LEARNING UNIT 1: INTRODUCTION TO MANAGEMENT

ACCOUNTING

SPECIFIC LEARNING OUTCOMES FOR THIS LEARNING

UNIT

After studying this learning unit you should be able to:

x describe the role of the management accountant

x describe the purpose of a management accounting system

ASSESSMENT CRITERIA

After working through this learning unit, you should be able to do the following:

x describe the difference between management accounting information and financial

accounting information
x describe the functions of a management accounting system

OVERVIEW

This learning unit is divided into the following sections:

1.1 Introduction
1.2 Management accounting and financial accounting
1.3 Functions of a management accounting system

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1.1 INTRODUCTION
The purpose of this learning unit is to introduce you to the field of management accounting, to
describe the functions of a management accounting system and to explain how management
accounting differs from financial accounting.

When you enrolled for your studies at Unisa this year, you had a certain goal in mind. That goal
was likely to increase your knowledge, pass the examination and improve your chances of
securing a successful career. To achieve this goal, you would have to make sure that you dedicate
enough time to your studies to master the learning outcomes. In order to ensure that you dedicate
sufficient time to each module that you have enrolled for, you would have prepared a study
programme (plan) to indicate by when you should have mastered each section of the material in
each module. Your daily plan will contain a list of the sections of the modules you would study on
any specific day. (Of course, when preparing your study plan, you will have to consider your other
responsibilities as well, such as the responsibilities you have towards your family and your
employer.) Throughout the year, you will check (monitor) your progress through your planned
studies on a regular basis (e.g. weekly or monthly) and adjust the plan (control) where necessary
to ensure that you will achieve your goal.

The preceding paragraph indicates that you have to plan, monitor and control in order to achieve
your goals.

The concepts planning, monitoring and control are central to business studies.

In your Business Management module, you will learn that every successful organisation will
prepare a strategic plan. This plan will ultimately assist every employee of that organisation to
focus on achieving the goals and objectives of the organisation. The strategic plan of an
organisation will typically include the following:

¾ its mission (i.e. a declaration of what it is that the organisation wishes to accomplish)
¾ its vision (i.e. what the organisation wishes to pursue in order to accomplish its mission)
¾ its goals and objectives (i.e. the "things" the organisation wishes to achieve by a future date,
and the steps that it will take in each period leading up to that date to ensure success)
¾ its value statement( i.e. a declaration of the organisation's core beliefs)

The strategic planning process entails envisioning what the future of the organisation should be in
the long term, ensuring this vision is aligned to the mission of the organisation, translating the
vision into broadly defined goals to be achieved in the medium term and formulating the goals into
more detailed and measureable objectives to be achieved in the short term.

The goals and more detailed objectives are disseminated into operational plans for each unit (e.g.
the accounting department, the production department, etc) indicated in the organigram (a
graphical representation of the structure of the organisation). The operational plan for each unit is
then developed into individual performance plans for each employee. Operational and
performance plans are monitored and controlled regularly to ensure that the goals will be achieved.

Management accounting plays an important role in the planning, monitoring, controlling and
decision-making processes in the organisation.

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Note that we write its vision, its mission, etc., and not it's vision, it's mission, etc.
The general rule is that, when you omit a letter in a word, you must write an apostrophe (') in its
place. It's means "it is"; we indicate the missing letter i in is with an apostrophe.
Another rule is that 's indicates possession, as in This is Thabo's book.', meaning the book belongs
to Thabo. The apostrophe is never used to indicate possession in personal pronouns; we always
write hers, ours, its, etc. That is why we write its vision, its mission, etc.
The apostrophe is also never used to indicate the plural of a word; we write books and not book's
when we wish to indicate more than one book. Book's means "book is".

Activity 1.1 (myUnisa Forum)

1 What is the purpose of strategic planning?

2 Why is it necessary to develop the strategic plan into operational plans per department?

1.2 MANAGEMENT AND FINANCIAL ACCOUNTING

We often hear people describing themselves as accountants. Does that mean that they all do the
same kind of work? The answer to this question is "No"! In the engineering profession, we find
civil engineers, electrical engineers, structural engineers, etc. Likewise, the accounting profession
lends itself to specialisation. Accountants may therefore work as financial accountants,
management accountants, tax accountants, etc. Depending on the size of organisation, one may
also find cost accountants, financial managers, etc.

In this module, we introduce you to the world of the management accountant and financial
manager. In practice, one person is often responsible for both the management accounting and
financial management functions in an organisation.

