University of London (LSE)

(UOL AC2097) Management Accounting

(2020 Academic Year)

Ms Joanna Chia

Session 1 Lecture Notes

Management Accounting and its Strategic Context
Future Trends in Strategic Management
Accounting

For SIM Students’ Use Only

Do not distribute or upload to websites or reproduce in any form.
Not to be reproduced for sale.

DEFECTS ARE INHERENT IN THE ORIGINAL COPY

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 LESSON PLAN
SESSION TOPICS

Management Accounting and its Strategic Context

01
Future Trends in Strategic Management Accounting
02 Cost Behaviour and Cost Estimation
03 Cost-Volume-Profit Analysis

04 Full Absorption Costing Methods: Overhead Allocation

05 Full Absorption Costing Methods: Job & Batch Costing

Activity-based Costing (ABC)
06
*Assignment 1
07 Activity-based Management (ABM)

08 Inventory, Process Costing and Capacity Management 1

09 Inventory, Process Costing and Capacity Management 2

10 Decision-Making
Long-term Decision Making and Capital Budgeting
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*Assignment 2
Theory and Practice of Pricing, Decisions under Scarce Resources
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and Linear Programming
13 Strategic Budgeting and Control 1

14 Strategic Budgeting and Control 2

Variance Analysis 1
15
*Assignment 3
16 Advanced Variance Analysis 2

17 Divisional Performance Measurement Systems

Transfer Pricing
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*Assignment 4
Cost Management: Target Costing; Life Cycle Costing and Just-In-
19
Time (JIT) Production
20 Quality Cost Management and Environmental Accounting
The Balanced Scorecard, Benchmarking, The Building Block
21
Model, and Customer Profitability Analysis
22 Revision 1

23 Revision 2

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* Assignment release date. The individual assignments are to be submitted within two
weeks after the release of the assignments. The marked assignments will be returned
about three weeks after submission.

Note:
Students are expected to read the lecture notes, the subject guide and any other
materials before every session. After each session, students are expected to attempt the
tutorial questions that are available from the lecture notes. From the second session
onwards, a review of the previous session’s topic and solutions to some of the tutorial
questions will be worked out, so do always bring along the current session’s materials
together with the previous session’s and your solutions to the tutorial questions.

Essential Reading

Bhimani A., C.T. Horngren, S.M. Datar and M. Rajan Management and Cost Accounting.
(Harlow: Pearson Education, 2019) 7th edition. [ISBN 9781292232669]

Do obtain a copy of this UOL recommended textbook and read the relevant
chapters. Work out the questions to gain a better understanding of the
topics.

Further Reading:

Drury, C., 2018, Management and Cost Accounting, 10th Edn, Cengage Learning
EMEA, UK. [ISBN 9781473748873]

Horngren, Charles T., Datar, Srikant M. & Rajan Madhav V., 2015 Cost
Accounting: A Managerial Emphasis, 15th Edition, Pearson, England.
[ISBN:9781292018225]

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 Session 1

Management Accounting and its Strategic Context

1.0 Introduction to Management Accounting

The Institute of Management Accountants define management accounting as:

“a value-adding continuous improvement process of planning, designing, measuring, and

operating both nonfinancial information systems and financial information systems that
guides management action, motivates behaviour, and supports and creates the cultural
values necessary to achieve an organisation’s strategic, tactical, and operating
objectives.” (Atkinson, Kaplan & Young 2004, p 3)

Management accounting ‘is the process of measuring, analyzing, and providing

operational and financial information’, both financial and non-financial, that guides
managerial action, motivates and assists managers(internal users) to fulfill the
organizational’s goals. (Horngren, Datar & Rajan 2015, p. 26).

The primary function of management accounting is to provide information that assists

management to make better decisions and function efficiently and effectively, in the short
as well as the long term. Management accounting information is used by managers to
‘develop, communicate and implement strategy’ and also ‘to coordinate product design,
production and marketing decisions and to evaluate performance.’ (Horngren et al 2015,
p. 26).

The information is used by managers in their planning, controlling, continuous

improvement and decision making.

• Planning - detailed formulation of future actions such as setting objectives and

goals and identifying methods to meet those goals. Eg. The budget - a financial
plan, is the most important planning tool
• Controlling – monitoring a plan’s implementation, using feedback to ensure the
goals of the plan are being met and taking corrective actions as needed (Hansen
& Mowen 2006, p. 14)
• Continuous Improvement – ‘the relentless pursuit of improvement in the delivery
of value to customers’ (Turney & Anderson 1989, pp.37-47). Finding ways to
increase efficiency through reducing waste, improving quality reducing costs
including cost management - managing costs. (Hansen & Mowen 2006)
• Decision making – choosing among competing alternatives e.g. should we make
product A or B to maximise profit?

1.1 Differences between Management Accounting and Financial Accounting

The key difference between management accounting and financial accounting is that
management accounting information is aimed at helping managers within the
organization make decisions, but, in contrast, financial accounting is aimed at providing
information to external users - parties outside the organization. (www.investopedia.com)

The major differences are presented in the chart below which were taken from the UOL
Management Accounting Examiner’s 2009 Zone B’s report and with some adaptation
from the textbook, Horngren et al (2015, p. 26) Exhibit 1-1.

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 Management Accounting Financial Accounting
(i) Purpose of Help managers with Communicate
information operational and strategic organisation’s financial
decision making to fulfil position to investors,
organisational goals. banks, regulators and
other outside parties.
(ii) Primary users Managers of External users as above
organisations
(iii) Focus and Present- and future- Past-orientated
emphasis orientated
(iv) Rules on Measures and reports do GAAP
measurement not have to follow GAAP. National Company law
and reporting Based on cost-benefit Audit required.
analysis.
(v) Time span and Varies from hourly Annual and quarterly
types of report information to long-range financial reports, income
planning (e.g. 15-20 statement, balance
years). Reports on sheet, cash flow
products, departments, statement in required
territories. Regular and formats. Mostly
ad hoc reports. summarised to cover
Operational and company as a whole
strategic. Includes with some segmental
financial and non- reporting.
financial reports.

(vi) Behavioural Designed to motivate / Mainly reports on

implications influence managerial economic events but
and other employees also influences
behaviour behaviour as the
compensation of the
managers and
employees are often tied
to the financial results
reported

1.1.1 Purpose of information:

Financial accounting produces financial information in general purpose financial reports

for a broad range of users – investors, lenders, regulators and other outside parties while
management accounting reports are designed and produced for specific management
purposes – to help managers make better decisions.

1.1.2 Primary Users:

Financial accounting information is mainly for external users while management

accounting information is for internal users.

1.1.3 Focus and emphasis : Time horizon

Financial accounting is past orientated – it reflects what has happened in terms of the
performance and position to date, it is backward looking.
Management accounting is future-oriented - forward-looking and provides information
that concerns the future performance but do compare it to the past performance as well.

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However, financial accounting reports do give some information about the future in times
when they are required to raise capital (eg rights issue) or fend off unwanted takeover
bids.

1.1.4 Rules of Measurement and Reporting - Restrictions:

Financial accounting and reporting is subject to legislation and accounting regulations,

that is, they must abide by the each and every rule in the law such as the Companies
Act, stock exchange listing rules and the accounting standards. However, there are no
restrictions on the form or content for management accounting reports as they are for
internal use only.

1.1.5 Time span and types of report - Reporting interval

Financial accounting reports are normally required to be made annually; however, large
companies do produce monthly, quarterly and semi-annual reports. Management
accounting reports may be produced at any time, as frequently as required by the
management; some reports are produced daily, weekly or monthly allowing managers
timely information to check on the progress of that unit.

