Accounting is an information system. It exists to provide information for the end-user. It is possible to distinguish between two branches of accounting.

1 Financial accounting.

The purpose of financial accounting is to report the financial performance of the company. It’s main focus is on external reporting to a number of groups viz.

Owners (shareholders)

Loan creditors (banks)

Trade creditors (suppliers)

Sundry creditors (suppliers of services)

Government agencies (tax authorities)

Employees (trade unions)

A set of financial statements - a profit and loss account, a balance sheet and a cash flow statement are prepared and published.

2 Management accounting

The main purpose of management accounting is to provide information to the management team at all levels within the organisation for the following purposes:

(a) formulating the policies - strategic planning

(b) planning the activities of the organisation - corporate planning

(c) controlling the activities of the organisation

(d) decision-making - long-term and tactical

(e) performance appraisal at strategic and operational level

Definition: Management accounting is the application of professional knowledge and skill in the preparation and presentation of accounting information in such a way as to assist management in the formulation of policies and in planning and controlling the operations of the organisation.

Let us look at a simple financial statement.

Example Financial Accounts

	£	£
Sales		30,000
Cost of sales		24,000
		--------
Gross profit		6,000
		--------
Deduct
Administration expenses	2,000
Selling and distribution expenses	1,000
	--------	3,000
		--------
Net profit		3,000
		--------

Financial accounts indicate the results of a business over a period of time. They deal with historic or past costs and are concerned with stewardship accounting.

A management accounting/ cost statement provides information to allow managers to plan, control and organise the activities of the business. The purpose of a costing/maagement accounting information system is:

To provide information about product costing to be used in financial

Statements.

To provide information for planning, controlling and organising.

The information provided by the costing system should be:

Relevant

Reliable

Timely

Succinct

Presented in the desired format.

A cost system should be

Cost effective

Appropriate for the organisation

Encourage managerial action.

Example Management Accounts

		Products
	A	B	C	Total
Materials	£4,800	£3,700	£6,500	£15,000
Wages	1,500	2,500	3,000	7,000
Prod. overhead				2,000
	-------	-------	-------	-------
Prod. cost	6,800	6,800	10,400	24,000
Admin. costs				2,000
Selling costs				1,000
	-------	-------	-------	-------
Total cost	7,800	8,000	1,200	27,000
Sales	10,240	10,800	8,960	30,000
Profit	2,240	2,800	----	3,000
(Loss)	----	----	(2,240)	----
Net profit margin	24%	26%	----	10%
	-------	-------	-------	-------

This performance statement is of the same business as the previous example of

Financial accounts. However, it gives management much more information. It analyses the cost elements in respect to materials, labour and overheads allowing management to focus on costs which require investigation and control. It facilitates decision-making. E.g. should product C be discontinued?

Compared to the financial accounts the management accounting information which is much more comprehensive will allow management to better carry out their functions of planning, controlling organising and decision-making.

Cost classification

The management accountant will use cost information for two main reasons.

To ascertain the cost of a product. This information is used to value stock which is required for external reporting.

To assist management in the decision-making process.

Depending on the cost objective the costs will be classified into a number of categories.

(a) By nature of resource

(i) Materials

(ii) Labour

(iii) Other Expenses

(b) By type of cost

(i) Direct Costs

(ii) Indirect Costs - Overheads

(c) By function

Production, Administration, Selling and Distribution

(d) By the behaviour of costs

(i) Fixed or Periodic Costs

(ii) Variable Costs

(iii) Semi-fixed, or Semi-variable Costs

Cost Objectives

(a) Product costing

It is essential for an organisation to ascertain the cost of manufacturing a product. The information is used for two purposes: