Peter Atrill and Eddie McLaney PEARSON Harlow, England London New York Boston San Francisco Toronto Sydney Auckland Singapore Hong Kong Tokyo Seoul Taipei New Delhi Cape Town Sao Paulo Mexico City Madrid Amsterdam Munich Paris Milan
Contents Guided tour of the book Guided tour of MyAccountingLab Preface How to use this book Acknowledgements Introduction to management accounting Introduction Learning outcomes What is the purpose of a business? How are businesses organised? How are businesses managed? 1 Establish mission and objectives 2 Undertake a position analysis 3 Identify and assess the strategic options 4 Select strategic options and formulate plans 5 Perform, review and control The changing business landscape Setting financial aims and objectives Enhancing the owners' wealth Balancing risk and return What is management accounting? How useful is management accounting information? Providing a service But... is it material? Weighing up the costs and benefits Management accounting as an information system It's just a phase... What information do managers need? Reporting non-financial information Influencing managers' behaviour Reaping the benefits of IT From bean counter to team member Reasons to be ethical Management accounting and financial accounting Not-for-profit organisations XVIII xx xxii xxiv xxvi 1 1 2 3 6 7 8 9 9 10 11 12 12 15 16 18 18 19 20 22 23 25 26 27 28 29 30 32 34
VIII CONTENTS Summary 35 Key terms 37 References 37 Further reading 37 Review questions 38 Exercises 38 Relevant costs for decision making 40 Introduction 40 Learning outcomes 40 What is meant by 'cost'? 41 A definition of cost 42 Relevant costs: opportunity and outlay costs 43 Sunk costs and committed costs 47 Qualitative factors of decisions 48 Self-assessment question 2.1 49 Summary 50 Key terms 51 Further reading 51 Review questions 52 Exercises 52 Cost-volume-profit analysis 58 Introduction 58 Learning outcomes 58 Cost behaviour 59 Fixed cost 59 Variable cost 61 Semi-fixed (semi-variable) cost 62 Analysing semi-fixed (semi-variable) costs 63 Finding the break-even point 64 Contribution 69 Contribution margin ratio 70 Margin of safety 70 Achieving a target profit 73 Operating gearing 73 Operating gearing and its effect on profit 74 Profit-volume charts 75 The economist's view of the break-even chart 76 Failing to break even 77 Weaknesses of break-even analysis 78 Using contribution to make decisions: marginal analysis 81 Pricing/assessing opportunities to enter into contracts 82 The most efficient use of scarce resources 83 Make-or-buy decisions 85 Closing or continuation decisions 88
CONTENTS ( IX Self-assessment question 3.1 90 Summary 90 Key terms 91 Further reading 91 Review questions 92 Exercises 92 Full costing 97 Introduction 97 Learning outcomes 97 Why do managers want to know the full cost? 98 What is full costing? 99 Single-product businesses 100 Multi-product businesses 101 Direct and indirect cost 101 Job costing 103 Full (absorption) costing and the behaviour of cost 104 The problem of indirect cost 105 Overheads as service renderers 106 Job costing: a worked example 106 Selecting a basis for charging overheads 110 Segmenting the overheads 112 Dealing with overheads on a cost centre basis 113 Batch costing 124 Non-manufacturing overheads 125 The forward-looking nature of full (absorption) costing 125 Self-assessment question 4.1 127 Using full (absorption) cost information 128 Criticisms of full (absorption) costing 130 Full (absorption) costing versus variable costing 130 Which method is better? 132 Summary 133 Key terms 135 Reference 135 Further reading.... 135 Review questions, 136 Exercises 136 Costing and pricing in a competitive environment 141 Introduction 141 Learning outcomes 142 Cost determination in the changed business environment 142 Costing and pricing: the traditional way 142 Costing and pricing: the new environment 143 Cost management systems 143 The problem of overheads 144 Taking a closer look 144