1.1.6 Range of information:

Financial reports provide information that is more likely to be reliable as it is based on

historic data using the historical cost concept and its emphasis is on the use of objective
and verifiable evidence using mainly information that can be quantified in monetary
terms(monetary concept).

Management accounting information may include financial information but also include
non-financial information such as quality, physical quantities of inventory, process times
and customer satisfaction. Some of the information are futuristic, such as forecasts and
projections to the future, that may be less objective and verifiable, but more relevant to
managers.

1.1.7 Level of Detail:

Financial accounting reports provide information on the financial performance, financial

position and cash flows of the organisation for the accounting period. Information is
aggregated and not much detail is given.

Management accounting reports often provide lots of details to managers to assist them
with a particular decision or to monitor and control the activities.

1.2 Cost Accounting

Cost Accounting is the process of measuring, analyzing and reporting financial and
nonfinancial cost information relating to the resource acquisition or use. Cost
Accounting forms a major part of Management Accounting, is concerned with "The
classification, recording and appropriate allocation of expenditure in order to determine
the total cost of products or services".

Cost accounting is concerned with:

• Ascertaining the costs.
• Controlling the costs.
• Reducing the costs.

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Cost Accounting provides information both for Management Accounting and Financial
Accounting such as the product cost that is required by the financial accounting for
inventory valuation but is used in management accounting for decision making purposes
such as the choice of the most profitable product to sell, for cost management in the
process, materials usage, design, etc.

Cost accounting today, takes the perspective that cost information collection is a function
of management decisions, so it is not so clearly to make a distinction between
management accounting and cost accounting. (Horngren et al 2009)

1.3 Strategic Decisions and the Management Accountant

– The Role of Management Accountants in Implementing Strategy

Management accounting today, provides the necessary information for managers to

make decisions that can lead the organizations they are managing to outstanding
performances. Horngren et al (2015) mentioned that management accountants work
closely with managers to formulate strategy by providing information about the sources
of competitive advantage and resources on hand. It involves managers using the
management accounting information, to enable them to choose a strategy, communicate
it and determine how best to implement it.

1.4 Strategy

A strategy ‘specifies how an organisation matches its own capabilities with the
opportunities in the marketplace in order to accomplish its overall objectives.’ (Horngren
et al 2015, p. 27). Simply, it is ‘the courses of action that must be taken to achieve an
organisation’s overall objective’ (Drury 2018, p. 734).

It is the identifying, choosing and implementing activities to:

• enhance long term performance
• create compatibility between sectional interests
• fit external environment
• flexibility - continuous adaptation with internal abilities and adapt to external
forces

Management accountants help in formulating strategy in areas such as:

- Is there enough cash to fund the new strategy ie the new project?
- What is the most critical capability? Is it technology, production, or marketing?
- Will the new product be profitable? Is the price competitive?
- Are there any substitutes? If there are, how do we compare in terms of
functionality, quality, price?
- Can we identify who is our most important customer (that we cannot afford to
lose)? In what ways can we take to retain this important customer?
- In what ways can we deliver value to customers?
- What will be the estimated sales revenue, expenses and profits next year?
- At what point do we breakeven?
- How many units of the different products should we sell next year to obtain the
targeted profits?
- Do we have adequate financing in the next few months and years?
- Should we make or buy (outsource)?
- Do we require more or fewer employees, machines, space etc?

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 - Should that particular branch or department be closed down?
- Should we take on the special order at a price lower than what we normally
charged to existing customers?

1.4.1 Porter’s Business Competitive Strategies

Porter (1980) suggested three broad generic successful business strategies to achieve
competitive advantage:
(1) Cost leadership strategy: is the competitive strategy in which the firm succeeds
by producing at the lowest cost in the industry enabling it to compete and sell at
lower selling prices.
(2) Differentiation strategy: is the competitive strategy in which a firm succeeds by
developing and maintaining a superior and unique characteristics or value for the
product/services as perceived by consumers such as: superior/unique quality,
service, flexibility, dependability, after-sales service, etc eg branded/luxury goods.
(3) Focusing strategy (niche market): ‘focus on a narrow segment of the market that
has special needs that are poorly served by other competitors in the industry’
(Drury 2015, p. 599). It recognizes differences existing within segments if the
same market such as customers and geographical regions and for eg. focusses
on a product or service that no one else sells.

Strategic positioning ‘relates to the choice of the optimal mix of the three general
strategies’ (Drury 2015, p. 599).

The strategies the companies adopt can be either a low price strategy or command a
higher price using a differentiated product strategy. If it cannot sustain either of these
then it is stuck in the middle, so since it neither has a competitive cost structure to have
the lowest cost base nor sufficient product differentiation to command a higher price,
then it could adopt to focus on the third strategy to focus on a particular niche in the
market, for example, to provide excellent customer service or produce a product or
service that none of its competitors has. (CPA Australia 2003)

1.5 Management Process

Management accounting information provides managers with appropriate information for

the management functions.
The five main functions of the management process are:
(i) Planning
(ii) Organizing
(iii) Control
(iv) Communication
(v) Motivation

1.5.1 Planning

Planning is the process of translating business objectives and developing a strategies to

achieve them in a systematic manner by selecting goals, predicting results under various
alternatives ways of achieving those goals with strategic planning, long and short-term
financial plans through budgeting

It is vital for organizations plan their future and managers need financial information to
help them in the selection of goals and organizational objectives, assessing the
environment they operate in, assess existing resources and making efficient use of those
scarce resources – the four Ms:

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i) Manpower (or Men)
ii) Machine
iii) Materials
iv) Money
Determining the strategy for achieving stated objectives by means of an overall plan
specifying the strategic goals and predicting results under various alternatives ways of
achieving those goals, including long and short-term financial plans through budgeting.

1.5.2 Organizing

Organizing or directing involves the setting up of a proper organizational structure for the
implementation of strategic decisions. The structure and form should define the
responsibilities and line of authority appropriate to achieve those strategic goals and
determining who perform those tasks and assigning the responsibility to managers to be
accountable for their divisional or departmental performances. It includes directing, that
is the setting of objectives, organisation structuring and responsibility accounting.

1.5.3 Control

Control is the process of making planned events actually occur. Control is closely linked
to the planning function and its purpose is to ensure the activities conform to the plans.
Managers implement planning decisions by exerting managerial influence on operations
so that they will conform to plans, by evaluating performance, providing feedback that
will help future decision making through budgetary control, variance analysis and
reporting

Planned outcomes are compared to actual outcomes and managers can take steps to
get the business back on track if variances are highlighted between planned and actual
outcomes. Actions are taken to implement planning decisions, and performance
evaluations are made, providing feedback that will help future decision making.

Control is essential to achieving the long range and short term goals that were planned.

1.5.4 Communication

Communication involves the transmitting of information and instructions within the

organization. To inform openly and clearly for example, the objectives conveyed before
the event and periodic reports provided after the event.

1.5.5 Motivation

Motivation involves the challenges to get members of the organization to work towards
achieving the organizational objectives. Empowering the management and rewarding
them based on their performances are some of the ways to motivate them to achieve the
goals set.

Motivation is the encouraging of a ‘desire to attain a selected goal (goal congruence

aspect) combined with the resulting pursuit of that goal(the effort aspect)’.

‘Goal congruence exists when individuals and groups work toward achieving the
organisation’s goals – that is, managers working in their own best interest take actions
that align with the overall goals of top management’ (Horngren et al 2015, p.864).

‘Effort is the extent to which managers strive or endeavour in order to achieve a goal.’
(Horngren et al 2015, p.864). Management control systems motivate employees to exert

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effort through monetary rewards such as shares, cash, car, club membership, etc or
nonmonetary rewards such as better title, greater responsibility, or authority over more
employees, for achieving observable goals such as profit targets or stock returns.
(Horngren et al 2015)

1.6 Decision-Making

‘Management accounting is aimed at producing and communicating information that is

relevant to managerial decision making’ (Nayak & Mongiello 2017, p.15).