1.2.1 Financial accounting

In your studies of financial accounting, you will find that in essence, financial accounting entails
the following:
¾ recording the business transactions in the accounting records of an entity
¾ reporting the financial results of the operations and the financial position and cash flows of the
entity in accordance with the prescriptions of applicable legislation and reporting standards

Recording of business transactions

We initially record business transactions in journals (e.g. the purchases/creditors journal,
sales/debtors journal, cash receipts journal, cash payments journal, petty cash journal, salaries
and wages journal and the general journal). We post these journals in summary form to accounts
in the general ledger. We extract a trial balance containing the balances of all the accounts from
the general ledger from time to time.

Financial reporting
The trial balance serves as basis for the preparation of the following financial statements: the
statement of profit or loss and other comprehensive income, the statement of financial position,
the statement of changes in equity, the statement of cash flows and the notes to the financial
statements. These financial statements are often included in a printed book called the annual
report of that entity.

The financial statements of companies must comply with the requirements of, amongst others, the
Companies Act and International Financial Reporting Standards (IFRS). The financial statements

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of government departments and public entities must comply with the requirements of, amongst
others, the Public Finance Management Act and Generally Recognised Accounting Principles
(GRAP)

All public companies, government departments and public entities must submit their financial
statements to external auditors for audit. Companies appoint external auditors (firms like
Ernst & Young) at the annual general meeting of the company. The Auditor-General of South
Africa audits government departments and public entities.

The purpose of the external audit is to establish if the financial statements of (1) an organisation,
which were prepared for the (2) past financial year are a (3) true and fair reflection of the
organisation's affairs, profit or loss, cash flows and financial position and were prepared (4) in
compliance with the applicable laws and prescribed reporting standards. The audited financial
statements are presented to various (5) stakeholders of the organisation. For example, a company
would submit its audited financial statements to its shareholders, the South African Revenue
Service (SARS), banks, etc. Government departments must submit their audited financial
statements to parliament and its various committees.

The focus of financial accounting is clearly

(1) on the whole organisation (i.e. not only a section thereof)

(2) on the past and not the future
(3) on accuracy, as the auditors must be able to verify that the financial statements are true and
fair
(4) in compliance with legislation and prescribed standards
(5) external, meaning that information is presented to parties outside the organisation (i.e.
parties not on the payroll of the organisation)

In your financial accounting courses, you will study the detail of the recording and reporting of
financial transactions.

SARS is the abbreviation for the South African Revenue Service and not Services. Likewise,
SAPS is the abbreviation for the South African Police Service and not Services. There is only
one revenue service and only one police service.

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1.2.2 Management accounting
While financial accounting focuses on the preparation of information and reports for use by parties
external to the organisation, management accounting is concerned with providing information to
managers internal to the organisation (i.e. people inside and on the payroll of) the organisation.

In your business management studies, you will learn that the functions of management are
planning, decision-making, monitoring and control. Management accounting provides information
that assists with the following:
¾ planning, for example, by using historical data to make future projections that will help
management with medium and long-term planning and budgeting
¾ decision-making, for example, by preparing reports on the expected cash flows of two or
more projects so that the relevant manager can use this information when deciding which
project to embark upon
¾ monitoring and control, for example, by preparing reports of actual expenditure compared to
budgeted expenditure

It should be clear that management accounting focuses

¾ on the whole organisation as well as sections (e.g. departments) thereof
¾ more on the future than on the past
¾ on timely and relevant information used in decision-making rather than accurate and
verifiable information
¾ internally (i.e. present reports to parties internal to the organisation)

Unlike financial accounting, there are no prescripts for the preparation of management accounting
reports. In management accounting, managers can decide on the most appropriate format and
content of the internal reports for the execution of their duties. However, they must always be
aware that the cost of preparing the reports should not outweigh the benefits of the information
contained in the reports.

Ethical issues facing management accountants

Management accountants must always act with great integrity when faced with ethical dilemmas.
The following are a few examples of ethical issues:
Management accountants must be competent to prepare and present relevant information to
management for decision-making. Some management decisions may have far-reaching
consequences for other people. For example, management may decide to shut down part of the
operations of the company based on a report prepared by the management accountant; this may
result in some employees being retrenched, and some of those retrenched may not be skilled
enough to find alternative employment.
Managers may put pressure on management accountants to manipulate reports for the board of
directors. Management accountants must maintain their credibility and do all their reports without
bias.
Management accountants will also have access to sensitive and confidential information about the
company. They must keep this information confidential and should never be tempted to use it for
personal gain.

1.2.3 A brief history of management accounting

In economics, one learns about different economic systems. Mercantilism (the regulation of
international trade by the state) was one of these systems and dominated in Europe before the
19th century. According to mercantilism, national prosperity is achieved by ensuring that exports
exceed imports by as wide a margin as possible. The Industrial Revolution was one of the factors

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that led to mercantilism's appearance in history books. During the Industrial Revolution in the 19th
century, most businesses were owner managed. Therefore, there were no shareholders and
owners personally had to provide security for any debt of the business. In this type of business,
management accounting was far more important than financial reporting. It is only with the
burgeoning of publicly-owned companies in the 20th century that the need for audited financial
statements became essential for raising capital and calculating and paying taxes, leading to a shift
in focus from management accounting to financial accounting.

