Chapter 1 — Introduction to Cost Management
CHAPTER 1
INTRODUCTION TO COST MANAGEMENT
Learning Objectives
This chapter presents the fundamental concepts of cost management necessary in
understanding the subsequent chapters.
After studying this chapter, readers must be able to comprehend, demonstrate
and discuss the following:
The concept of management as well as its functions
The difference between financial accounting and management accounting
wh
Line and staff functions
Functions of controller and treasurer
Standards for Ethical Conduct for Management Accountants
TOPIC OUTLINE
As an overview of this chapter, please refer to the concept map below.
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Basic Concepts
Introduction to
pape Line vs. Staff Functions
er VS. Competence
Treasurer
Integrity
Conduct for Management
Accountants ntiali
Objectivity
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Chapter 1 — Introduction to Cost Management
BASIC CONCEPTS
WHAT IS MANAGEMENT?
The word “MANAGEMENT” is a broad concept. It can be defined in various ways
but into:
(1) Asa group of people
To most people within the organization, the term "management" means the
group of people (whether executives or other managers) who are primarily
responsible for decision making in the organization leading to
achievement of organization's goals and objectives.
In other words, management may “make or break” an organization through
decision making.
(2) As a function or process
Management is the systematic process of planning, organizing and
controlling tasks to achieve or meet the goals of organization.
This is actually the traditional view or definition of management. This chapter
will focus on this definition since it enumerates the different functions of
management.
THE FUNCTIONS OF MANAGEMENT
The basic managerial functions or activities are as follows:
(1) Planning
Planning is the process of setting goals and objectives of the firm, whether
short-term or long-term. This includes evaluating and choosing of the best
courses of action or best alternatives in meeting the goals.
Under planning, management must evaluate future contingencies affecting
the organization, and shape the future operational and strategic landscape of
the company.
NOTE: Plans should be SMART (Specific, Measureable, Attainable, Realistic
and Time-bounded).
(2) Directing or Organizing
These are known as tackling activities. Why? Because under this function,
management instructs, guides, and inspires the employees by communicating
with them.
Simply stated, management “taps” the resources of an organization for
better use or consumption which shall be in accordance with the plan.
Management oversees the day-to-day operations to make sure that
everything is functioning smoothly in carrying out the plan.
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Chapter 1 — Introduction to Cost Management
(3) Controlling
Controlling is the process of performance evaluation. It involves evaluation
of actual performance if it conforms to the planned results.
From the word itself, management “controls” the future actions of an
organization by deciding the corrective actions to take if the actual
performance didn’t go as planned.
(4) Decision Making
Decision making was not mentioned on the definition since it is inherent in
all management functions. In other words, all the aforementioned
management functions involve decision making.
WHAT IS MANAGEMENT ACCOUNTING?
Information to be used by management for decision making is provided by
management accountants. Thus, management accounting helps managers within a
company make decisions.
Management accounting is also known as “managerial accounting” or “internal
accounting’. Management accounting is 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 organization and to assure
use of and accountability for its resources. (FAC 1999)
MANAGEMENT ACCOUNTING vs. FINANCIAL ACCOUNTING
In order to properly understand the nature of and principles used by management
accounting, it is important to compare it from financial accounting based on the
following areas of comparison:
Area (1) - Users of Information (The Bottom Line)
The key difference between management accounting and financial accounting
relates to the intended users of the information.
Later on, it will be explained that financial accounting reports should be prepared
and presented in accordance with GAAP or PFRS. Under the Conceptual
Framework, the primary users of general purpose reports are potential and
existing investors, lenders and other creditors, all of which are external users.
Nevertheless, users within the organization such as officers and managers may
use the financial accounting reports if they find them relevant for their decision
making.
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Chapter 1 — Introduction to Cost Management
On the other hand, management accounting reports are intended exclusively to
internal users. Management accounting is aimed at helping managers and other
personnel within the organization make well-informed business decisions.
Area (2) - Restrictive Guidelines
Since the users of financial accounting reports are primarily external users, it is a
must that financial accounting must follow guidelines and standards in preparing
and presenting reports with the objective of addressing the common needs of
those users. Financial accounting is directed in addressing the common needs only
since external users do not have direct access to the financial records of an entity
and the entity does not have an idea about their specific needs on those furnished
reports.
Simply stated, financial accounting must follow GAAP or PFRS as a guide in
providing reports so that it can address the common needs of a wide range of
external users.
On the other hand, since the users of management accounting are exclusively
internal users, management accounting is not bounded by outside guidelines or
rules (GAAP or PFRS). Managerial accounting reports are prepared to address the
specific needs of its users since they are internal decision makers (persons within
the organization that can directly access the records of the organization).
Each company is free to create its own system and rules on managerial reports.
This means there is no centralized system regulating reports and reports can be
modified to address the specific need of the user of the report.
In summary, management accounting is based on business needs and is more
flexible that it does not need to follow any specific structure.