Decision making is a process of choosing the best alternative to implement a decision. It

involves the use of reasonably accurate costs and revenues information for decision
making eg pricing decisions, determining the best methods to produce and deliver,
make or buy decisions, product additions or deletions, acquiring and financing product
capacity, capital investment projects evaluation, etc

1.6.1 The Decision-Making Process

The decision-making process, outlined by Drury (2015, p. 7), follow a series of steps.
There are six steps and they are:
1. Identify objectives.
2. Search for alternative courses of action.
3. Select appropriate courses of action.
4. Implement the decisions.
5. Compare actual and planned outcomes.
6. Respond to divergences from the plan.
(Drury, p.7)

The first four stages (Steps 1 to 4) represent the decision-making or planning process
while the last two stages (Steps 5 & 6 ) represent the control process’ which is ‘the
processes of measuring and correcting actual performance to ensure the alternatives
that are chosen and the plans for implementing them are carried out’ (Drury 2015, p. 7).

For those who have previously used the Horngren et al (2015) textbook, the decision-
making process is described as a five step decision-making process as follows:
(1) identify the problem and uncertainties
(2) obtain information
(3) make predictions about the future
(4) make decisions by choosing among alternatives and
(5) implement the decision, evaluate performance and learn.
(Horngren et al 2015, pp 32-35)

Note: Both versions are about the same but as the latest UOL 2017 subject guide used
the Drury (2015) version, it would be good to use the six steps decision-making, planning
and control process in your answer but do elaborate each of the steps. Refer to Drury
(2015, pp. 7 – 9). If you are using Horngren’s five step process, do cite ‘Horngren et al
2015) in your answer.

1.7 Key Management Accounting Guidelines

The three guidelines that management accountants use to increase their value to
managers are:
(1) Employ a cost-benefit approach
(2) Recognize behavioral and technical considerations

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(3) Apply the notion of “different costs for different purposes”.

1.7.1 Employ a Cost-Benefit Approach

Resource-allocation decisions are often encountered by management accountants. In

making decisions, the cost-benefit approach should be used, which means that
resources should be spent only if expected benefits exceed the expected costs, that is,
the benefits must outweigh the costs (Horngren et al 2015, p 35).

1.7.2 Recognize Behavioural and Technical Considerations

There are two simultaneous missions in a management accounting system:

(1) Technical – Technical considerations help managers make wise economic
decisions from the information provided at the preferred frequency, while,
(2) Behavioural – Behavioural considerations would motivate managers and
other employees to work towards the organisational goals.

Horngren et al (2015, p 35) states that ‘management is primarily a human activity’ that
focuses on how to motivate ‘individuals to do their jobs better’. Should workers
underperform, they should be guided on how to improve performance, so that they
understand how to add value, and not by just sending them a report that highlights their
underperformance.

1.7.3 Different Costs for Different Purposes

Management accounting information must be tailored to meet the needs of the user. It
should be noted that “one size does not fit all” so the management accounting must be
able to provide the information appropriate for the different purposes it is intended for. A
cost concept for eg the FIFO method for inventory valuation. For financial accounting
purposes is required to abide by the accounting standards, however, it is not appropriate
for use in a pricing decision which is used to set prices in the next year. The replacement
costs of that inventory expected next year, will be more appropriate instead. So,
depending on the situation, a cost concept for external(financial) reporting may not be
appropriate for internal routine reporting to managers.

1.8 Information for Decision Making

The provision of relevant and reliable information, that is: the quality of information for
decision making is a pre-requisite to managerial success. For example: the costs
relevant to decisions such as for make or buy, product addition or deletion, capital
investment projects evaluation, etc

Decisions may be classified, according to Glautier and Undertown (2001), to the

following areas:
Strategic planning – which involves the determination of corporate objectives and
goals as well as the broad policies and strategies by which they may be achieved;
Management control – which is concerned with implementing the strategic plans;
Operational control – which is the process of ensuring that specific tasks are carried
out effectively and efficiently.

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1.9 Traditional and Management Accounting Today

1.9.1 Traditional Management Accounting

The traditional management accounting involves mainly three functions:
(i) Score keeping – the recording of transactions and other data ie, the accumulation
of data and the reporting of reliable results to management
(ii) Attention directing – directing attention to problems and also alerts the managers
to opportunities that would add value to the business. Eg investigate the
differences between the planned and actual results
(iii) Problem solving – providing cost and other information to assist management to
take action and solve the problems such as choosing the best among the
alternatives available

Some of the traditional management accounting techniques are budgeting, cost volume
profit analysis, standard costing and variance analysis. The control systems
concentrated on tight standards, frequent reporting and centralized decision making.
They are still in use today, however, in the present dynamic business environment, there
is an emphasis on both financial and non-financial information that should be relevant
and timely as they are required for management decision making. Management
accountants today have also to contribute to decisions about strategy, planning and
control.

The impact of competition and the market has been ignored in traditional management
accounting Inman (1999) criticised that traditional management accounting was
introspective in the control aspects that it had almost become a closed system within its
own right.

1.10 Role of the Management Accountant

The management accountant holds an important role that affect the management
decisions of an organisation. As such, they shall behave ethically and make a
commitment to ethical professional practice. They are to abide by the code of
professional conduct that requires them to be honest, fair, objective and responsible.
They must also be competent, credible, have a strong sense of integrity and maintain
confidentiality of the information they obtain in the course of their work, with the
exception of those disclosures that are authorised or are legally required (Institute of
Management Accountants, Inc.).

The following are some of the role of the management accountant (though not all may
apply to all organisations):
• member of management team
• ‘business partner and trusted advisor’ (Hilton & Platt 2017, p. 5)
• involved in the value-added participation processes – involved in strategy
formulation, control, change.
• involved in the design information systems and performance measurement
systems
• proactive in creating value
• be technically competent, providing expert advice, leadership in teams,
leadership in analysis
• a teacher and guide
• be able to emphasize on users, customers, clients
• involved in resource related direction-setting
• involved in strategy formulation and planning

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 • aware of linkages between strategies, processes, performance measures
• supports change in organisational and business process redesign, recognise
risks and uncertainty in systems, and must react quickly - real time in a virtual
world (at a moment’s notice)
• spend less time dealing with financial accounting, audit and tax issues and more
time on learning about operations systems, product and process technology,
marketing strategy, behavioral and organizational issues relating to
implementation of new systems and processes.(Kaplan et al, 1995)
• familiar with the business, possess interpersonal skills, leadership skills,
understand the industry and business and have good speaking and presentation
skills. (Kershaw & Mahenthiran 1998)
• able to design, implement, review performance measurement with the use of both
financial and non-financial measures, identify key performance indicators
measures, operational measures and control systems
• involved in the development of information systems due to the need for changing
information in changing circumstances including financial and non-financial
information, internally and externally sourced information, broad ranging and
narrow information depending on the purpose
• Able to tailor information for strategic and tactical levels depending on their
needs, that is, more information for lower level staff and less detailed but relevant
information for top management, preventing the situation of information overload
• work well in cross-functional teams and as a business partner’
• ‘must promote fact-based analysis and make tough-minded critical judgments
without being adversarial’
• ‘must lead and motivate people to change and be innovative’
• ‘must be able to communicate clearly, openly, and candidly’,

1.11 Sources of Information

The management accountant must be able to obtain relevant information from various
sources not only internally within the organisation but from external sources as well.