In the first part of the 20th century, management accounting aimed only to ensure that financial
accounting requirements were met. Indeed, in these early years the discipline was referred to as
cost accounting, and its purpose was merely to determine the cost of products, services, projects,
etc., so that the correct amounts could be reported in the financial statements.

As companies became more complex, it became clear that management accounting should also
be more inward focussed and forward looking to supply managers with relevant information for
decision-making.

Activity 1.2 (myUnisa Forum)

1. What are the two main objectives of financial accounting?

2. What is management accounting concerned with?
3. What are some of the ethical dilemmas that management accountants may have to face?
4. Distinguish between the focus of financial accounting and management accounting by
completing the following table:

Focus Financial accounting Management accounting

Users
Time
Verifiability/Relevance
Accuracy/Timeliness
Whole organisation/Segments
Legal compliance requirements

Feedback on activity 1.2

4. The difference in focus between financial accounting and management accounting:

Focus Financial accounting Management accounting

Users External users Internal users
Time Past Past and future
Verifiability/Relevance Verifiable for accuracy Relevant for decision-making
Accuracy/Timeliness Accuracy more important than Timely information more important
time of reporting within than absolute accuracy
prescribed deadlines
Whole organisation/Segments Whole organisation Whole organisation and segments
Legal compliance Relevant laws and standards None
requirements

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1.3 FUNCTIONS OF A MANAGEMENT ACCOUNTING SYSTEM

Up to now, we have referred to organisations and entities rather than companies. The reason is
that we wanted you to understand that management accounting is important for any organisation,
regardless of whether that organisation is a company, government department, public entity,
university or non-profit organisation. The purpose of this section is to introduce you to the functions
of a management accounting system in a business environment, and therefore we will mostly refer
to companies.

Many practising management accountants are members of the international body, the Chartered
Institute of Management Accountants (CIMA). CIMA (www.cimaglobal) defines management
accounting as follows:
Management accounting may be defined as the process of identification, measurement,
accumulation, analysis, preparation, interpretation, and communication of information (both
financial and operating) used by management to plan, evaluate and control within an organisation
and to assure the responsible use of and accountability for its resources.
Management accounting, therefore, is an integral part of the management process. It provides
information essential for

x controlling the current activities of an organisation

x planning its future strategies, tactics and operations
x optimising the use of its resources
x measuring and evaluating performance
x reducing subjectivity in the decision-making process
x improving internal and external communication

By now, you will understand that the objective of management accounting is to assist management
in the planning, monitoring, control and decision-making processes of the company by making
useful information available timely. A properly designed management accounting information
system (of which the cost accounting system is a sub-system) will provide timely and relevant
information required by managers for the efficient execution of their duties and responsibilities.

The functions of the management accounting system are to

x collect and store data
x modify and process the data into useful information
x analyse and interpret data and information

and then to
x communicate useful information to management

in order to assist management in their

x planning and strategic decision-making responsibilities and

x monitoring and control responsibilities

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Data can include numbers, text, graphics, video, etc. or any combination of these. Information is
data that has been processed and converted into a format that is meaningful to managers.

Collection and storage of data

We collect data about issues that could affect the organisation from various sources, such as the
financial accounting system, the cost accounting system, economic forecasts, newspapers and
business journals, which is then stored until required.

Modification and processing of data

The data collected from the various sources is not necessarily in a format that management can
understand easily. This is because individuals forming part of management will have different
backgrounds and therefore different knowledge levels. For example, the technical manager will
not have the same level of understanding of the financial statements as the financial manager.
We therefore have to modify data and present it as information in a format that management can
use in decision-making. For example, the financial statements may contain a single figure
representing the sales of the organisation. Management accounting can use the data on sales
that was collected from various sources to indicate the make-up of sales per product, geographical
area, etc. and to present this information in graphic format to the management of the organisation.

Analysis and interpretation

By analysing and interpreting data and information, management accounting can assist
management in strategic decision-making. Let's use a manufacturing company that is
manufacturing three products. By analysing and interpreting data, management accounting can
establish which sales mix is best for the company. The management accountant then presents
this information to management for a final decision. (Sales mix refers to the combination in which
products are manufactured and sold, for example, 100 units of product A, 170 units of product B
and 80 units of product C per month.)

