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Summary IMA - Accounting for decision making and control
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Summary of 48 pages for the course Intermediate Management Accounting at UVT
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Chapter 1: IntroductionA: Managerial Accounting: Decision making and control
The term information system should not be interpreted to mean a single, integrated system. Most
information systems consist not only of formal, organized, tangible records (payroll, purchasing
documents) but also informal, intangible bits of data (memos, managers’ impressions and opinions).
The firm’s information system also contains non-financial information (customer satisfaction).
The internal accounting system, an important component of a firm’s information system, includes
budgets, data on the costs of each product and current inventory and periodic financial reports.
These accounting reports are the only formalized part of the information system providing
knowledge for decision making, especially in small firms. Accounting information is useful to help
manage the inflow and outflow of resources and to help align the owners’ and employees’ interests,
not matter what objectives the owners wish to pursue. All successful firms must devise mechanisms
that help align employee interest with maximizing the organization’s value. All of these mechanisms
constitute the firm’s control system; they include performance measures and incentive
compensation systems, promotions, demotions and terminations, security guards and video
surveillance, internal auditors and the firm’s internal accounting system.
Internal accounting systems serve two purposes: (1) to provide some of the knowledge necessary for
planning and making decisions (decision making) and (2) to help motivate and monitor people in
organizations (control). Using one system gives rise to the fundamental trade-off in these systems:
some ability to deliver knowledge for decision making is usually sacrificed to provide better
motivation.
B: Design and use of cost systems
Managers make decisions and monitor subordinates who make decisions. Both mangers and
accountants must acquire sufficient familiarity with cost systems to perform their jobs. Accountants
are charged with designing, improving and operating the firm’s accounting system. Both managers
and accountants must understand the strengths and weaknesses of current accounting systems.
An internal accounting system should have the following characteristics:
- Provides the information necessary to assess the profitability of products or services and to
optimally price and market these products or services
- Provides information to detect production inefficiencies to ensure that the proposed products
and volumes are produced at minimum cost
- When combined with the performance evaluation and reward systems, creates incentives for
managers to maximize firm value
- Supports the financial accounting and tax accounting reporting functions
- Contributes more to firm value than its costs.
Figure 1-1 (5) portrays the functions of the accounting system. It supports both external and internal
reporting systems. The accounting procedures chosen for external reports to shareholders and taxing
authorities are dictated in part by regulators. The Securities and Exchange Commission (SEC) and
the Financial Accounting Standards Board (FASB) regulate the financial statements issued to
shareholders. The Internal Revenue Service (IRS) administers the accounting procedures used in
calculating corporate income taxes.
If the firm is involved in international trade, foreign tax authorities prescribe the accounting rules
applied in calculating foreign taxes. Management compensation plans and debt covenants often rely
on external reports.
Internal reports are often used for decision making as well as control of organizational problems. The
internal accounting system provides one important source.
Inexpensive accounting software packages and falling costs of information technology have reduced
some of the costs of maintaining multiple accounting systems. However, confusion arises when the
systems report different numbers for the same concept. Using the same accounting system for
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,multiple purposes saves time and increases the credibility of the financial reports for each purpose.
Probably the most important reason firms use a single accounting system is it allows reclassification
of the data.
C: Marmots and grizzly bears
Economists and operating managers often criticize accounting data’s usefulness for decision making.
Accounting data are often not in the form managers want for decision making.
“The searching for marmots exceeded the calories obtained from their consumption, searching for
marmots is an inefficient use of the bear’s limited resources and thus these bears should become
extinct”. “The bears survive, the benefits of consuming marmots must exceed the costs”. The
marmot-and-bear parable is an extremely important proposition in the social sciences known as
economic Darwinism. In a competitive world, if surviving organizations use some operation
procedure over long periods of time, then this procedure likely yields benefits in excess of its costs.
Economic Darwinism suggests that in successful (surviving) firms, things should not be fixed unless
they are clearly broken. Currently, considerable attention is being directed at revising and updating
firms’ internal accounting systems because many managers believe their current accounting systems
are “broken” and require major overhaul. Alternative internal accounting systems are being
proposed, among them activity-based costing (ABC), balanced scorecards, economic value added
(EVA) and lean accounting systems.