1.11.1 External information:

Some of the sources of external information are:

• Published financial reports
• Press release, newspapers, magazines,
• Government statistics
• Suppliers
• Industry experts and consultants
• Trade associations
• Physical observations
• Physical analysis of competitors’ products
• Own employees
• Ex-employees of competitors

1.11.2 Sources of Internal information

Internal information may be obtained from the following:

• Accounting reports
• Policy and procedure manuals
• Analysis of costs and revenues

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 • Consultants’ analysis
• Employee feedback
• Other reports eg production reports, etc

1.12 Characteristics of Useful Information Produced by the Management

Accounting System

The features of useful information should include each of the following characteristics :
• relevance: to the needs of the user of the information;
• significance: capability of making a difference to the user’s decision;
• reliability: freedom from bias and capable of verification;
• understandability – clarity of information and readability of presentation
• sufficiency: whether the information stands on its own for the decision in question or
needs additional information;
• practicality: whether the information is available in a timely manner and is worth more
than it costs ie benefits outweighs costs.

1.13 The Impact of the Changing Business Environment on Management

Accounting.

The nature of the business environment have changed due to ‘global competition,
deregulation, growth in the service industries, declines in product life cycles, advances in
manufacturing and information technologies, environment issues and competitive
environment’. These changes requires companies to be more customer driven and ‘have
significantly altered the ways which firms operate and resulted in changes to
management accounting practices’ (Drury 2015, p. 9)

1.13.1 Factors Causing Changes to Management Accounting:

Management accounting is changing due to the following factors:

• Global competition - changing business environment leads to a truly global

marketplace resulting in greater variety of goods and services, at higher quality
and lower prices

• Growth in the service industries –The service sector has grown rapidly in many
countries. Airlines, utilities, hospitality and financial services industries are many.
Privatisation of government controlled service companies and deregulation
change the competitive environment. The intensive competition and the
expanding range of services provided requires service organisations to focus on
cost management and management accounting information is required to help
them to understand and manage the costs for eg business transformation
strategies, customer profitability, to understand their customers and markets
better and to compete. (Drury 2015)

• Changing product life cycles - Horngren et al (2015, p.553) defines a product life
cycle as ‘the product life cycle spans the time from initial research and
development on a product to when customer service and support is no longer
offered for that product.’ Shorter product life cycles are the result of intensive
competition, technological innovation, sophisticated customers demands.
Companies must introduce new products quickly to be ahead of competition.
Example: mobile phones, cosmetics. Management accounting information are

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 needed as it need to identify the committed or lock in costs at the design stage
and manage costs effectively and be adaptable to new different and changing
customer requirements, reducing ‘time to market new or modified products’.
(Drury 2015, p.11-12)

• Advances in manufacturing technologies – Manufacturing excellence is a

competitive weapon to compete in sophisticated worldwide markets. A need to
invest in advanced manufacturing technologies to be able to be innovative and
manufacture products of high quality at low costs, provide excellent customer
service, flexibility to cope with short product life cycles, produce greater variety of
products to meet the sophisticated and demanding customers and increasing
international competition. (Drury 2015)

• The impact of technology - the use of information technology (IT) increased

dramatically and online businesses via e-business, e-commerce or internet
commerce are now a requirement to compete in today’s business. Consumers
prefer the convenience of being able to compare the prices and relative merits of
each of the products before buying and transactions can also be done from
different parts of the world. Management accountants need to provide relevant
information to provide business support for managers.
Advanced IT applications such as the enterprise resource planning systems
(ERPS) a business information system may be used to process information and
provide managers with information directly for their own analyses. This frees
accountants to provide business support to managers by interpreting information
generated from the ERPS and acting as advisers and internal consultants to
these managers. (Drury 2015)

• Environmental issues – environmental management accounting is now important

as customers and even the community expects organisations to be socially
responsible, as well as be responsible for safety and environmental issues.
These developments require management accountants to provide reports on
environmental costs and related information. (Drury 2015)

• Customer orientation - The need to be customer-focused in today’s competitive

environment. The key success factors to provide customer satisfaction are cost
efficiency, quality, reliability, delivery, time, innovation and explained as follows:

• Cost Efficiency – Cost management, keep costs low is a strong competitive

advantage. Management accountants need to support in providing more accurate
cost information on product costs and services, monitor cost trends, point out
loss-making activities, profitability analysis reports ‘on products and services,
sales outlets, customers and markets’ (Drury 2015, p. 13)

• Quality – The importance of quality as customers demand high quality products

and services. (Drury 2015) Total Quality Management (TQM) focuses on
management’s commitment to quality and is a process of continuous
improvement. Quality is a key competitive weapon that is to be emphasised in the
overall strategy of an organization. Management accountants provide the costs of
quality and other quality reports to help management in this area.

• Time – a competitive weapon. Faster response time to customer’s requests, on

time delivery, reduce time taken to develop and bring new product to market,
shorter lead time or cycle time increases customer satisfaction. The role of the
management accounting system is to provide information on these as well as to

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 identify and report on time devoted to value added and non-value added activities
(Drury 2015, p. 14)

• Innovation– to be able to provide ‘a steady stream of innovative new products

and services and have the capability to adapt to changing customer requirement’
(Drury 2015, p. 14). Management accounting systems support management with
reports on performance measures used to measure innovation.

• Continuous Improvement – do the job better, reducing costs, improving quality,

eliminating waste to increase customer value or satisfaction. ‘Management
accounting supports continuous improvement by identifying opportunities for
change and then reporting on the progress’ (Drury 2015, p. 14)

To keep up the changes, management accounting tools, techniques and also the
management’s mindset has to be well advanced today. Technology advancement and
the e-commerce environment is now the way businesses operate. Management
accounting has to keep up with the changing environment and have to be more outward
looking towards markets (customers, competitors and suppliers) rather than just look
inwards towards process, etc.
Today’s management accounting moved away from tight controls and to loose controls
and non-financial measurements were more frequently used. Current tools and
strategies such as the Customer Profitability Analysis, Activity-based Costing(ABC),
Total Quality Management(TQM), Just-in-Time (JIT), Business Process Re-
engineering(BPR), Competitor Analysis, Life Cycle Costing, Target Costing, Balance
Scorecard, Environmental Management and other techniques are used to improve the
business and enhance the ability of organisations to face the competitive environment in
order to succeed.

1.14 Pressures for Change

During the 1950s to 1960’s, Western industrialised countries held strong positions in
international markets and products were easily sold. Competition on basis of price and
quality were low. As such, management controls were orientated towards manufacturing
and the internal administration, as opposed to strategic and environmental
considerations.

The recession and the oil crisis high oil prices during the 1970s to 1980s threatened
established markets and led to the decline in protected markets and increased global
competition affecting Europe and the emerging industrial nations.

New technologies were developed to reduce costs and improve quality. This led to the
substantial impact on information processing with the emphasis on quality, reduction of
inventory, shorter manufacturing lead times, the advent of computer controlled
manufacturing operations, continuous improvement, come into being.

1.15 Adapting to the Changing Business Environment

Organisations have to adapt to the changing business environment so as to compete

successfully in today’s environment. Some of the ways are:
•Making customer satisfaction an overriding priority;
•Adopting new management approaches;
•Changing manufacturing systems;
•Investing in Advanced Manufacturing Technology (AMT) such as the computer-aided
design/manufacturing (CAD)/CAM, computer numerically controlled (CNC) and the
computer-integrated manufacturing(CIM).

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1.16 Key Themes Driving Change in Management Accounting

The key themes driving the evolution of management accounting systems are:

1) Customer orientation or focus

The need to be customer driven, to deliver value to customer, customer
satisfaction
2) Value chain analysis
‘The value chain is the sequence of business functions by which a product is
made progressively more useful to customers’ (Horngren et al 2015, p. 28).
Foreman (2003) defined it as ‘a linked set of value creating activities beginning
with basic raw materials from suppliers, moving on to a series of value added
activities involved in producing, marketing and distribution of the good or service,
and ending with any support or after sales service for the end customer.’
3) Supply chain analysis
Supply chain is ‘the flow of goods, services, and information from the initial
sources of materials and services to the delivery of products to consumers,
regardless of whether those activities occur in the same organization or in other
organisations.’(Horngren et al 2015, p. 29)
4) Key success factors
In terms of cost efficiency, quality, reliability, delivery, time, product features,
innovation and service.
5) Continuous improvement and benchmarking
Frequent soul searching to improve the way things are done, comparisons of
performance with competitors, restructuring, process reengineering, etc

1.17 Limitations of Management Accounting:

• The ever changing business environment causes the assumptions used in

management accounting to require frequent changes and updates
• The inflation factor is uncertain and often changing invalidating standards set and
need constant updates
• Technological changes led to management accounting information being out of
date and have to keep up with the changes
• Management techniques and tools need to keep up with these changes
• It is expensive/costly to maintain a good management accounting information
system
• Resistance to change by employees in the organisation is another perennial
problem

1.18 Ethical Standards

‘Management accountants must reflect on the ethical implications of their job, which
implies also addressing the question of to whom they respond with their actions and
decisions’ (Nayak & Mongiello 2017, p. 20).

In business organisations where the major goal of management accounting is to assist

the management to increase the profitability, such goals should be achieved through
ethical means. Ethical behaviour involves choosing actions that are ‘right’, ‘proper’ and
‘just’. (Mowen et al 2007). It is concerned with making the right choices and usually
involves sacrificing individual self-interests for the well-being of others. Managers should

17
make decisions that are ethical and not ‘overemphasised the economic dimension and
engaged in unethical and illegal actions.’ (Mowen et al 2007).

In the light of accounting scandals in Singapore and elsewhere, ethical behaviour of

managers had become a growing concern, as the volatile and competitive environment
had made it more complex and challenging for managers, leading to risks of
compromising the rules on ethics in the business world.

Business and professional ethics is the learning of what is right or wrong in the work
environment and choosing to do what is right. Integrity should be made the cornerstone
of the way a business is conducted. The result of failure to build a business on integrity
can make a company suffer substantial losses as bad publicity cause severe damages to
the credibility and image of the company. Most companies would adopt codes of ethical
conduct which include integrity and conducting business in compliance with all laws and
regulations.

Employees, creditors, suppliers, shareholders, customers and the public can suffer dire
consequences when unethical decisions are made.
‘For example, manufacturing firms are accountable to the wider community for their
contribution to the pollution of the external environment or to the government’s regulators,
etc. Overall, these concerns go under the name of corporate social responsibility and
constitute a pillar of contemporary firms’ strategies for survival and success’ (Nayak &
Mongiello 2017, p. 20).

Ethical standards are motivated by a very practical consideration—if the standards are
not followed in business, then the economy and all of us would suffer. Abandoning
ethical standards would lead to a lower standard of living with lower-quality goods and
services, less to choose from, higher prices and in some cases, may be detrimental to
health.

Management Accountants have ethical responsibilities in the following areas:

• Integrity – ‘being honest and not being a party to any falsification’ (Drury 2015 p.
15) and ‘refrain from engaging in any conduct that will prejudice carrying out
duties ethically’ (Institute of Management Accountants 2005), that is to be ‘
straightforward and honest in all professional and business relationships. Integrity
also implies fair dealing and truthfulness.’ (CPA Australia 2010, p. 17), ‘avoid
conflicts of interest and if there are any unavoidable potential conflicts, advise all
parties involved,
• Objectivity – credibility, be fair and objective, must not allow prejudice, conflict of
interest or bias to override their objectivity.
• Confidentiality and professional competence and due care – ‘respect the
confidentiality of information acquired in the course of their work’. Competence –
should have professional expertise, perform with due care, competence and
diligence, maintain professional knowledge and skill at a level to ensure that their
skills and knowledge are up to date.’ (CPA Australia 2010)
• Professional Behaviour -Compliance with relevant laws and regulations and not
behave in a way that discredits the profession

Accountants and managers should avoid situations where they may pose a risk to their
credibility and image and also to the organisations they work in. Their integrity and
credibility may be compromised if for example, they are saddled with huge debts, from
excessive consumption beyond their means, eg. excessive credit card spending on
luxury goods, travelling, clubbing and other expensive hobbies, being over-leveraged on
cars, property, gambling debts, speculating in the stockmarket, forex trading, options,
derivatives with little or no knowledge of the risks involved, and other high risk actions

18
that may cause severe damage to their image, integrity, credibility and finances. Such
employees may pose a high risk to the organisations they work in. There had been many
published high profile cases where such high risk personnel resort to unethical means to
resolve their financial problems and so, organisations today are now very careful with
whom they hire. Stringent background checks are now made by most employers. If the
individual is unable to manage their own finances, can they be trusted to manage those
in the organisations they work in?

The benefits of ethical behaviour are many and here are some of them:
• It may avoid litigation costs and investigation by authorities
• It may create customer and employee loyalty
• Improves corporate image and increases the likelihood of commercial success

Refer to Drury (2015) 9th edition textbook pages 15, (10th edition pp. 12-13) on
management accounting and ethical behaviour and Horngren et al (2015) 15th Edition
pp.38-41 and read up on “Professional Ethics”.

1.19 Strategic Management Accounting

The term strategic management accounting (SMA) was introduced by Simmonds (1981,
p.26) and defined by him as ‘the provision and analysis of management accounting data
about a business and its competitors, for use in developing and monitoring business
strategy’ (CIMA 2015)

Strategic Management Accounting is ‘an integrated framework for strategic and financial
decision making and for interpreting business performance which brings together
competitive, operational and financial analysis’ (Grundy et al 1998).

Ward (1992) described it as ‘management accounting in the context of the business

strategies being planned and implemented.’

Strategic Management Accounting is differentiated from previous management

accounting approaches by its external orientation as it ‘offers a means of releasing
management accounting from the factory floor’ Bromwich & Bhimani (1989).

Strategic Management Accounting is ‘a form of management accounting in which

emphasis is placed on information which relates to factors external to the firm as well as
non-financial information and internally generated information’ (CIMA 2005).

Extends beyond simply collecting data about a business and its competitors. It includes
competitors costs in the firm’s management accounting system and the ability to
measure competitive position. It involves the use of strategic cost analysis, experience
curve to predict the real cost advantage of market leadership, product life-cycle costing,
value chain analysis for the firm and its competitors.

Ward (1992, p 9) states that

‘The role of Strategic Management Accounting is very definitely not that of a passive,
financial score-keeper or ‘bean-counter’ and is also not restricted to the more normally used
definition of ‘management accounting’, with its concentration on supporting internally based
financial decisions. It is a much more positive role of supporting the financial needs of
management in their task of directing and controlling the business in the best interests of its
owners and other relevant stakeholders’

‘Bean counting’ means ‘an overriding concern with administration, record keeping, and

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elementary financial reporting work.’ (Ahrens 2011, p.15)

1.20 The Strategic Turn in Management Accounting

The traditional management accounting information is internally orientated and is often

too narrow for strategic decision making. The competitive positioning of businesses in
world markets requires accountants in management teams to adopt a strategic
perspective.

Strategic management is about the aspects of management that are concerned with
core competencies of the organization, relating to relationships with customers,
suppliers, competitors, and the markets for labour and capital. Strategies on what an
organization can offer its customers in ways that are superior to the competition, using its
own process capabilities as well as its relationships to suppliers and its own specific
access to labour and capital markets. (Ahrens 2005).

For example: lower priced products or services, focusing on a product or service no one
else sells, superior characteristics of the product or services in terms of quality, service,
flexibility product differentiation, etc.

