting and its techniques

Running head: DECISION MAKING IN MANAGERIAL ACCOUNTING 1

MANAGERIAL ACCOUNTING AND ITS TECHNIQUES

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DECISION MAKING IN MANAGERIAL ACCOUNTING 2

Abstract

The paper discusses the Managerial accounting in general and the role of managerial

accountants in any business or company. The paper provides an in depth analysis of management

accounting techniques and how they can help the company to manage the financial information

related to the company. The paper also provides us with applications to management accounting

techniques and their role in day-to-day decision-making. The paper gives us a detailed review of

real world applications for different accounting techniques used by the management accountants

to handle the financial security of their company or business. Apart from that, the paper also

discusses as to how management accounting can help managers while making decisions on

different projects with limited capital. The management accounting addresses all such issues and

hence it is of practical importance to us as it manages the accounting tools and techniques of any

particular business.


MANAGERIAL ACCOUNTING AND ITS TECHNIQUES

Management Accounting is a type of accounting that helps in providing financial and

statistical information to the managers in any business. This helps them in making managerial

decisions regarding day-to-day goals and other short-term managerial goals (Investopedia, 2012).

The provision of financial information include details on availability of cash to company,

generation of sales revenue, the current state of company’s account payable and accounts

receivables through cash budget, balance sheet and income statement.

Role of Managerial Accounting and Management Accountants in the business

Managerial accounting deals with the basic role of finding out the internal cost for any

particular process in the business. This type of information will help the company to make

decisions related to production, operations and investments in market that include capital

investment decisions like Net Present Value, Internal rate of return etc. All details are described

below. For this purpose, companies need managerial accounting to ensure that the budget they

utilize is being used efficiently and then make effective decisions accordingly related to

production, sales and investment. The role of management accountant in a business or

organization is to record the financial information which is then used by the company to make

wise decisions. They develop budgets like production budgets, cash budget, sales budget etc.

They also perform the management of assets and create important reports respectively. Hence the

role of management accountants in to ensure the financial security of their company by taking

responsibility of handling all the financial matters of company. Through this, they help in the

formation business strategy for the attainment of goals and other objectives of company (School,

2012).


Ethical Issues Faced by the Management Accountant

There are several ethical issues faced by the management accountants which are as under:

1. Over Production: This can occur when managerial accountants work the

operational managers. Managerial accountants desire to increase the operating profits due to

which they record more expenses as production costs. This results in increased inventory of

finished goods or final goods. The absorption costing is abused here during over production.

They adopt absorption costing so that the fixed costs can be recorded in the accounts of final

inventory (Vitez, 2011).

2. Cost Allocation: Managerial accountants transfer overhead costs to contracts

from the income statements of the company. This results in customers paying higher prices for

goods or services. This cost allocation disrupts the financial statements and creates disturbances

in customer relationships due to excess billing.

3. Conflicting Interests: Management accountants’ role is to work for the interest of

the company as a whole. However, this might not work when he is particularly not following this

particular principle. A management accountant, for example, can work with an operational

manager to change or modify numbers related to financial statements or other operational

budgets which can better his personal position. Management accountants are responsible to work

for the interest of the company ensuring the feasibility of operational capacity for any particular

business. So working for one segment only can create conflicts of interest.


4. Asset Replacements: This is the main ethical issue faced by the management

accountants. They are responsible to make decisions on the replacement of assets when required.

However, sometimes they are reluctant to make decisions for that purpose, as the return on

investment will decline. This is because the new asset has a higher cost that will definitely

reduce the ROI.

Management Accounting Techniques.

1. Cost Volume Profit Analysis: This is a method of management accounting,

which is based on computing the break-even point on cost and volume basis for goods or

services (Mateo, 2011). CVP analysis can estimate the effect on profits when changes are

observed for selling price per unit, variable costs, fixed costs and the total sales volume. The

most general equation used is :

Profit = Sales – Variable costs – Fixed costs

2. Activity based costing: This method identify different activities involved in the

production of the finished good. The process also explores expenses involved in such activities

for the final production of a finished good. The application in the business world for such

method deals with the expenses and other costs attached with different activities involved in the

final production of goods or services. This can help in identifying the variations in manufacturing

or production costs easily.

3. Net Present Value: This method enables the management accountants to compute

and determine the net present value of the investment. The present value of the future cash flows


are subtracted from the initial cash outlay i.e. initial investment so that the present value of the

investment can be tracked for the final decision of investment. The best application is discussed

below with an example.

