STRATEGIC COST MANAGEMENT AND 1 MANAGEMENT ACCOUNTING This chapter aims that the student be able to: Define management and the objectives of management. Define strategic cost management Define Management Accounting and identify the objectives of Management Accounting. Know the relationship of Financial Accounting and Management Accounting. Know the relationship of Management Accounting with Cost Accounting, Understand the need for accounting information by the management. Understand the changing role of traditional accountant to financial managers, * Understand the role of management accountant in controlling and evaluating performance and decision making. + Understand the organizational structure and the role of accounting in the organization. Understand Financial Management Responsibilities. * Differentiate the functions of a financial officer (controller) and a treasurer. Understand different management terms Understand the need for an information system. Know the definition, nature and objectives of management accounting systems. Know the qualities and essential components of an accounting system, Procedures and steps in setting up management accounting systems and design. Know the essential characteristics and qualities of good management information system. Know the different sources of accounting information, and elements of good internal control. + Set up Management Information and Control System. Introduction Management~is—the—proceso—ofachieving—organizational—objectives, This involves planning, organizing, leading, and controlling. Planning and controlling are the two important functions of management. Planning is setting goals and developing strategies and tactics to achieve them. Some planning is routine, recurring, and relates mainly to a period of one year. Controlling is determining whether goals are being met, and if not, what can be done. Performance evaluation is a must in controlling. Managers must review the accomplishments and compare with what was planned. Both of these functions require decisions. Decision making is selecting one alternative from a set of choices. Making the best choice depends on the manager's goals, the expected results from each alternative, and the information available when the decision is made. Decisions made are highly information dependent. This chapter focuses on: > how information should be generated > how information should be used by decision makersChapter 1 Strategic Cost Mané and Mar > how the firm should be organized > what changes are occurring in business environments that will affect information needed > how decisions are framed > how management accountants are involved in decision making Accountants develop and communicate much of the economic information used by managers of businesses and other economic organizations as extemal users. Information provided to internal users are called management accounting information, and are done by ‘management accountants. Management accounting is an indispensable part of the system that provides information to managers - the people whose decisions and actions determines the success or failure of the organization: Strategic Cost Management Defined Strategic cost management is the application of cost management-techniques—which aims-to-reduce-coste-while-strengthening the strategic position of a business. Strategic cost management methods can be applied in service, manufacturing, and not-for-profit organizations. This objective can be attained if the company could determine which costs support a company's strategic position. In this case, it would be beneficial tn increase casts that support the strategic position of the business-itis mot goottorcat costs in strategically important areas, Doing so reduces the customer satisfaction and experience. Eventually, it could lead to a decline in sales, ultimately, in profit. Acide from the The company chould alee identify which costs either causes decline in the strategic position of the business or have no impact at all. Thus, management needs to focus on reduction initiatives on these types of cost so that they can provide input regarding how certain costs should be incurred to support the competitive position of the firm. ‘Three ways to institute cost management techniques that will not only manage costs, but also augment profit realization. are as follows: 1. Develop systems that would streamline the transactions between corporate support departments and the operating units. 2. Establish transfer pricing systems to coordinate the buyer-supplier interactions between decentralized organizational operating units 3. Utilize pseudo profit centers to create profit maximizing behavior in what were formerly cost centers. Management Accounting Defined Management Accounting focuses on the information needs of an organization's internal ‘managers that are related to their planning-contralling_and decisionmaking functions. Itis the process of identifying, measuring, accumulating, analyzing, preparing, interpreting, and communicating information that helps managers fulfill organizational objectives. Because management accounting is designed to assist the organization's managers, relatively, few restrictions are imposed by regulatory bodies, and not governed by generally accepted accounting principles (GAAP). Therefore, a manager must define which data are relevant for a particular purpose and which are not.(Chapter 1 Strategic Cost Management and Management Accounting > Some management needs are satisfied by historical, monetary information based on generally accepted accounting principles > Other needs require forecasted, qualitative, and frequently non-financial information that has been developed and computed for their specific decision making functions. Management accountants should do all efforts possible or must strive harder to recognize: > What are the information needed by the managers; > Why these information are needed; > How these information be presented in the best feasible form that will enhance the understandability character of these reports to the users; and, > How the information be given to the user in the earliest time possible to be more useful to decision making. Objectives of Management Accounting eile cae eer ane The four major objectives of management accounting activity are: > Providing managers with information for decision making and planning. > Assisting managers in directing and controlling operations. > Motivating managers toward achieving organization's goals. > Measuring