Area (3) - Type of Information
Financial accounting reports present data on the company’s financial health and
performance over a specific period of time. Thus, it is primarily concerned on
presenting monetary or financial information. In addition, according to
Conceptual Framework, the overall objective of financial reporting is to provide
financial information about the reporting entity that is useful to existing and
potential investors, lenders and other creditors in making decisions about
providing resources to the entity.
Management accounting reports are basically used for internal decision making.
Therefore, it presents financial as well as non-financial information since they are
a perfect combination in making economic decisions of an entity. Remember that
managerial accounting reports may be customized (which may include non-
financial information) as long as it is useful for the decision making of
management.
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Chapter 1 — Introduction to Cost Management
Area (4) - Emphasis of Reports
Since the primary users of financial accounting are people outside the
organization, the report emphasizes precision and reliability. The main reason for
this is that the external users do not have a way of validating the contents of the
reports since they do not have access on the financial data of the reporting entity.
In addition, to be reliable, financial statements under financial accounting shall be
faithfully represented. To achieve this, the financial statements shall be free from
error and bias, and also complete. (The ingredients of faithful representation
under the Conceptual Framework)
In contrast, managerial accounting reports focus on relevance and timeliness since
these reports address the specific needs of its users. Relevant and timely reports
provide the maximum aid in management decisions. Reliability and precision are
not the focus of management accounting since its users are internal users (i.e.
management), those that can directly verify the contents of the reports since they
have direct access on the information contained Init. °
Area (5) - Information Source
As mentioned before, the overall objective of providing financial accounting
reports under the Conceptual Framework is to provide financial information
“about the reporting entity” that is useful in decision making of external users.
This means the information contained in financial accounting reports are all about
the reporting entity. In other words, the source of data is within the company
alone; no information about other entities is contained in the financial accounting
report.
On the contrary, managerial accounting reports contain information from any
source (both internal and external data). This is true since the decision of
management might be affected by information outside the entity such as interest
rates, political environment, economic and industry concerns, etc.. The best
example of this is benchmarking. Benchmarking is the practice of comparing
business processes and performance metrics to industry’s bests and best practices
from other companies.
Area (6) - Focus of Analysis
Financial accounting reports tend to be aggregated, concise, and generalized since
it follows certain guidelines (PFRS). This is very evident on PAS 1 where it
requires minimum line items to be presented on the face of the financial
statements, the details of which are disclosed on the notes to financial statements.
However, management accounting reports more detailed, technical and specific.
Management, in making decisions, is always looking for a competitive advantage
by examining multitude of information. This is also the reason why managerial
accounting reports may contain information outside the organization.
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Chapter 1 — Introduction to Cost Management
Area (7) - Frequency of Reporting
Financial accounting reports are prepared periodically. In other words, there is a
specific time-frame for an entity to report which is in accordance with GAAP. Since
the entity doesn’t know when the reports are needed by the external users, PFRS
sets a uniform frequency of reporting. Under PAS 1, an entity shall report a
complete set of financial statements at least annually.
Moreover, financial statements are released on a regular schedule, establishing
consistency of external information flows.
As mentioned before, the exclusive users of managerial accounting are internal
users. This is the reason why reports in management accounting are prepared as
the need arises. Moreover, in managerial accounting, reports run much more
frequently and tend to focus on day-to-day operations.
Area (8) - Time Orientation
The information created through financial accounting is entirely historical;
financial statements contain data for a defined period of time. Financial
accounting processes historical information and summarizes them in the
preparation of financial statements.
Remember that the emphasis of a financial accounting report is reliability. How
could an information be reliable if it didn’t happen in the past? This is again
evident in PFRS. The following definitions were provided under the Conceptual
Framework.
An asset is a present economic resource controlled by the entity as a result of a past
event.
Liability is a present obligation of an entity arising from past transaction or event,
the settlement of which is expected to result in an outflow from the entity of
resources embodying economic benefits.
On the other hand, management accounting deals with the future since decision
making of management affects the future of the organization. Remember that
under relevant costing, what happened in the past cannot be changed anymore
but the future can be changed. Managerial accounting looks at past performance
and creates business forecasts, strategic plans, budgets and estimates, and etc.
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Chapter 1 — Introduction to Cost Management
For the summary of the differences between management accounting and
financial accounting, please see the table below:
—
Financial Management
Areas of Comparison Accounting Accounting
, Internal & External
(1) Users of fl Information (Primarily) Internal (Exclusively)
(2) Restrictive Guidelines PFRS / PAS / GAAP None
. Monetary & Non-
(3) Type of Information Monetary monetary
(4) Emphasis of Report Reliability (Precision) | Relevance (Timeliness)
(5) Information Source Internal Data en
(6) Focus of Analysis Business as a Whole Various Segments
(7) Frequency of Reporting Periodic Whenever needed
(8) Time Orientation Historical Projected Va faery) 5
Historical
Which is more important, management accounting or financial accounting?
Actually, this is a pointless argument as they are used simultaneously to create a
more efficient and profitable organization. While managerial accounting works
more as a problem solver, financial accounting shows exactly what business has
accomplished to date. Each has its own purpose in the business environment.