MANAGEMENT ACCOUNTING TECHNIQUES WITH EXAMPLES

Following are the management accounting techniques with examples:

1. Job order costing is a costing method to assign manufacturing costs to a

product or its batches. The example of job order costing is as under:

ABC Company plans to sell a batch of 28 special equipment (Job 590) to a retailer for

$119,000.

The steps to show the working of job order costing is as under:

I. Identify cost object i.e. Job 590.

II. Identify direct costs i.e. Direct materials = $40,000 and Direct Labor = $ 22,000

III. Identify machine hours for this particular job and complete machine hours used

by total jobs. Job 590 used 450 machines hours and 2650 machines hours were utilized by all

jobs.

IV. Identify overhead costs i.e. $62,000

V. Indirect cost rate $62,000 / 2650 = $23.4 / machine hour

VI. $23.4 / Machine hour * 450 machine hours = $10528

VII. Direct materials cost = $40,000

Direct Labor cost = $22,000

Overhead (factory) =$10528

Total =$72582


Process Costing is a costing method used when it is impossible to separate production

units due to continuous production processes.

Taking a general example of any process where input is processed in to it. The input is

2000 units at a cost of $9,500. The normal loss is reported to be 11%. There are no beginning and

ending stocks. Therefore, we need to complete the process accounts if the output is 1700 units.

Since there is 11% normal loss, the output cost would equal = 89% * 2000 = 1780

I. We first need to determine the following:

Total input = 2200 units

Output = 1700 units

Normal loss = 220 units

Abnormal loss = 80 units

II. Now we need to compute the output cost / unit and losses

Cost incurred / Expected output = 9500 / 1780 = $5.33 per unit

III. Calculating total cost of output and losses

Output = $ 9061

Abnormal loss = $439

Since there is no share of cost for normal loss then,

Total cost of output and losses = $9500


2. The other real world application of Managerial Accounting is several investment

decisions.

The first investment decision is made through net present value (NPV) i.e. present

value of future cash flows through the investment in a project less initial cost of investment. The

formula is as under:

Where n is no: of cash flows attained from the investment in a project and rp is the return

required on the investment which is the minimum annual percentage earned by investment into

any particular project.

It can also help in making decisions between two projects.

Example:

ABC manufacturer plans to purchase any one of two machines GT-C Textile Testing

Equipment and Fabric Abrasion Tester (Martindale). The required rate of return is 10% The

Cash flows for each of the projects are specified below.

GT-C Textile Testing Equipment

N=Years 0 1 2 3 4 5

CashFlow -200090

0

90

0

90

0

90

0900

By using the formula above, the NPV for the above investment i.e. GT-C Textile Testing

Equipment is calculated as $1411.72

http://www.alibaba.com/product-gs/364657112/GT_C_Textile_Testing_Equipment.html

http://www.alibaba.com/product-free/11476952/Fabric_Abrasion_Tester_Martindale_.html




The cash flows for the second Project i.e. investment in Fabric Abrasion Tester is stated

below:

Yea

r0 1 2 3 4 5

Ca

sh Flow

-

2,000

7

00

7

00

7

00

7

00

70

0

By using the formula mentioned previously for calculating NPV, the NPV for this project

is calculated as 634.2.

Therefore, from the two projects we can see that the NPV is higher for the second project

i.e. Fabric Abrasion Tester. Therefore, ABC manufacturing company should invest in this

equipment.

The second investment decision that is applicable in management accounting is stated as

Internal Rate of Return. The internal rate of return is the rate of return, which equals the net

present value of cash flows for any project to zero. The IRR solves the following equation as

below:

The ABC Company plans to invest in a project, which has the data as under:


N=Years 0 1 2 3 4

Cash Flows 1,000 500 500 500 500

The internal rate of return is calculated as 34.9%. (Calculated by using the excel

function). Since the calculate IRR is greater than the required rate of return. Therefore the project

can be accepted for investment purposes.

The third investment decision is Payback Period. This period is computed to determine

the actual length of time to recover the initial investment or cash outflow for the project.

For example:

ABC Company in considering investing in any one of two projects. The data is given as:

Project C Project D

Year 0 Flow -2,000 -2,000

Year 1 Flow 900 900

Year 2 Flow 1100 700

Year 3 Flow 300 400

PP 2 3


The payback period for project C is 2 years as in year 2 the initial cash outlay is

recovered whereas the initial cash outlay is recovered in year 3 for Project D. Therefore, the

project C is better than Project D.