performance of managers and sub-units within the organization. The Relationship of Management Accounting with Financial and Cost Accounting as provider of information Accounting information ic euppoced to address three different functions: 1. To provide information to. external parties such as stockholders, creditors, and various regulatory bodies for investment and _ 2. To estimate the cost of products produced or services rendered; and 3. To provide information useful for malsiuns vevisions and conuviling operations. Financial accounting is the field of accounting that develops information for external decision-makers such as stockholders, suppliers, banks, and government regulatory agencies. The primary financial accounting reports are the balance sheet, statement of income, and the cash flows. Since many businesses are complex, guidelines, known as the GAAP, are provided for the strict adherence of these financial accounting reports. ‘Though management and financial accounting use acrannting system ac the sonrce of information, they neo them differently. Some basic differences of management accounting and financial accounting will be outlined in the succeeding discussions. Cost accounting is the field of accounting that creates an overlap between financial accounting and management accounting. It integrates with financial accounting by providing product costing information for financial statements, and with management accounting by providing some of the quantitative, cost-based. information managers need to perform their functions, The following statements define the functions of cost accounting:Chapter 1 Strategic Cost Management and Management Accounting —_—______________4 > Cost accounting focuses primarily on the determination of the cost of making products or performing services. > Cost accounting determines the cost of products or services by direct measurement, arbitrary assignment, and systematic or rational allocation of such costs. > Cost accounting is an integral part of the broader field of management accounting and its overlap causes the financial and management accounting systems to be more integrated to form a complete informational network. ‘The boundaries between financial accounting and management accounting are not clearly and definitely drawn as shown in our flowchart on the next page. Accounting System (one part of the organization's ‘Management information system.) Cost Accounting System (one part of the organization’s overall accounting system) Accumulates cost information MANAGEMENT ACCOUNTING Preparation of information for Planning, directing, controlling ‘organization’s operations, FINANCIAL ACCOUNTING Preparation of published financial statements and other financial reports. ‘Managers at al levels in the organization and decision-making INTERNAL USERS OF EXTERNAL USERS OF INFORMATION INFORMATION Stockholders, financial analysts, lenders, unions, ‘consumer groups, and government agencies Management accounting, as defined earlier, is more concerned-with individual segments of the business rathor-than-the orgonization-ae-¢-whole-oo-management accounting information normally addresses specific concems rather than the “big picture" of financial_acconnting. that serves the needs of management and are useful to managers’ functions. It must provide the basis for appropriate cost estimations that are needed for the financial statement presentations like in inventory and cost of goods sold or services. It must als provide adequate and seful information 19 accict managers in performing the basic functions of planning, controlling, evaluating performance, and making decisions. Managers must also see to it that in the provision of information, the cost-benefit analysis is being applied. Cost-benefit analysis is the analytical process of comparing the relative costs and benefits that result from a specific course of action. ‘That information shouldChapter 1 Strategic Cost Management and Management Accounting be developed and provided only if the cost of producing the information is less than the benefit of having it Management accountants, though, are not required to adhere to GAAP in providing such information for internal use of managers. Presented below is a summary of basic differences of management accounting and financial accounting: Basis Management Accounting, Financial Accounting As to Users of Internal Users External Users Information Not required and unregulated, | Required and must conform to As to Regulations to since it is intended only for (Gaap), Follow management. The organization's basic | Data are drawn almost exclusively accounting system plus| from the organization’s basic ‘As to Sources of Data _| various other sources, such as| accounting system, which external information. accumulates the —_ financial information. Reports often focus on sub- units within the organization, As to Nature of| Reports are based on aj almost exclusively on historical Reports and | combination of historical data, | transactions or data. Procedures estimates and projections of Reports focus on the company in. its entirety. Reports are based future events. Aside from what has been outlined, the following could also be considered as distinguishing characteristics of management accounting: > ‘Management accounting has no constraints, may be other than costs, as to benefits of improved management decisions, Behavioral implication is evident, as it concerns how measurements and reports will influence managers’ daily behavior. Management accounting is called to be “time focus’. The users of management accounting reports always compare the past and its relationship to the future. Management accounting reporis could vary in period coverage. It could be as long as 5 to 10 years or as short as daily. Management accounting reporis could be as detailed it could be. Sales could be presented in total or as detailed as to by product line, by territory, by department or as low as by agent.(Chapter 1 Strategic Cost Management and Management Accounting 4 > Management accounting covers so many fields of discipline. Usually managers heavily use the field of economics, decision sciences, behavioral sciences or sometime even political science. The Need for Accounting Information Managers do make decisions; and in making decisions, managers need information. As mentioned earlier, managers select one alternative from set of choices. Information comes from a variety of sources, such as economics, finance, marketing, research, production, personnel and, definitely, accounting. Information is processed in a systematic way through the use of an information system. At present, many firms developed their own management information system, run by several key personnel coming from different fields of discipline. This department will provide all information needed by the firm in whatever form. However, this chapter focuses only on the accounting information needed by the management, which is provided by an accounting system ‘Accounting system is a formal mechanism for gathering, organizing, and communicating information about an organization's activities. This system is only one part of the entire Information System of the firm. Both management accounting and financial accounting use accounting system to accomplish their objectives. Without information, no decision will ever be made. Details of accounting information system are discussed in a separate chapter. Managers need information to make decisions about: Acquiring and financing production capacity Determining which products to produce and market Pricing products, jobs or services Determining the best method of distributing goods and services to the target market Locating the best property for production facilities Financing the costs of production and operations vvvvvyv Management accountants should provide both quantitative and qualitative information to assist managers in decision making. Quantitative information allows managers to know the number impact of every alternative choice, while qualitative information furnishes the facts that help eliminate some of the inherent uncertainties related to such alternative choices. Managers are information users, while accountants are information providers. Management accountants play an important role in management functions or process. These functions, as discussed in detail, are: > Planning - is the process of translating the goals and objectives of an organization and developing a strategy for achieving those goals in a systematic manner. Managers depend heavily on jen planning are ahctract achievements while, objectives are desired auantifiable achievements for a period of time. These objectives must be logically desired results based on goals. > Controlling - is the process of setting performance standards, measuring performance, periodically comparing actual performance with standards, and taking correctiveChapter 1 Strategic Cost Management and Management Accounting 3 ‘measures or actions when operations do not conform with what is expected. Managers must exert their best efforts to achieve what was planned, > Performance evaluation - is the process of determining the degree of success in accomplishing the plan. It is done to determine if the actual results materially differ ‘with what was set by the firm. It tries to equate bath effectiveness and efficiency. As the performance has been measured by the control process, managers must evaluate the effectiveness and efficiency of that performance. + Effectiveness — is a meacnre of how well an organization's goals and objectives are achieved. It compares actual output results to desired results and determines the successful accomplishment of an objective. + Efficiency - is a measure of the degree to which tasks were ders to produce the best yield at the lowes that it ‘measures the degree to which a satisfactory relationship occurs when comparing, outputs to inputs. > Decision making - is the process of choosing among the possible solutions available to a given problem situation. The manager's ability to choose the best solutions or the most acceptable alternative course of action depends on the manager's ability to make good decisions. Organizational Structure Organizational structures vary from firm to firm, but the role ofa finance officer is fairly the same. Organizational structure refers to how authority as well as responsibility for making, decisions is distributed in the organization. Segments need to be organized according to their missions in order to effectively define segments, manage resources, and implement strategies. To achieve such, a good organizational chart must depict the flow of authority and responsibility, The chart will show lines of authority and lines of responsibility. The line going, down depicts the line of authority and the same line going up depicts the line of responsibility. This chapter limits its chart to the department that will show the flow of information as well as the functions of responsible officers for such information. The most common officers involve in the financial information are: Chief Executive Officer (CEO) Chief Financial Officer (CFO) The Treasurer ‘The Comptroller or Controller The Chief Accountant, ‘The CFO normally revorts to the President or to the CFO. The CFCs key enhordinates, sasurer and the controller, or the chief accountant. The treasurer has direct responsibility for managing the firm's cash and marketable securities, for planning its capital structure, for selling stock and bonds to raise capital, and for overseeing the corporate pension fund. The treasurer also handles the credit and collection, inventory management and capital budgeting. Although in some firms these are handled by the controller. The controller is1 Strateaic Cost Manas i responsible for the activities of the accounting and tax departments. That is why, normally, a controller is a CPA by profession. Presented is a typical business organization where the financial functions are located: President Vice-President: Sales ‘Vice-President: Finance || Vice-Pres: Manufacturing Te Sri gs ig al ee eee Setneees seas irae Disector Inventory || of Capital Cost Financial Tex t Manager [| Budgeing | | Accountin || Accountin || Department | { z g i coat s i ‘The Changing Role of a Traditional Accountant's Function to a Financial Manager's Function Information system and financial management is now the name of competition among firms. Good financial management will help any business provide: > better products or services to its customers > pay higher wages and salaries to its workers and employees, and even managers > greater returns to the investors who put up capital needed to form the company and then operate the firm, Since the economy, both national and worldwide, consists of customers, employees, and investors, sound financial management contributes to the success of any economic entity. One way to become good financial officer or manager is to have a sound understanding of