CONTENTS Activity-based costing 145 Attributing overheads 146 Benefits of ABC 147 ABC versus the traditional approach 147 ABC and service industries 147 Criticisms of ABC 152 Self-assessment question 5.1 154 Other costing approaches in the modern environment 155 Total (or whole) life-cycle costing 155 Total quality management 158 Costing quality procedures 159 Target costing 160 Kaizen costing 162 Benchmarking 162 Pricing 164 Economic theory 164 Some practical considerations 172 Full cost (cost-plus) pricing 173 Pricing on the basis of relevant/marginal cost 176 Target pricing 178 Pricing strategies 178 Summary 180 Key terms 182 Further reading 182 Review questions 183 Exercises. 183 Budgeting Introduction 187 Learning outcomes 188 How budgets link with strategic plans and objectives 188 Collecting information on performance and exercising control 189 Time horizon of plans and budgets 191 Limiting factors 192 Budgets and forecasts 192 Periodic and continual budgets 192 How budgets link to one another 193 How budgets help managers 196 The budget-setting process 198 Step 1: Establish who will take responsibility 198 Step 2: Communicate budget guidelines to relevant managers 199 Step 3: Identify the key, or limiting, factor 199 Step 4: Prepare the budget for the area of the limiting factor 199 Step 5: Prepare draft budgets for all other areas 199 Step 6: Review and co-ordinate budgets 200 Step 7: Prepare the master budgets 200 w
CONTENTS Step 8: Communicate the budgets to all interested parties 200 Step 9: Monitor performance relative to the budget 200 Using budgets in practice - 202 Incremental and zero-base budgeting 203 Preparing the cash budget 206 Preparing other budgets 210 Activity-based budgeting 213 Self-assessment question 6.1 215 Non-financial measures in budgeting 216 Budgets and management behaviour 216 Who needs budgets? 216 Beyond conventional budgeting 217 Long live budgets! 220 Summary 222 Key terms 223 References 223 Further reading 223 Review questions 224 Exercises 224 Accounting for control 231 Introduction 231 Learning outcomes 232 Budgeting for control 232 Types of control 234 Variances from budget, 235 Flexing the budget 236 Sales volume variance ~ 237 Sales price variance 240 Materials variances 241 Labour variances 242 Fixed overhead variance 244 Reasons for adverse variances 248 Variance analysis in service industries 250 Non-operating profit variances 250 Investigating variances 250 Compensating variances 253 Making budgetary control effective 254 Behavioural issues 255 The impact of management style 256 Failing to meet the budget 258 Budgets and innovation 258 Self-assessment question 7.1 259 Standard quantities and costs 260 Setting standards 261 Who sets the standards?, 261
Xii i CONTENTS How is information gathered? 261 What kind of standards should be used? 261 The learning-curve effect 262 Other uses for standard costing 263 Some problems... 264 The new business environment 266 Summary 267 Key terms 269 Reference 269 Further reading 269 Review questions 270 Exercises 270 Making capital investment decisions 274 Introduction 274 Learning outcomes 27A The nature of investment decisions 275 Investment appraisal methods 276 Accounting rate of return (ARR) 278 ARR and ROCE 279 Problems with ARR 280 Payback period (PP) 282 Problems with PP 284 Net present value (NPV) 287 Interest lost 288 Risk 288 Inflation 289 What will logical investors do? 290 Using present value tables. 293 The discount rate and the cost of capital 295 Why NPV is better 295 NPV's wider application 296 Internal rate of return (IRR) 296 Problems with IRR 301 Some practical points 301 Investment appraisal in practice 305 Self-assessment question 8.1 307 Investment appraisal and strategic planning 308 Dealing with risk 309 Assessing the level of risk 309 Reacting to the level of risk 319 Managing investment projects 320 Stage 1: Determine investment funds available 321 Stage 2: Identify profitable project opportunities 321 Stage 3: Evaluate the proposed project 322