Technological advances resulted in huge investments in technology and highly

automated operations require managers of high-tech firms to take longer-run perspective
in making decisions. (Glautier and Undertown 2001)

Strategic management accounting, according to Glautier and Undertown (2001), has

developed to assist senior management in taking a genuinely long-term view of their
business by providing information which
(a) enables them to monitor and control the organisation’s activities in a manner
measurable against the strategy and objectives, and
(b) contributes to the strategic decision-making process.

‘The strategic relevance of management accounting would depend on the extent to

which it supports management in finding out which strategy is most promising for an
organization.’ (Ahrens 2005, p. 10)

Management accounting provides information on costs implication of the different design

choices, calculates the incremental revenue from the additional product attributes such
as: reliability, functionality, appearance, etc.

‘The defining characteristic of strategic management accounting is its external emphasis.

Another way of describing this is its emphasis on the market, hence, the notion of strategic
management accounting as market-orientated, or even market-driven, accounting. Within
this emphasis, there are three focuses: competitors, customers and, linking them, products.
Strategic management accounting seeks to produce a range of information about these
three focuses.’ (Roslender et al 1988)

1.21 Strategic Role of Management Accounting

The role of management accounting in the area of strategic management should change
from being a passive supplier of supporting information to one which takes a key role in
strategic management.

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This necessitates a change in the nature and extent of accounting information to include
competitor information and to adopt different approaches in the area of costing.

1.22 The Objectives of Strategic Planning

Strategic planning involves the systematic attempt to influence the medium and long-
term future of the entity and to manage change. It involves the determination of
corporate objectives and goals as well as the development of broad policies and
strategies by which they may be achieved.

Strategic planning relies heavily on information about the environment. In the formulating
of a strategy, that is; a course of action, including the specification of resources required
to, achieve a specific objective or an organised development of resources to achieve
specific objectives against competition from rival organizations.

The main objective of strategic planning is to develop and sustain a competitive

advantage in its chosen marketplace so that it can earn super profits, that is, above the
normal rate of return.

“Competitive advantage describes the way a firm can choose and implement a generic
strategy to achieve and sustain a competitive advantage. It addresses the interplay
between the types of competitive advantage – cost and differentiation – and the scope of
the firm’s activities. Competitive advantage cannot be understood by looking at a firm as a
whole. It stems from the way discrete activities, a firm performs in designing, producing,
marketing, delivering and supporting its product. Each of these activities can contribute to a
firm’s relative cost position and create a basis for differentiation” Porter (1980).

A competitive strategy is aimed at establishing a profitable and sustainable position

against the forces that determine industry competition. (Porter 1980)

1.23 Porter’s Five Forces of Competition

Porter (1980) mentioned that understanding the industry on which it operates is

necessary and to use the following industry analysis technique called the Porter’s five
forces of competition:
1) Competitors – rivalry among existing competitors
2) Potential entrants in the market (entry of new competitors)
3) Equivalent products – threat of substitutes
4) Bargaining power of buyers (major customers)
5) Bargaining power of input suppliers

In each of the five forces are the constituents of profitability, prices, costs and
investment. Prices are influenced by the bargaining power of buyers and the threat of
substitutes. Costs are influenced by the bargaining power of suppliers and the rivalry
between competitors.

1.23.1 Rivalry among existing competitors

The way the existing firms in an industry compete in also determine the level of returns
available to any one competitor. Any action by one firm will almost certainly generate a
reaction from other competitors.

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In UK, intense rivalry between Sainsbury’s, Tesco and ASDA for a bigger share of the
grocery and food market is intense. At the bottom end of the market, there are a number
of smaller and possibly cheaper players, while at the top, the food departments of Marks
& Spencer compete against Waitrose.

Intense rivalry is related to the following factors:

• Number of competitors
• Rate of industry growth
• Amount of fixed costs
• Capacity
• Exit barriers

1.23.2 Potential entrants in the market

New entrants are a threat to current competitors’ ability to generate the desired financial
returns. It is influenced by the cost of entry into a market and perhaps the opportunity to
make a profit, this threat remains. In principle, the larger the organization, the more
investment required, the less likelihood of any competition. However, looking at the
recent history of commercial aviation, where deregulation has allowed small airlines to
enter the market and compete successfully, and the UK telecommunications industry has
seen a monopoly situation turned into one of fierce competition.
New entrants can have another implication. They can expand the number of competitors
without expanding the market. Entrants into the supermarket business have this
problem. In a country of a fixed population, growth in the supermarkets business can
only be at the expense of rivals and the ultimate destruction of the corner shop.

Affected by the following factors:

- capital requirements
- switching costs
- brand identity
- economies of scales
- access to distribution
- government policy
- expected retaliation
- absolute cost disadvantages

1.23.3 Equivalent products - The threat of substitute products or services

The more substitutes the buyers have for the industry’s products or services, the higher
the bargaining power. A substitute is an alternative and may be a direct substitute like
Pepsi and Coke.

Affect by the following factors:

- relative price performance of substitutes
- switching costs
- buyer propensity to substitute

1.23.4 Bargaining power of buyers (major customers )

Customers buying powers in terms of:

Bargaining Leverage:
- buyer’s volume
- switching costs

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- buyer’s information
- substitute products
- buyer’s concentration versus firm’s concentration

Price Sensitivity:
- brand identity
- product differences
- buyer’s profits
- price/total purchases
- product differences

1.23.5 The bargaining power of suppliers

Suppliers affect returns through their ability to raise prices, determine quality, etc.
Affect by the following factors:
- differentiation of inputs
- switching costs of suppliers and firms in the industry
- presence of substitute inputs
- supplier concentration
- impact of inputs on cost or differentiation
- presence of substitute inputs
- importance of volume to supplier

1.24 Difference between Strategic Planning and Strategic Management

Strategic Planning involves determination of objectives and strategies while Strategic

Management incorporates implementation and control as well as their determination.

1.25 Strategic Management Accounting Techniques

World class enterprises need the following techniques in their quest to be successful:
(1) Activity analysis
(2) Customer profitability and analysis
(3) Competitor analysis
(4) Market-led accounting
(5) Development of non-financial measures of performance.

1.25.1 Activity Analysis (Activity-based Costing and Activity-based Management)

Porter (1980) suggests that firms can be viewed as a flow of activities performed to
provide products or services to customers. Two key variables may be used to achieve
above average performances:
(i) Distinctiveness or differentiation of products
(ii) Costs

Porter focuses on the ability of activities to add value either by cost leadership or
differentiation. (Refer to para. 1.4.1 above)

Activity-based Costing (ABC) systems provide information about the costs and the
performance of activities and resources. Activities may be linked across departments
forming cross-functional processes, the model structure of an organization is simplified
and all activities can be analysed and through Activity-based Management (ABM) is the
application of activity analysis to cost management, often in support of continuous

23
improvement in an organisation. The umbrella for a range of organisational initiatives
aimed at producing sustainable, enhanced performance.

Activities and processes are underlying variables which cause costs to be incurred, so
the focus is on management of costs via the management of activities.

Use ABC for activity analysis for cost management purposes – management of cost
drivers, further examination of activities to allow classification as value adding or non-
value adding, cost management through a value-chain perspective and supporting
performance measurement systems.

A value adding activity is an activity that if eliminated would reduce the product’s service
to the customer in the long run while a non-value adding activity is an activity which
presents the opportunity for cost reduction without reducing the product’s service
potential to the customer. (Atkinson et al. 1995, p 60-1)

Whether a particular activity is value adding or non-value-adding depends on the

organisation and its characteristics, and the contribution of that activity to the final
product’s service and functionality.

From the customer’s perspective, it is clear that he/she will be willing to pay for the value
adding activities and costs but not for non-value-adding activities. Non-value-adding
activities represent waste and can be reduced or eliminated. They often exist due to poor
process planning, poor or inefficient plant layout, cumbersome administrative processes.
The organization on identifying the list of non-value adding activities, can create teams to
find innovative ways to eliminate, reduce or re-engineer those activities.