financial management functions and the need for accounting information. The traditional accountant’srt 3c Cost Mans ment Accountin function is to provide information about the firm’s financial activities for decision making. Management accountants became users of this information and introduced many changes towards better management decisions. Some of these changes include: > A shift towards addressing the needs of service companies and improving practices to better serve and meet the needs of managers Improved practices which include a focus on managing the value chain through techniques such as JIT (Just-in-time) system and ERP (Enterprise Resource Planning) The use of balanced scorecard in order to attain a more comprehensive view of the company's operations. w v Financial Management Responsibilities ‘The primary task of a financial manager is to plan fer the acqisitian and nce af frrnds So as to maximize the value of the firm. that is, he or she makes decisions about alternative sources and uses of funds. Some of its specific activities are: > Forecasting and planning - The financial manager must coordinate or interact with other executives as they iointly Innk ahead and formulate plans, which will shape the firm’s future position. Capital investment and financing decisions - On a long-term basis, the financial manager must raise the capital needed to support growth, A successful firm usually achieves a high rate of growth in sales, which requires increased investment in the plant, equipment, and current assets necessary to produce goods and services. The financial officer must help determine the optimal rate of sales growth, and decide on the specific investments to be made as well as on the types of fnds fo he nsed tn finance these investments, such as thc use of inter! varsne evternal finde: nea of long term versus short term debt. v > Controlling and coordinating - The financial manager must interact with other executives i.e,, (CEO, COO) so that the firm could operate as efficiently as possible. All business decisions have financial implications and all managers whether financial, operation or marketing, need to take this into account. For instance, marketing decisions affect sales growth, which in turn changes in capital requirements. Therefore the marketing managers must consider the effect of their credit policies while production managers must consider plant capacity utilization. Basic Duties of Controller In some firms, a separate controller or comptroller is employed other than the financial manager. The basic duties of a controller are: > Planning, controlling, designing, installing, and maintaining the cost accounting, system > Predicting future costs > Coordinating the development of the budget > Accumulating and analyzing actual costsChapter 1_ Strategie Cost Management and Management Accounting 10 Preparing and analyzing performance reports Preparing reports for external users Providing information for special decisions Consulting with management as to cost information Internal auditing Tax administration Protection of assets Economic appraisal vvvvvVVY Basic Duties of Treasurer ‘The treasurer who is, basically, one of the members of the board of directors is positioned to the organization to handle the following basic duties: Financial planning or fund management Obiaining funds to finance the acquisition of fixed assets Evaluating the acquisition of fixed assets Short-term finance sourcing or managing working capital needed Banking and custody Managing the pension fund ‘Managing foreign exchange transactions Credits and collection Distribution of corporate earnings to owners VV VV viv In summary, the major responsibilities of financial management whether they are financial managers, controllers, and treasurers involve decisions such as: 1. which investments the firm should make; 2. how their projects should be financed; and 3, how managers of the firm can most effectively protect and manage its existing resources. In line with these, future financial executives can perform their individual functions effectively if they are equipped with a better understanding of management accounting, organizational structure and professional ethics as well as good management accounting systems. Professional Ethics for Management Accountants As discussed earlier, management accountants are both information providers and users whose main goal is to maximize shareholders wealth, Maximizing shareholders wealth should be achieved subject to ethical constraints. Users of information generally assume that whatever information the accounting systems generates, is presented and used in an ethical manner. However, it was found to be otherwise, and in recent years, the magnitude and severity of “white collar crime” has increased almost global in nature. Thus, in the United States, the Sarbanes-Oxley Act of 2002 has been passed to reduce the apparent conflicts of interest that exist in many corporate structures, One of the major thrust of this act is to reduce the number of situations in which a conflict of interest can arise and to hold management more accountable forChapter 1 Str jement and Management Accot the financial and operating information they communicate to the public. All corporations and their executives have been subjected to scrutiny. This resulted to force firms to establish corporate ethics guidelines and policies to cover employees and executives’ actions in dealing with all corporate constituents. The adoption of these high ethical standards strengthens companies’ competitive positions by reducing the potential losses on litigations, creating and maintaining positive image, and building stakeholders’ confidence. Companies developed guidelines for good corporate governance. Corporate governance is a system of organizational control that is used to define and establish lines of responsibility and accountability among major participants in the corporation. These participants include the shareholders, board of directors, officers and managers and other stakeholders. The organizational chart of the company shows the corporate governance. A more detailed job responsibilities and accountabilities will be done within each branch, center, departments or divisions. Ethical conduct is a necessary asset of a management accountant. The credibility of the information provided, analyses done, and opinions offered depends heavily on the reputation of the responsible accountant. As required and should be expected from all managers, management accountants in particular must maintain integrity and ethical behavior and must make top management aware of any unethical behavior done by the people within the organization. The management accountant must promote and encourage ethical behavior in all aspects of business life. The Institute of Management Accountants (IMA) believes ethics is a comerstone of its organization and recognizes the importance of providing ethical guidelines. Standards of Ethical Conduct for Management Accountants, issued by IMA, formerly National Association of Accountants (NAA): Statements on Management Accounting: Objectives of Management Accounting, Statement No.1B, New York, N.Y., June 17, 1982 is outlined below. Adherence to these standards is integral to the achievement of management accounting objectives. Management accountants shall not commit acts contrary to these standards nor shall they condone the commission of such acts by others within the organization. Ethical Conduct development oftheir knowledge and skils. > Perform their professional duties in accordance with laws, regulations, and technical standards. > Prepare complete and clear reports and recommendations after appropriate analyses af ralovant and roliahle information 2. Confidentiality - Management accountants ibility to: > Refrain from disclosing confidential information acquired in the course of their work, except when authorized, unless legally obligated to do so > Inform subordinates as appropriate regarding the confidentiality of information acquired in the course of their work and monitor their activities to assure the maintenance of that confidentiality.11 Strategic Cost Management and Management Accountin > Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage either personally or through third parties. 3, Integrity - Management accountants have the responsibility to: > Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. > Refrain from engaging in any activity that would prejudice their ability to carry out their duties ethically. > Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions. > Refrain from either actively or passively subverting the attainment of the organization's legitimate and ethical objectives. > Recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity. > Communicate unfavorable as well as favorable information and professional judgments or opinions. > Refrain from engaging in or supporting any activity that would discredit the prokeseiaiie 4, Objectivity - Management accountants have the responsibility to: > Communicate information fairly and objectively > Disclose fully all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, comments, and recommendations presented. Resolution of Ethical Conflict In applying the standards of ethical conduct, management accountants may encounter problems in identifying unethical behavior or in resolving an ethical conflict. When faced with significant ethical issues, management accountants should follow the established policies of the organization bearing on the resolution of such conflict. If these policies do not resolve the ethical conflict, management accountants should consider the following course of action: > Discuss such problems with the immediate superior except when it appears that the superior is involved, in which case the problem should be presented initially to the next higher management level. If satisfactory resolution cannot be achieved when the problem is initially presented, submit the issues to the next higher managerial level. > If the immediate superior is the chief executive officer, or equivalent, the acceptable reviewing authority may be a group such as the audit committee, board of directors, board of trustees, or owners. Contact with levels above the immediate superior should be initiated only with the superior’s knowledge, assuming the superior is not involved. > Clarify relevant concepts by confidential discussions with an objective advisor to obtain an understanding of possible courses of action.rt Stra Management and Management, > If the ethical conflict still exists after exhausting all levels of internal review, the management accountant may have no other recourse on significant matters than to resign from the organization and to submit an informative memorandum to an appropriate representative of the organization. Except where legally prescribed, communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate. Some basic terms to note in management process: > Administrative management ~ is an appro inciples that can be used by managers to coordinate the internal activities of organizations. > Functional authority - the authority of staff depa' in the organization in ators ralated directly to their respective functions. > Functional managers - are managers who have responsibility for a specific specialized area of the organization and supervise mainly individuals with expertise and training in that area. > Functional structure - is a structure in which positions are grouped according to their main functional or specialized aren oe > Functional-level strategy - is a type of strategy that focuses on action plans for managing a particular functional area within a business in a way that supports the business-level strategy. > Goal commitment - is one’s attachment to, ordeterminatics ‘conch. > Operating plans - contain the details necessary to implement and maintain an organization’s strategies. > Strategic goal - is broadly defined targets or future end results set by top management. > Strategic management - is a process through which managers formulate and implement strategies geared toward optimizing strategic goal achievement, with given available environmental and internal conditions. > Grand strategy - is a master strategy that provides the basic strategic direction at the corporate level. > Strategy formulation is the process of identifying the mission and strategic goals, conducting competitive analysis, and developing specific strategies. It is the foundation level of organizational planning. > Strategy implementation ~ is the process of carrying out strategic plans and maintaining control over how those plans are carried out. > Total Quality Management (TQM) - is a management system that is an integral part of an organization's strategy and is aimed at continually improving product and service quality 50 as to achieve high levels of customer satisfaction and build strong customer loyalty. ‘Management Accounting Information System "The new source of power