Two caveats must be raised concerning too strict an application of economic Darwinism:
- Some surviving operating procedures can be neutral mutations. Just because a system survives
does not mean that its benefits exceed its costs. Benefits less costs might be close to zero.
- Just because a given system survives does not mean it is optimal. A better system might exist but
has not yet been discovered.
The fact that most managers use their accounting system as the primary formal information system
suggests that these accounting systems are yielding total benefits that exceed their total costs. These
benefits include financial and tax reporting, providing information for decision making and creating
internal incentives.
D: Management accountant’s role in the organization
Figure 1-2 (10) presents one common organization chart. The design and operating of the internal
and external accounting systems are the responsibility of the firm’s chief financial officer (CFO). The
firm’s line-of-business or functional areas are combined and shown under a single organization
“operating divisions”. The CFO oversees all the financial and accounting functions in the firms and
reports directly to the president. The CFO’s three major functions:
- Controller: tax administration, the internal and external accounting reports, planning and control
systems
- Treasury: short- and long-term financing, banking, credit and collections, investments, insurance
and capital budgeting
- Internal audit: reporting directly to the CFO, controller, CEO or board of directors
The controller is the firm’s chief management accountant and is responsible for data collection and
reporting. Usually, each operating division has its own controller.
The internal audit group’s primary roles are to seek out and eliminate internal fraud and to provide
internal consulting and risk management (SOX).
To reduce the likelihood of embezzlement, firms install internal control systems, which are an
integral part of the firm’s internal control system. Internal and external auditors’ first responsibility is
to test the integrity of the firm’s internal control. Internal control systems include internal
procedures, codes of conduct and policies that prohibit corruption, bribery and kickbacks. Finally,
internal control systems should prevent intentional financial misrepresentation by managers.
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, E: Evaluation of management accounting: A framework for change
Since 1975, two major environmental forces have changed organizations and caused managers to
question whether traditional management accounting procedures are still appropriate. These
environmental forces are (1) factory automation and computer/information technology and (2)
global competition. These changes force managers to reconsider their organizational structure and
their management accounting procedures.
Figure 1-3 (14) is a framework for understanding the role of accounting systems within firms and the
forces that cause accounting systems to change. An organizations architecture is composed of three
related processes: (1) the assignment of decision-making responsibilities, (2) the measurement of
performance and (3) the rewarding of individuals within the organization.
Changes in the business environment lead to new strategies and ultimately to changes in the firm’s
organizational architecture, including changes in the accounting system to better align the interests
of the employees with the objectives of the organization. The new organizational architecture
provides incentives for members of the organization to make decisions which leads to a change in
the value of the organization.
F: Vortec medical probe example
Example on pages 15 – 18
The Robinson-Patman Act is a U.S. federal law prohibiting charging customers different prices if
doing so is injurious to competition.
Four key points: beware of average costs, use opportunity costs, supplement accounting data with
other information and use accounting numbers as performance measures cautiously.
Chapter 2: The nature of costs
A: Opportunity costs
“The cost of doing anything consists of the receipts that could have been obtained if that particular
decision had not been taken”. This notion is called opportunity cost – the benefit forgone as a result
of choosing one course of action rather than another. The alternative actions comprise the
opportunity set. Before making a decision and calculating opportunity cost, the opportunity set itself
must be enumerated. Thus, it is important to remember that opportunity costs can be determined
only within the context of a specific decision and only after specifying all the alternative actions. The
opportunity cost concept focuses managers’ attention on the available alternative courses of action.
The next best alternative is the opportunity cost if you have multiple choices.
1: Characteristics of opportunity costs
- Opportunity costs are not necessarily the same as payment: the opportunity cost of obtaining
some good or service is what must be surrendered or forgone in order to get it.
- Opportunity costs are forward looking: they are the estimated forgone benefits from actions that
could, but will not, be undertaken. In contrast, accounting is based on historical costs: the
resources expended for actions actually undertaken.
- Opportunity costs differ from (accounting) expenses: opportunity cost is the sacrifice of the best
alternative for a given action. An (accounting) expense is a cost incurred to generate a revenue.
Financial accounting is concerned with matching expenses and revenues. In decision making, the
concern is with estimating the opportunity cost of a proposed decision.
2: Examples of decisions based on opportunity costs
Example on pages 24-28
Sunk costs are expenditures incurred in the past that cannot be recovered.
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