The challenge of activity analysis is to find ways to produce goods or services without
using any of the non-value adding activities.

Activity-based Costing (ABC) will be covered in detail in Sessions 7 and 8.

1.25.2 Customer Profitability Analysis

Customers are pivotal to the success of an organization and so it must be customer

driven. Investing sufficient resources in customer satisfaction to attract and retain
profitable customers is a requirement for the organization.

Customer profitability analysis is the reporting and analysis of customer revenues and
costs. It is a useful tool for the evaluation of the portfolio of customer profiles. Detailed
analysis of customers and differential costs of providing the service, justified if cost of
obtaining and maintaining information not excessive and information obtained is useful
for making strategic decisions. It is through the use of customer profitability principles to
identify particular types of customers and the information from customer feedback
through surveys/interviews.

With accurate customer profitability information, a company may know which are the
customers which they cannot afford to lose and make strategic decisions such as pricing
to retain the customer. They also look at the costs of servicing the customer and there
are some customers that do incur very high technical support that are costly and if these
costs are averaged and impose on other customers, could result in strategic errors.

Customer profitability is as critical as product profitability according to Howell and Soucy

(1990). Managers need accurate information to understand which customers and
markets are profitable and to make an effort to improve customer satisfaction and know

24
their wants and how to retain them and at the same time, also look at innovative ways to
increase their market share.

1.25.3 Competitor Analysis

Competitors include other organizations marketing similar products and or services, or

marketing similar products and or services. The similar products or services marketed
could have equivalent functions, image and quality. Competitors pose negative effects
on the organization in terms of lower sales, lower profits, lost customers, etc.

At strategic level the competition and the market must be considered.

A business should:
• establish a basis for competitive strengths,
• identify the major competitors,
• compare with the major competitors,
• identify potential new competitors.

Competition in the market place on:

• Quality
• Lead-time
• Cost
• Flexibility
• Service
• Manufacturing technology
• Time to market (new product development)
• Lead times (order-to-delivery time lapse)
• Innovation
• Dependability (OTD - on time delivery)

Competitor analysis involves the knowing of who the competitors and potential
competitors are, the competitors’ cost and taking actions on the organisational
weaknesses and threats. The need to know competitors costs and to take actions
against risks of competitors reducing selling prices, advertising to attract customers away
and going for the same customers.

Identify substitute products, place competitors into strategic groups and then analyse the
competitors and their strategy.

The organization have to take actions on any weaknesses and threats.

Weaknesses include:
• Insufficient skills
• Insufficient resources

Threats include:
• Deregulation allowing more organisations to participate in the same industry
• Privatization
• New technology
• Lower costs of competitor organisations
• Staff defecting to competitor organisations

The identification and evaluation of the organization’s strengths and weaknesses and
also of competitors’, is a well-developed competitive strategy.

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Competitors’ actions are anticipated and the organization is ready with a plan to defend
its position and to prepare for opportunities that result from competitors’ mistakes and
weaknesses.

Bromwich and Bhimani (1989) mentioned that the main theme of strategic management
accounting is the need to consider the firm’s comparative advantage relative to
competitors and the benefits for which customers are willing to pay and their costs. A
major contemporary challenge to accountants is to provide the relevant accounting
information configured in a way which can be used in the strategy formulation.

By using Porters’ competitive model, the long term profitability is affected by the threat
of new entrants into the market (example deregulated telecommunication industry),
threat of substitute products (example: internet and overseas call charges), rivalry
among existing organisations (example Pepsi vs Coca-Cola) , bargaining power of
suppliers and customers.

1.25.4 Barriers to Entry to New Entrants

In competitor analysis, entry barriers are a factor to consider when entering a particular
market. Entry barriers make it difficult for a potential competitor to enter into the specific
industry or market.

They include the following factors:

(i) Economies of scale

Competitors with large scale operations with high volume of sales/production tend to
have lower costs because they are able to have lower costs through volume discounts
from suppliers, lower labour costs through learning effects, efficient capacity utilisation,
fixed costs spread over higher volume, etc. Industries such as the automotive industry,
require large scale operations to compete. New comers will be deterred from coming in
as the costs of establishing and equipping from scratch would be prohibitive.

The Japanese achieved their success from a home-based critical mass that gave them
the requisite scale economies to compete. Scale economies are not just confined to
production, the prohibitive costs of entry may be to develop effective distribution and
service channels. The Japanese automobile companies had to establish dealer
networks, service confidence and parts availability and it was achieved by granting
dealerships to disenchanted former British Leyland dealers. The Korean Daewoo, have
resolved this problem by integrating distribution with their own brand name, and
effectively owning the distribution and service network.

(ii) Product Differentiation – Brand Loyalty

Many established consumer brands have a high level of customer loyalty which would be
extremely difficult for a new entrant to go in. The cost of wooing loyal customers away
from an established well-known brand is high. However, there are some who have
achieved, e.g., Canon has taken a substantial slice of the office copier market.

(iii) Capital requirements

Some industries require high capital investments to make and sell the product or service
such as the semiconductor industry, airline, pharmaceutical (research and development)
which has high fixed costs.

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(iv) Switching costs

Customers cannot readily change to another supplier due to high costs of changing to an
alternative. In the aerospace industry there is limited choice worldwide for major
components. Certificates of airworthiness depend on aeroplanes being built of
components that have been certified by the licensing authorities. Telco companies at first
did not allow number portability and they also charge high switching costs if customer
decides to another Telco before the contracted period is up.

(v) Access to distribution channels

New entrants may find difficulty in distributing their products or services as they do not
have established distribution channels. Eg For a food product to be successful, it must
get on the supermarket shelves. If the major supermarkets are prepared to add it to their
array of existing products, then success is virtually assured.

(vi) Non-scale disadvantages

Established companies may have advantages not readily available to new entrants. The
English wine industry lacks image, it is inherently small, often forced to pool processing
facilities, and has difficulty getting into major outlets.

(vii) Government regulation/policies

Some governments may be protective to their home markets and can restrict new
entrants through licensing restrictions, import quotas, imposition of additional taxes and
levies, limiting foreign investments, etc.

1.26 Market-led Accounting – Target Pricing

Market-led accounting is the setting of the competitive market price or target price based
on the estimated target costs. A target price is the estimated price of a product that
potential customers will pay. Target costs are usually well below those currently
achievable by the firm, managers then set benchmarks to measure their progress
towards meeting the target costs by means of design and technology improvements.
This amounts to a market-led approach whereby operating costs and efficiencies are
designed to achieve a desired state of competitiveness.

Japanese companies tend to use their management control systems to support their
manufacturing strategies, according to Hiromoto (1988). Daihatsu Motor Company’s
process starts with the product development manager instructing the functional
departments to submit the features and performance specification that they believe the
car should include.

The next stage is cost estimation. The company does not simply present the
development specification to the accountants to determine what is should cost to build
the car but rather establishes a target selling price, based on what it believes the market
will accept and specifies a target profit margin that reflects the company’s strategic plans
and financial projections. The difference between the target selling price and the target
profit margin is the allowable or target cost per car.

Market driven management emphasizes doing what is necessary to achieve the desired
performance level under market conditions. How efficiently a company should be able to

27
make a product is less important to the Japanese than how efficiently it must be able to
built it for marketplace success.

In Japan, a central principle that seems to guide management accounting, accounting

practices are subservient to corporate strategy and not independent of it. (Glautier &
Undertown 2001)

Market considerations and target price focus, motivates managers to perform value
engineering and to design products to achieve target cost.