Xl'i ; CONTENTS How is information gathered? 261 What kind of standards should be used? 261 The learning-curve effect 262 Other uses for standard costing 263 Some problems... 264 The new business environment 266 Summary 267 Key terms 269 Reference 269 Further reading 269 Review questions 270 Exercises 270 Making capital investment decisions 274 Introduction 274 Learning outcomes 27'4 The nature of investment decisions 275 Investment appraisal methods 276 Accounting rate of return (ARR) 278 ARR and ROCE 279 Problems with ARR 280 Payback period (PP) 282 Problems with PP 284 Net present value (NPV) 287 Interest lost 288 Risk 288 Inflation 289 What will logical investors do? 290 Using present value tables 293 The discount rate and the cost of capital 295 Why NPV is better 295 NPV's wider application 296 Internal rate of return (IRR) 296 Problems with IRR 301 Some practical points 301. Investment appraisal in practice. 305 Self-assessment question 8.1 307 Investment appraisal and strategic planning 308 Dealing with risk 309 Assessing the level of risk 309 Reacting to the level of risk 319 Managing investment projects 320 Stage 1: Determine investment funds available 321 Stage 2: Identify profitable project opportunities 321 Stage 3: Evaluate the proposed project 322
CONTENTS Stage 4: Approve the project 322 Stage 5: Monitor and control the project 322 Summary 325 Key terms 327 Reference 328 Further reading 328 Review questions 329 Exercises 329 Strategic management accounting 335 Introduction 335 Learning outcomes 336 What is strategic management accounting? 336 Facing outwards 337 Competitor analysis 337 Customer profitability analysis 341 Competitive advantage through cost leadership 345 Total life-cycle costing 346 Target costing 347 Kaizen costing 348 Value chain analysis 348 An alternative view 351 Translating strategy into action 353 The balanced scorecard 354 Measuring shareholder value 360 The quest for shareholder value 360 How can shareholder value be created? 361 The need for new measures 361 Net present value (NPV) analysis 363 Extending NPV analysis: shareholder value analysis (SVA) 364 Measuring free cash flows 365 Business value and shareholder value 367 Managing with SVA 369 The implications of SVA 370 Economic value added (EVA ) 371 EVA and SVA compared 376 EVA or SVA? 378 Just another fad? 380 Self-assessment question 9.1 380 Summary 381 Key terms 382 References 382 Further reading 382 Review questions 383 Exercises : 383
XIV > CONTENTS Measuring performance 387 Introduction 387 Learning outcomes 387 Divisionalisation 388 Why do businesses divisionalise? 388 Types of divisions 388 Divisional structures 388 Is divisionalisation a good idea? 389 Measuring divisional profit 394 Contribution 394 Controllable profit 395 Divisional profit before common expenses 395 Divisional profit for the period 396 Divisional performance measures 397 Return on investment (ROI) 398 Residual income (Rl) 400 Looking to the longer term 402 Comparing performance 404 EVA revisited 405 Self-assessment question 10.1 406 Transfer pricing 407 The objectives of transfer pricing 408 Transfer pricing and tax mitigation 410 Transfer pricing policies 412 Market prices 412 Variable cost 413 Full cost 413 Negotiated prices 414 Divisions with mixed sales 415 Differential transfer prices 417 Transfer pricing and service industries 419 Non-financial measures of performance 419 What is measured? 420 Choosing non-financial measures 423 Who should report? 423 Summary 424 Key terms 426 Further reading 427 Review questions 428 Exercises 428 Managing working capital 433 Introduction 433 Learning outcomes 433 What is working capital? 434 Managing working capital 435
CONTENTS j XV The scale of working capital 435 Managing inventories 438 Budgeting future demand 440 Financial ratios 440 Recording and reordering systems 440 Levels of control 443 Inventories management models 444 Economic order quantity 444 Materials requirement planning systems 447 Just-in-time inventories management 448 Managing receivables 449 Which customers should receive credit and how much should they be offered? 450 Length of credit period 452 Cash discounts 455 Debt factoring and invoice discounting 456 Credit insurance 456 Collection policies and reducing the risk of non-payment 456 Self-assessment question 11.1 460 Managing cash 460 Why hold cash? 460 How much cash should be held? 461 Controlling the cash balance 462 Cash budgets and managing cash 463 Operating cash cycle 464 Cash transmission 468 Bank overdrafts 468 Managing trade payables 469 Taking advantage of cash discounts 470 Controlling trade payables 471 Summary 472 Key terms. 474 Further reading 474 Review questions 475 Exercises 475 Appendix A: Glossary of key terms 482 Appendix B: Solutions to self-assessment questions 491 Appendix C: Solutions to review questions 501 Appendix D: Solutions to selected exercises 511 Appendix E: Present value table 551 Index 553