Communication
Reporting is a very important function of the management accounting system. Management
accounting must prepare different types of reports periodically for dissemination to various
departments and management. These reports often contain graphs, diagrams and other graphics
to make them easily to understand. It is essential for the success of the organisation that
individuals who have to act on these reports understand them clearly. The following are examples
of the reports typically prepared by the management accounting system:
¾ margin analysis reports to determine the profit (and ultimately the cash) that is generated per
product, geographical area, etc.
¾ breakeven analysis reports to indicate the level of sales mix at which the company breaks
even (i.e. where it makes neither a profit nor a loss)
¾ trend analysis reports to identify unusual variances over a period so that these variances
could be investigated and reported to management
¾ capital budgeting reports to determine if long-term assets are required and, if so, what the
best option for financing the acquisition would be

Monitoring and control

As indicated earlier, management accounting plays an important role in providing managers with
the required information to monitor and control performance within their sections. It is essential
that deviations from plans are reported in a timely manner to allow for corrective action. Note that
management accounting is not responsible for control in an organisation; it is merely responsible
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to provide timely and relevant information to managers so that managers can monitor and control
to ensure that they achieve their goals as efficiently as possible.

Strategic decision-making
Management is often required to make complicated decisions, for example whether to
manufacture a product or to buy it from another company. By employing a range of analyses and
appraisal methods, management accounting can prepare useful reports to assist management in
making their decision.
As mentioned earlier, the cost accounting system is a sub-system of the management accounting
system. We discuss the cost accounting system in learning unit 3.

Activity 1.3 (myUnisa Forum)

Briefly explain each of the following functions of a management accounting system:

x collection and storage of data
x modification and processing of data
x analysis and interpretation
x communication
x monitoring and control
x strategic decision-making

1.4 SELF-ASSESSMENT QUESTIONS

QUESTION 1

With reference to the functions of a good management accounting system, briefly explain by
means of an example how the system can assist the management of a manufacturing company
in its planning and control responsibilities.

QUESTION 2

Describe the differences between management accounting and financial accounting.

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1.5 SOLUTIONS TO SELF-ASSESSMENT QUESTIONS

QUESTION 1

The functions of the management accounting system are the following:

¾ collecting and storing of data

¾ modifying and processing of data for supplying useful information for decision-making
¾ analysing and interpreting data and information
¾ communicating useful information to management
¾ monitoring and control
¾ strategic decision-making

The objective of a management accounting system is to provide management at all levels with
information they can use for sound decision-making. The information that can be obtained to
prepare the production plan for a company is an example of how a good management accounting
system can assist the factory management with their planning and control responsibility.

A good management accounting system collects and stores data that is reliable for planning,
forecasting and decision-making. The system collects data from a variety of sources and stores
the data until required. Although the main source of data is the financial accounting system, the
management accounting system is not restricted to the use of monetary data (i.e. data relating to
money) only.

For example, while preparing the company's annual budget, the management accounting system
will use past data of products sold from the stores records and classify it according to product,
quality and time taken to produce. This data is analysed with other collected data and stored, for
example data obtained from consumer surveys and economic forecasts. The analysis is then
interpreted and an opinion about various alternative courses of action is communicated to senior
management for a decision.

Although senior management makes broad policy decisions, the day-to-day decisions are left to
lower levels of management. Senior management will decide on the product line and sales mix
target, but the management of the production department must prepare a production schedule of
when to produce what and in what quantities in order to achieve the targets. Management
accounting can assist these managers by using inventory strategy models to determine how many
orders they should place for materials purchases and in what quantities.

The management accounting system will also monitor the performance of all departments. Any
deviations from the approved plans are presented in reports. The reports are then communicated
to the relevant managers in a format that they can easily understand so that they can control their
performance by adjusting plans timeously. This control aims to efficiently facilitate the
accomplishment of plans. A variance analysis for the production department is an example of a
report generated through the control function. A variance analysis will indicate, amongst other
things, the planned production quantities compared to the actual production quantities and the
actual quantities of materials used compared to the quantities planned for. Factory management
can then use these reports to investigate the variances and take corrective action as required.

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QUESTION 2

Financial accounting prepares the annual financial statements of the entity in compliance with
relevant prescriptions (e.g. applicable laws and reporting standards) and for parties external to the
entity. Financial statements are based on the past performance of the entity as a whole and are
subject to external audit. Therefore, financial statements rather focus on fair presentation than
timely presentation.

Management accounting prepares a variety of reports for the internal management of the entity to
assist them in the execution of their responsibilities. These internal reports are not subject to
legislation and reporting standards. Management reports contain information on past performance
(e.g. a comparison of actual expenses and budgets), scenario planning for the future as well as
project comparisons for the present and can be intended for the whole entity or only segments
thereof. Internal management reports are not subject to external audit. Internal reports rather focus
on timely presentation than complete accuracy.

---oOo---

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