is not money in the hands ofthe few, but information in the hands of the many." -- John Naisbit “Knowledge is of two kinds. We know a subject ourselves or we know we can find information upon it” - Samuel Johnsons At this point in the history of computing and information processing, the most talked about information is management information system. Management information system hasChapter 1 Strategic Cost Management and Management Accounting 4 been defined by many information system experts. They say it's a method, a function, an approach or even as an organization. Some of which are enumerated below for whatever we think would be best appropriate to the need of the organization or management: > is a business system that provides past, present, and projected information about a company and its environment - David M. Kroenke and Kathleen A Nolan > is a formal method of making available to management the accurate and timely information necessary to facilitate the decision-making process and enable the organization's planning, control, and operational functions to be carried out effectively - James A F. Stoner is the system that monitors and retrieves data from the environment, captures data from transactions and operations within the firm, filters, organizes, and selects data and presents them as information to managers, and provides the means for managers to generate information as desired - Robert G. Maurdick ¥ ‘The way we obtain and use information has forever changed the way we as a society go about the routine of living. Today, timely information can be made available and readily accessible to those who need it. As we emphasized in the preceding chapter, information is the name of competition among firms. Knowing and understanding information is a must to every manager. We routinely deal with the concepts of data and information in our everyday activities. We produced information from data to help us make decisions for thousands of situations each day. In many industries, computer based information systems are becoming a powerful competitive weapon because organizations are able to handle larger amounts of information timely and in better ways. Designing a Management Accounting System Managers and management accountants must be attuned to the individual or unique characteristics of their organizations, and each firm requires a management accounting system that is tailored to its circumstances, such as: organizational form, structure, and culture. > The firm’s legal nature must be reflected in its organizational form (proprietorship, partnership, or corporation). > The firm's organizational structure refers to how authority and) responsibility for decision making are distributed (centralized or decentralized form). > The firm’s organizational culture refers to the underlying set of assumptions about an entity and the goals, processes, practices, and values that are shared by its members. ‘The need to integrate an organization's present information system is another item to consider in designing management accounting system. ‘The systems that are already in placed should be evaluated to determine answers to the following questions: 1. What data is being gathered and in what form? 2, What outputs are being generated and in what form? 3, How do the current systems interact with one another and how effective are those interactions? 4, Is the current chart of accounts appropriate for the management accounting information desired?hapter 1 Strategic Cost Mi nt and Management Account 5. What significant information issues are not presently being addressed by the information system and could those issues be integrated into the current system? Cost-benefit tradeoffs related to the design of the management accounting information system must also be the concern of the management, Proper incentives and reporting systems, must be incorporated into the system for managers to make appropriate decisions. ‘The system must be composed of the three primary elements: 1. Motivational clements ~includec-pariormance moasures,reward structure, support of organizational mission and competitive 2. Informational elements - includes all necessary information related to budgeting, cost control, value added and non-value added activities, and assessment of core competencies and analysis of make-or-outsource decisions. 3. Reporting elements - includes the yacpucton of francs! chtemante fer both, letails of responsibilty accounting system). ‘Management control system (MCS) guides the -organizations—in—designing and implementing strategies such that the organizational goals and objectives are achieved. It has four primary components: 1. a detector or sensor — is a measuring device that identifies what is actually happening in the process being controlle¢————— 2. an assessor ~ is a device for determining the significance of what is happening. Significance is assessed by comparing tive information on what is actually happening, with some standard or expectation of what should be happening. 3. am effector ~ is a device that alters behavior ifthe assessor indicates the need for doing, so. This is what we call “feedback”. eps network—transmits~information-between the detector and the jeen the assessor and the effeetoe-_——— Cost Management System (CMS) consists of a set of formal methods developed for planning and controlling an organizations cost-generating activities relative to its goals and objectives. ts primary goal is to provide the means to develop reasonably accurate product or service costs, requiring that the system be designed to use cost driver information to trace costs to products and services. The product or service costs generated by the CMS constitute the input to managerial processes and such costs are used to: plan, prepare financial statements, assess individual product or service profitability, establish prices for cost-plus contracts, and create a basis for performance measurements. CMS helps managers: > identify the cost of resources consumed in performing significant activities of the firm - the accounting models and practices. > determine the efficiency and effectiveness of the activities performed - performance measurement > identify and evaluate new activities that can improve the future performance of the firm = investment management; andhi teaic Cost 1d Management 16 > accomplishing the first three functions stated above in an environment characterized by changing technology ~ adapting the firm in the changes of technologies. Essential