1.27 Development of Non-Financial Measures of Performance

Non-financial measures are now important in management accounting instead of just

basing on the financial measures such as profit margins, etc. The non-finanicial
performance measurements such as lead time, set up time, number of line stops,
number of units scrapped, deviation from scheduled production, delivery performance,
quality, reliability, rate of flow, set up time, customer satisfaction, customer response
time, delivery time, supplier performance, market share, productivity etc.

Non-financial measures are useful as it provides fast feedback.

1.28 The Value Chain

The value chain was defined by Foreman (2003) as ‘a linked set of value creating
activities beginning with basic raw materials from suppliers, moving on to a series of
value added activities involved in producing, marketing and distribution of the good or
service, and ending with any support or after sales service for the end customer.’
‘The value chain is the sequence of business functions by which a product is made
progressively more useful to customers’ (Horngren et al 2015, p. 28). The understanding
of the value chain led to the examination of the role of management accounting in the
determination of strategies leading to the emerging of the concept of strategic
management accounting.

1.29 Value Chain’s Six Primary Business Functions :

Horngren et al (2015, p. 28) states that in the value chain, there are six primary
business functions and they are:
(i) Research and development—‘generating and experimenting with ideas
related to new products, services, or processes’ and developing into viable
products.

(ii) Design of products, services, and processes—the ‘detailed planning,

engineering and testing of products, services, or processes’, informed by
market research, technical requirements and competitive alternatives.

(iii) Production—acquiring, ‘transporting and storing (or inbound logistics),

coordinating, and assembling (or operations) resources to produce a product
or deliver a service.’ May vary due to the nature of products/services. There
may be few or many types of products/services and may be mass-produced
or customized.

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 (iv) Marketing—‘promoting and selling products or services to customers or
prospective customers’ ranging from market research, advertisement media,
promotion strategies, through advertisements on television, newspapers,
magazines, the internet, trade shows, etc

(v) Distribution—delivering products or services to customers at the right place,

right time and in the right condition. It is also term as ‘outbound logistics’.
Distribution via shipping to retail outlets, directly to customers, vendors and
other channels

(vi) Customer service—‘providing after-sales’ support to customers, including

customer-help telephone lines, customer and technical support on the
internet, handling of returns, and warranty repair work.

Management accounting provides information on each of the value chain so that

managers may track the costs incurred in each value-chain category and use the
information to reduce and manage costs so as to improve efficiency. (Horngren et al
2015)

1.30 Value Chain and Management Accounting Information

The management accountants track the costs in each of the value-chain category so as
to reduce costs and improve efficiency. The costs information assists managers in
making cost-benefit tradeoffs decisions such as should they outsource, or is it worthwhile
to invest more in some of the areas such as the design and production, which area can
they reduce costs, and so on.

The value chain categories and the relevant management accounting information are:

a. Research and Development

• the estimated time from idea to product
• Provide the design team with the estimated costs for each product
• Determine the fixed establishment cost of the department.
• Use of the annual budget to monitor the cost of research.
b. Design of products, services or processes:
• Estimated time to create technically viable product
• Estimated costs for each product
• Work with design team on costing of each product, including the use target costing to
keep costs to a realistic level, that involves the choice of materials, the degree of
complexity of the design of the product and other considerations.
• Packaging and presentation in conjunction with marketing.
• Determine the fixed establishment cost of the department.

c. Production
• Set up the standard cost systems,
• Production scheduling to ensure effective use of capacity,
• Limiting factor analysis etc.

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• Determine the fixed establishment cost of the department.

d. Marketing

• Market research – providing information on the financial aspects

• Provide costs and revenue data on changes in price and volume,
• Cost–benefit analysis of promotional and advertising campaigns,
• Provide costs of developing new markets
• Determine the fixed establishment cost of the department.

e. Distribution

• Providing information on the financial aspects of the different methods of distribution

incorporating customer expectations on delivery and related costs.
• Information on Customer Service such as:
- Cost of after sales support, returns, warranty and repair work.
• Determine the fixed establishment cost of the department.
(UOL 2007 Zone B, Q5, Management Accounting Examiner’s Report pp. 33-34)

1.31 Value Chain Analysis

The value chain analysis involves consideration of the firm’s own set of value creating
activities.
The Value Chain Methodology for constructing and using a value chain is:
• Identify industry’s value chain and assign costs, revenues, and value activities.
• Diagnose the cost drivers regulating each value activity
• Develop sustainable competitive advantage, either through controlling cost
drivers better than competitors or by reconfiguring the value chain. (Shank &
Govindarajan 1993, p. 58)

1.32 Supply Chain Analysis

A supply chain ‘describes the flow of goods, services, and information from the initial
sources of materials and services to the delivery of products to consumers, regardless of
whether those activities occur in the one organization or in multiple organizations’
(Horngren et al 2015, p. 29).

Cost management is most effective when it integrates and coordinates activities across
all companies in the supply chain as well as across each business function in an
individual company’s value chain. Attempts are made to restructure all cost areas to be
more cost-effective.

1.33 Organisation Structure and the Management Accountant

The changing business environment led to the need for organisations to consider
fundamental changes for it to survive and prosper. Organisational structures need to be
changed to adapt to the ever changing and dynamic environment so that it fits to the new
strategies. There is a need to align the organisation with its environment and to arrange
resources internally to support that environment so that it can:

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 - Respond quickly to changes
- Be flexible and adaptable to change
- Stay customer-focussed

Divisional structures have to be changed from functional forms to decentralised divisional

structures as it faces diverse and differentiated markets. The move to divisionalised
structures led to flatter organisation structures reducing or even eliminating the middle
management - as layers of management are stripped away. It reduces costs as well as
reduce communication distance between top management and also interface with
customers.

These organisational structures and responsibility centres do change the nature, content
and frequency of management accounting reports and affects the management
accountant.

Refer to the Management Accounting 2019 Subject Guide Chapter 20: Future
trends in strategic management accounting.

QUESTIONS
Question 1

Discuss the role of management accounting information in supporting the strategic

management activities of organisations. ( UOL 2010 / Zone B/Q 5)

Question 2

Discuss the relationship between financial (or stewardship) accounting and management
accounting. Identify and enlarge upon the similarities and the key differences between
the two disciplines. (UOL 2009/ Zone B/ Q 5)

Question 3

Describe the six parts of the value chain identified in Horngren, Datar and Foster (2005)
and for each part describe one type of financial information which might be provided by
the management accounting function. (UOL 2007 / Zone B/Q 5)

Question 4

The provision of management accounting information differs, depending on the features

of the organisation. Describe the factors which affect the provision of management
accounting information using examples where appropriate. (UOL 2011 / Zone B/Q 5)

Readings:

Bhimani A., C.T. Horngren, S.M. Datar and M. Rajan Management and cost accounting.
(Harlow: Pearson Education, 2019) 7th edition [ISBN 9781292232669] Chapters 1 and
2.

UOL AC2097 Management Accounting Subject Guide: Chapter 1 and 20.

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References:

Ahrens T. 2011, Management Accounting, UOL Subject Guide, University of

London International Programmes, Publications Office, UK.

Atkinson A.A., Kaplan R S & Young S M. 2004, Management Accounting, 4th

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Bromwich, M. and Bhimani, A. 1989, Management Accounting: Evolution not

Revolution”, Management Accounting, 67(9).

CIMA 2005, Official Terminology, London: CIMA Publishing.

CIMA 2015, Management Accounting in Support of the Strategic Management

Process, CIMA Executive Summary Report, Volume 11 Issue 1,
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Porter, M.E. 1980, Competitive Advantage: Creating and Sustaining Superior
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Turney, P.B.B. & Anderson, B.1989, ‘Accounting for Continuous Improvement’

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Ward, K. 1992. Strategic Management Accounting, Butterworth-Heinemann,

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