The next investment decision in accordance with this capital budgeting techniques is the

Profitability Index. The profitability index can help us in selecting the combination of different

investments in projects where the capital is fixed. It is calculated by dividing the NPV by the

initial investment. But it should be noted that it is not the only deciding technique for an

investment as the shareholder value is not maximized. The example is given below:

ABC firm considers the investment projects as under where NPV and PI are also

calculated.The availability of capital to this company is $14,000.

Project Investment Cost NPVProfitabilit

y index

A 1,000 600 0.6

B 4,000 2,000 0.5

C 6,000 2,400 0.4

D 2,000 400 0.2

E 5,000 500 0.1

Here the combination of Project A, B & C should be selected for investment purpose.

Here the aggregate NPV is $5000.


Now, we will look at another data where profitability index cannot be applicable. The

data is given below.

Project Investment Cost NPV PI

A 1,000 600 0.6

B 4,000 2,000 0.5

C 6,000 2,400 0.4

D 2,000 700 0.35

E 5,000 500 0.1

Here the combination of Project B, C & D is selected, as the aggregate of NPV is $5,100

as compared to projects A, B and C where the aggregate NPV is $5000 only. So, Profitability

index cannot be considered as the best method for investment decisions.

3. The other management accounting application is techniques for Cost

management. There are many cost management techniques. But the most important ones with

their respective examples commonly used are discussed as under.

i. Activity Based Costing

In ABC method, all the activities used to make any particular product are listed and costs

for such activities are assigned accordingly. The example for this technique is stated below.

The purchasing department has three different types of expenses with three different

activities. The activities include the reviewing of order purchases, reviewing of inventory and


evaluation of different vendors and suppliers. The expenses to be incurred within the

organization equal $150,000. Such expenses include wages $ 100,000, Computer $ 20,000 and

Travel $30,000. Then different expenses are assigned to different activities.

Then the unit cost is calculated accordingly:

Purchase orders: $104,000/1000 = $104 per purchase order

Review inventory: 18000/50 = $360

Evaluation of vendors: $30000/10 = $3000 per vendor.

ii. Just in time

Just in time means to produce what is needed, when it is needed and producing in

accordance with the amount needed. We can take an example of Toyota Production

System. There is production plan named as Kanban system. The system ensured that the

inventory was solely based on appropriate customer orders rather than management forecasts.

According to Investopedia:


“Kanban is a Japanese term meaning signboard or graphic. Cards appear as the

container of goods or materials is emptied, allowing the production and delivery of more

before a hold-up or shortage develops. These cards may have several colors that are ordered

according to priority. Frequently a two-card system is employed where "move" cards are

employed to move goods from one area of production to another, while "production" cards

that replace materials after they are sold or used (Global, 2012)”

There are several other cost management techniques but these are most commonly used.

4. The fourth management accounting technique is Quality control. The most

preferred term used for this purpose is total quality management. It is the coordination of all

functional units to gain continuous improvement in the products or service being produced. The

real application for this can be taken from the example of a company ABC operating in US. The

textile industry in highly competitive. And there is a danger of new Japanese entry in the

industry. However experts concluded that TQM should be implemented to compete against the

new entrants. Through TQM, the cost of quality was lessened by 26%. However, prevention

costs increased by 45%. External failure cost decreased by 31%. Hence, the total quality cost

recorded a decline of 26% and appraisal costs also increased by 55%. Therefore, TQM allowed

the company ABC to compete with new entrant Japanese company in the textile industry.


References

Global, T. (2012, March 15). Toyota Global. Retrieved from http://www.toyota-

global.com/company/vision_philosophy/toyota_production_system/just-in-time.html

Investopedia. (2012, November 11). Investopedia. Retrieved from

http://www.investopedia.com/terms/m/managerialaccounting.asp

Mateo, C. o. (2011, August 10). College of San Mateo. Retrieved from

http://smccd.edu/accounts/nurre/online/chtr6.htm

School, A. B. (2012, October 15). All Business School. Retrieved from

http://www.allbusinessschools.com/business-careers/article/role-of-the-management-accountant


Vitez, O. (2011, September 12). Chron. Retrieved from

http://smallbusiness.chron.com/ethics-managerial-accounting-3737.html

managerial accounting and its techniques

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