characteristics and qualities of information We describe cars in terms of features, color, and size, just as we describe information in terms of its accuracy and verifiability, completeness, relevance, and timeliness. > Accuracy and verifiablity - The accuracy quality of information refers to the degree to which information is free from error. Information is usually assumed to be accurate unless it is presented otherwise. Sometimes it is not economically feasible to collect information that is 100% accurate. For instance, in a market study being made by a market researcher, the researcher will only interview a fraction of the total target market and then apply the result to the entire potential consumers. At this point, the researcher can state that the information gathered from the sample can be applied to all consumers with a certain degree of confidence, say 90%. Accuracy and verifiability go hand in hand. A decision-maker is reluctant to assume that information is accurate unless it is verifiable. For instance, executives are usually comfortable with the accuracy of financial statements because this could be verified, usually by financial auditor. This is because records are kept of all transactions that impact the financial position of a company. Decision-makers may accept and use unverifiable information, but they do so with caution and skepticism. Too often, with the advangement of technology and use of computers, managers at all levels are ache LE ned information as free from errors. ‘This can be a mistake. Information is only as good as the data from which it is derived. As the saying goes, "Garbnge-in, Garbage-out" or GIGO. Thus, the need for a good information system is inevitable. > Completeness - Information can be completely accurate and verifiable, but it may not necessarily give the entire situation. The completeness quality of information refers to the degree to which it is free from omissions. The amount of information supplied to the decision-maker, of course, is not necessarily related to the completeness of information. Unfortunately, it is normally difficult to say if the information is really complete or incomplete. Benefit-cost analysis is a good example of the importance of considering the completeness of information in the decision-making process. This is what we refer to as sufficient information. The cost of gathering sufficient information may be tos much as o_henefi that i ion. Thus, the user of information must set guidelines to assess the completeness of information he needs. > Relevance - The relevance quality of information refers to the appropriateness of the information as input for a particular decision to be made. Not all information at hand could be relevant to the user. Information overload normally happens. Information overload occurs when the volume of available information is too many that the user cannot distinguish relevant information from that which is not, The primary cause of information overload is the accumulation of information that is not relevant to a particular decision. For example, supplying the full cost of production in a problem of limited capacity utilization,(Chapter 1 Strategic Cost Management and Account iz > Timeliness - The timeliness quality of information refers to the time sensitivity of information. Sensitivity refers to the effect of decision that should have been made if the information was given on time or not given on time. Up-to-date information on today’s trends may be so significant or of great value to a decision-maker, ‘The same information given today may be of less value now than if it has given a month earlier where the decision has to be made. The use of computer contributed a lot in improving the timeliness quality of information than any of the other information qualities. The power of computers has made it possible for managers to have not only the right information, but also the right information at the right time. Today, data processed in weeks could now be processed in minutes. Components of Information Systems (Computer Based System) System, as defined, is a group of components (functions, people, activities, events, etc.) that interface with and complement one another to achieve one or more predefined goals. Information system is a mixture or combination of hardware, software, people, procedures, and data. The term information system is normally referred to as a computer-based system that provides the following: a. Data processing (DP) capabilities of a department or perhaps an entire company, and b. Information - as people need to make better, more informed decisions is inevitable. ‘Major components of a system are: > Inputs ~ are the vari i resources put together required to produce goods and services. > Transformation processes = aie the viganizaiion’s managerial ail teluwlogical abilities that are applied to convert inputs into outputs. > Outputs - are the products, services, information or any other outcomes produced by the organization, > Feedback ~ is the information about the results and organizational status relative to the environment. Purpose of Accounting Information and Need for Accounting Systems ‘The ultimate use of accounting information is to help someone make decisions. This someone could be the company president, production manager, or even the ordinary staff/employee of a company. Despite of so many differences, most organizations prefer a general-purpose accounting system that can supply appropriate’ information to all users of accounting information, Accounting system is also defined as an orderly, efficient scheme for providing accurate financial information and controls. A’ well-defined and organized accounting system helps the firm achieve its goals and objectives generally classified as to:Chapter 1_Strateaic Cost Management and Management Accounting 18 > Operating results - Accounting information enables both internal and external users evaluate organizational performance. > Setting priorities - Accounting information, by way of accounting reports, enables the management to focus on operating problems, imperfections, inefficiencies, and opportunities. Managers set priorities and concentrate on important areas of operations promptly enough for effective action. Problem solving - Problem solving is commonly related with non-recurring decisions or situations that require special accounting analyses or reports. This is the aspect of accounting that quantifies the potential results of possible courses of