LINE FUNCTION vs. STAFF FUNCTION
The purpose of both staff function and line function is to ensure that the
organization meets its business objectives. What differentiates these two from
each other is the way they achieve their respective purpose.
LINE FUNCTION
These are people in the organization, the primary activities of which is essential to
the basic operation of business. In other words, Line function is the one which is
directly involved in the core work of an organization. It involves the primary
activities which are required to meet the business objectives, which is to-generate
revenues and profits. (e.g. production, marketing, sales and etc.) Managers with
line authority exercise downward authority or the authority to give command.
STAFF FUNCTION
Staff function belongs to those individuals or groups in an organization who
provide services and advices to line mangers. Simply, they are supportive in
nature because they provide assistance to the line function. Staff functions include
human resources, maintenance, legal and accounting.
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Chapter 1 — Introduction to Cost Management
Since most of the students are having difficult times in mastering this topic, kindly
use the next sample exercise regarding line and staff functions.
From the given positions below, identify which of them is considered as a line o,
staff function.
1. Vice President for productions 6. Sales Manager
2. Head Security of the grocery store 7, Production Manager
3. Chief Accountant 8. Head of the Legal Counsel
4. Human Resource Manager 9. Bagger of a supermarket
5. Pilot of an airline company 10. Vice President of Finance
Answers:
1. Line Function 6. Line Function
2. Line Function 7. Line Function
3. Staff Function 8. Staff Function
4. Staff Function 9. Line Function
5. Line Function 10. Staff Function
To summarize the explanation of the answers, if the position is directly related to
(1) the operations of the business such as production and sales or (2) is revenue
generating activity such as marketing, it is considered as a line function.
Otherwise, it is considered as staff function.
CONTROLLER vs. TREASURER
Controllership and treasurership constitute corporate finance. A controller has a
different function from treasurer in order to make corporate finance successful. As
a rule on segregation of incompatible duties, the above functions should NOT be
combined on the same person.
Controllership is the practice of the established science of control which is the
process by which management assures itself that the resources are procured and
utilized according to plans in order to achieve the company’s objectives.
A controller is known as the chief accountant. Its main function is related to
supervision of record keeping, taxation, reporting as well as processes to attain
the objectives of internal control.
Treasurership is concerned with the acquisition, financing and management of
assets of a business to maximize the wealth of the firm for its owners.
A treasurer, on the other hand, serves as the protector of a company’s value and
finances from financial risk that arises from business activities. A treasurer deals
with money, cash or wealth of an organization. They must know the sources of
money and exercises prudence on handling, using and managing the money of the
organization.
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Chapter 1 - Introduction to Cost Management
To summarize the functions of controller and treasurer, please see the table
below:
Controller's Functions Treasurer's Function
Reporting and Interpreting Data Provision of Capital
Tax Administration Investor Relations
Government Reporting Short-term Financing
Management Audit Banking and Custody of Funds
Internal Audit Credit and Collections
Government Reporting Investments and Insurance
Economic Appraisal
Protection of Assets
Planning and Controlling
STANDARDS OF ETHICAL CONDUCT FOR MANAGEMENT
ACCOUNTANTS
Institute of Management Accountants or IMA is the association of accountants and
financial professionals in business and considered as one of the largest and most
respected associations focused exclusively on advancing the management
accounting profession.
IMA has been committed to advocating the highest standards of ethical business
practices - both for its members and the profession at large - since the
organization was founded in 1919.
Since practitioners of management accounting have an obligation to the
organization they serve, their profession, the public and themselves to maintain
the highest standard of ethical conduct, IMA has promulgated the following ethical
standards:
(1) COMPETENCE
e Maintain an appropriate level of professional leadership and expertise
by enhancing knowledge and skills.
e Perform professional duties in accordance with relevant laws,
regulations, and technical standards.
e Provide decision support information and recommendations that are
accurate, clear, concise, and timely. Recognize and help manage risk.
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Chapter 1 — Introduction to Cost Management
(2) CONFIDENTIALITY
Keep information confidential except when disclosure is authorized 0,
legally required.
Inform all relevant parties regarding appropriate use of confidentia|
information. Monitor to ensure compliance.
Refrain from using confidential information for unethical or illega|
advantage.
(3) INTEGRITY
Mitigate actual conflicts of interest. Regularly communicate with
business associates to avoid apparent conflicts of interest. Advise all
parties of any potential conflicts of interest.
Refrain from engaging in any conduct that would prejudice carrying out
duties ethically.
Abstain from engaging in or supporting any activity that might discredit
the profession.
Contribute to a positive ethical culture and place integrity of the
profession above personal interests.
(4) CREDIBILITY or OBJECTIVITY
Communicate information fairly and objectively.
Provide all relevant information that could reasonably be expected to
influence an intended user’s understanding of the reports, analyses, or
recommendations.
Report any delays or deficiencies in information, timeliness, processing,
or internal controls in conformance with organization policy and/or
applicable law.
Communicate professional limitations or other constraints that would
preclude responsible judgment or successful performance of an activity.
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