Management Accounting - Essay Example

ACCOUNTING INFORMATION FOR DECISION MAKERS ACCOUNTING INFORMATION FOR DECISION MAKERS Introduction Business organisations in general, operate in a competitive environment and need effective management systems for sustenance. They need information systems to continuously measure, monitor and evaluate performance for taking actions to ensure realization of business objectives. Business broadly covers three types of activities respectively Financing, Investing and Operating. Financing is about mobilisation of resources, Investing is about spending funds to commence and continue business and Operating is about running the business that include buying, selling, employing people, paying taxes etc. Accounting deals with financial data that involves it’s processing into useful information and its internal and external communication including periodic reports to the stakeholders. Financial performance measurements of an entity that are communicated internally enable decision makers to optimally utilise the available and potential resources in the conduct of business. Externally communicated information enables differing objectives of shareholders, banks, other creditors and governmental regulatory agencies. This essay focuses on managerial accounting that deals with various aspects of generation and communication of information for internal decision makers and how effectively they are able to utilise these. Accounting systems Financial accounting and Managerial accounting are two overlapping systems that provide information for decision makers, the former focusing on external stakeholders and the latter focusing on internal decision makers. The internal decision makers are top level managers who formulate organisational policies and set objectives, other managers and employees who are involved in the day-to-day operations. Accounting information is used by different stakeholders for their individual purposes. Internal managers who are responsible for day-to-day operations use management accounting information for short-term planning and for the control of “routine operations.” Top management use the same information for deciding on overall policies and long-range plans besides other non-routine decisions such as investing in equipment, pricing of products and services or for identifying areas where focused attention is needed. Horngren (2002, p.5) defines Management accounting as “the process of identifying, measuring, accumulating, analyzing, preparing, interpreting, and communicating information that helps managers fulfil organizational objectives.” Although there are differences between management accounting and financial accounting, “most organisations prefer a general purpose accounting system.” (Horngren, 2002, p.5). Information in the common accounting system serves two purposes. These are: “(1) measurements of, revenues, cost and assets and (2) control.” Besides these, there is a third purpose, namely, choosing the optimum among alternative courses of action. The alternatives “cannot directly come from the management accounting system because each alternative choice problem requires its own arrangement of accounting information, and the formal system cannot feasibly provide all these variations. (Anthony, Robert.N.,Hawkins, David F., Merchant Kenneth A., 2007, p.463). The authors adds that “for each of the three management accounting purposes, there is a set of principles and generalizations applicable to the use of information for that purpose, but not necessarily for the other purposes.” (p.463) The uses of information for each of the three purposes mentioned above are given in Table 1. Table 1 Purpose Uses Historical data Future estimates Measurement Basis for external reporting Normal pricing decisions Analysis of external performance Cost-type contract payments Control Analysis of managerial performance Strategic planning Motivation and rewarding of managers Budgeting Alternative choices None Short-run decisions Capital budgeting Source: (Anthony Robert N, Hawkins, David F., Merchant Kenneth A., 2007, p.463). Budgeting is an important part of planning that conceives the activities of the organisation for a specified period of time (usually one year). Implementation entails managers to take actions to ensure availability of resources needed to achieve planned results and to respond to events that were not anticipated (Anthony Robert N, et al, 2007, p4). Control involves monitoring the results of the plan during stages of operations to identify deviations, to investigate the causes of deviations and for taking corrective steps. For taking full advantage of the accounting system, it is essential for an organisation to generate information covering different segments of the value chain. The value chain, to the extent applicable for particular organisations, include functions such as research and development, design of products, services or processes, production, marketing, distribution and customer service. Riahi-Belkaoui (2002) states that it is vital for managers to concentrate on four areas namely: “(a) customer focus, (b) key success factors (cost, quality, time and innovation), (c) continuous improvement, (d) value chain and supply chain analysis”( p.1). The accounting process should facilitate measurement of the outcome of business activities in all the relevant areas of the value chain and generate useful information in terms of defined organisational and functional objectives that shall be measurable and comparable with the objectives set. The reported measurements enable decision makers to take appropriate steps to overcome any observed deviations. Solving problems encountered is part of the decision making process. Information required to find solutions is many a time, exclusive to the problem and the context. The quality of the information is important to arrive at correct decisions. While decision making is aided or constrained by several other factors, the quality and verity of the information is critical to the solution. The requirement is that the information provider and the user should understand the specifics of the problem and the context. Arnold and Turley (1996, p.32) writes: “If accounting is to provide useful information for decision making, it should recognize the constraint under which users of information actually operate and provide information accordingly.” Understand ability of the information is a user specific quality and usefulness is the “overriding objective.” Other requirements of information quality include relevance reliability, comparability and consistency. Figure 1 below taken from published information, represents the hierarchy of the quality characteristics. The chart also gives the components of the primary qualities required respectively for relevance and reliability. Figure 1 Source: Qualitative characteristics of accounting information (online) Certain constraints are indicated under secondary qualities that are related to information on costing and the materiality constraint that relates to the individual’s perception. The constraints are generally understood to be inabilities in exercising prudence appropriate to the problems for which solutions are sought for. Four types of constraints are generally understood. These are respectively cost benefit, materiality, industry practice and conservatism. The concepts of constraints are explained in FSEB’s conceptual framework (available online). The cost benefit relationship constraint exists when the cost and benefits are not clearly identifiable and measurable or the cost of obtaining the information exceeds the benefit. Materiality is attributed to inability to correctly apply judgement on considerations of professionalism. Constraints in obtaining information on industry practice to benchmark the required performance. Conservatism is another malady that focuses on playing safe when in doubt. Conclusions Providing accounting information for management decision making by itself is a complex process as the information required in individual instances are different in different contexts. Individuals also are constrained due to several organisational factors if decision making is left to individuals. It is very essential for all those involved in the process to interact and understand the issues in the in the correct perspective and provide the correct information. References Anthony, Robert.N.,Hawkins, David F., Merchant Kenneth A., (2007). Accounting: Text and Cases.12th ed.New York: Mc-Graw-Hill Arnold, John.,Turley, Stuart. (1996). Accounting for Management Decisions. 3rd.ed. New Jersey: Prentice Hall. Bhimani, Alnoor, (2003). Management Accounting in the Digital Economy. Oxford: Oxford University Press. Heidmann, Marcus, (2008). The Role of Management Accounting Systems in Strategic Sesemaking.1st ed. Germany: Deutscher Universitas-Verlag. Horngren, Charles T., Sundem, Gary L., Stratton, William O., (2002), Introduction to Management Accounting. 12th ed. ( London: Pearson Education. Obaidat Ahmad N., (2007).Accounting Information Qualitative Characteristics Gap: Evidence from Jordan. International Management Review, 3, 2, 26+ Riahi-Belkaoui, Ahmed., (2002). Behavioral Management Accounting. Westport: Quorum Books. Qualitative characteristics of Accounting, Retrieved May 5 2010. Web site: http://highered.mcgraw-hill.com/sites/0072994029/student_view0/ebook/chapter1/chbody1/qualitative_characteristics_of_accounting_information.html Read More