action and often recommends the best or the most acceptable course of action. v Uses of Accounting System Accounting system is useful for: > Routine reporting to management, primarily for planning and controlling current operations; > Special reporting to management, primarily for long-range planning and short-term but non-recurring decisions; and > Routine reporting on financial and operating results, primarily for external parties. Components of an Accounting Sustom = Just like any system, account mie compoced of > Forms - are the docum=" whi i ‘pico are official receipts, sales invoices, checks and other similar business documents. > Equipment - consists of devices and machines such as computers, cash registers, and other business machines, vaults or even, filing cabinets. > Procedures - are series of operations or steps that must be performed to complete a task, For example, sales order forms will be filled up by the sales person subject to the approval of the authorized person before any delivery will be made. The procedure could be set up or documented by a narrative sales policy or sales flow chart. > People ~ no matter how sophisticated the other components of the organization have, an accounting system can only function efficiently and effectively if the people who are involved in it perform their duties carefully and accurately. General Guidelines in Setting Good Accounting System Design In setting on installing accounting system, the management must consider the following general guidelines: > Flexibility - It is very important that the system is adaptable to meet changing circumstances and demands. > Reliability - Accuracy and timeliness, as we discussed, are both relative and subjective evaluation of information. The system must also be strong and can stand up to misuse, both deliberate and accidentalapter 1 Strategic Cost Management and Management Accounting 2 > Simplicity - As we refer to information overload, the system must be simple and easy to understand by the people in the organization. As normally observed, best ideas are always simple ones and this is true to systems, > Helpfulness - It is not just the achievement of goals and objectives, but also the ‘usefulness of the system to those who have to work with it. As in this computer age, software should be user-friendly to be useful. > Economy - It is always related to the idea of cost-benefit analysis. An accounting, system may be too good but too costly for an organization. > Control mechanisms - Accounting system must contain controls to ensure: + Accuracy - records are checked at various stages of the accounting cycle. + Honesty - effective controls are needed to prevent temptation of mishandling, theft and other possible commission of fraud and irregularities. ‘+ Efficiency and speed - it is essential that the records be designed so that more than one person can work on related records at the same time. This is normally refers to the theory of *check and balance". Elements of Good Internal Control ‘No matter how sophisticated the accounting system is, control can only be effective if it has the following essential elements: > Reliable personnel - Personnel should be given duties and responsibilities appropriate to their interests, experience, and capabilities. > Separation of duties - Recording, and custodianship functions of assets should not be in the hands of one person. No one person must be in complete or total control of any activity. > Supervision ~ Each superior oversees and appraises the performance of his subordinates. > Responsibility - Responsibility of every personnel must be clearly laid out to trace who should be praised and who should be punished. > Document control - This means immediate, complete, and tamper-proof recording. > Job rotations and forced leaves and bonds - key employees handling custodianship functions should be forced to take some vacation leaves and be rotated occasionally and if possible to place bonds. > Periodic review of the system - periodic review of all phases of the system by internal or external auditors are necessary. > Physical safeguards - Safe boxes, locks, and other safety measures must be installed, and limited access to authorized personnel will minimize asset and record losses. > Routine and spot checks - Routine but unscheduled checks must be done by authorized personnel to prevent commission of fraud at any time. > Cost feasibility - Benefits should outweigh costs in setting up internal control systems in all cases. Sources of Accounting Data ‘Accounting system served as the source of financial and non-financial data. Accounting, systems accumulate, classify, store, and report relevant information and convert them intoyhapter 1 Strat ‘Management and Management Aé meaningful information that will meet each user's needs. The common transaction systems in a typical firm are: > Onder (sales or service) Entry System - sales orders from customers are processed and filled, and customers are billed for their purchases. > Cash Receipts System - cash receipts from customers are recorded, and cash is deposited intact. > Purchases. System recorded. > Production Planning and Control System - in manufacturing firms, production schedules are set; purchases are made; materials, labor, and equipment are scheduled; and production output is monitored. > Cash Disbursement System - all payments for purchases and any other activities are made and recorded. > Personnel System - all personnel events are recorded. ae major activities include hiring, giving benefits, evaluation, and payroll activitigne > General Accounting System - data from all other wane, | PMA brought together, and most management reports and financial statements are generated. items for sale or for production use are ordered, received and Elements of a Computerized Accounting System Input Output a =>. Process | >>: tnformation The above flow of system indicates that raw data are entered into the system, (computer if computer-based or book of original entry if manual record keeping) then the system will process necessary activities to convert such into a useful reports known as the information. See example below: DATA PROCESSING INFORMATION Customer's name, details of Invoice prepared and Sales reports generated, items needed by customer |< | approved recorded and | -—», | Daily, weekly or (qty., unit price, etc.) terms billings prepared. monthly by product line “of sale (delivery, payment, TOTAL sales or by territory whatever etc.) summarized isavolicable