Part A: Foundations
The context of management accounting
Key takeaways
- Cost accounting ascertains, records, classifies and analyses the costs of products, services, activities and departments; management accounting uses that cost information, with other financial and non-financial data, to help managers plan, control and decide.
- A decision is a choice among alternatives whose consequences lie in the future, so the management accountant identifies the relevant costs and revenues, the future cash flows that differ between the alternatives, and leaves out historical and sunk ones.
- Management accounting serves internal users, has no legal requirement or prescribed format, looks to the future and uses non-monetary as well as monetary data; financial accounting serves outsiders under IFRS and the Companies Act, 2015.
- The management accountant holds a staff position: they frame and quantify, the line manager decides and is accountable, and under the Accountants Act, 2008 and ICPAK's code of ethics they report what the figures show.
- Its limits are real: it depends on the underlying records, rests on estimates and judgement, costs money to run, changes behaviour and captures only what can be measured.
Financial accounting tells the world what a business has done; management accounting tells the people running it what things cost, what they should cost, and what will happen if they choose one course rather than another. It is accounting turned inward and forward. This chapter places the discipline: what it is and how far it reaches, why managers need it, who uses it, how cost accounting fits inside it, how it differs from financial accounting, where the management accountant sits among other managers, and what it cannot do.
How to work through this chapter
The chapter is descriptive, and the examiner tests it with definitions, distinctions and short applications: define, list, distinguish, explain the role. Learn the distinctions as tables, attach one business example to each point, and be ready to say what the management accountant would actually prepare for a named decision. The professional and ethical setting is the Accountants Act, 2008, under which ICPAK registers and disciplines accountants, and the IESBA Code of Ethics that ICPAK adopts.
What management accounting is
Cost accounting is the process of ascertaining, recording, classifying and analysing the costs of products, services, activities and departments, so that the cost of anything the business does can be stated. Management accounting is the wider discipline that uses that cost information, together with financial and non-financial data, to help managers plan, control and make decisions; the Chartered Institute of Management Accountants defines it as the application of the principles of accounting and financial management to create, protect, preserve and increase value for the stakeholders of an organisation.
Its scope runs from cost ascertainment (what did this loaf cost?) through cost control (is the bakery spending more than it should?) and planning (budgets, forecasts, cash projections) to decision support (should we make or buy, accept this order, drop this product, invest in this oven?) and performance measurement (how did each branch and each manager do against plan?). It is not confined to money: units, hours, defect rates, customer counts and market shares are management accounting data whenever managers need them.
Its role in decisions
A decision is a choice among alternatives whose consequences lie in the future, and the management accountant's role is to put a reliable estimate of those consequences in front of the manager before the choice is made. That means identifying the relevant costs and revenues (the future cash flows that differ between the alternatives, not the historical or sunk ones), quantifying them, presenting the comparison in a form a non-accountant can act on, and stating the assumptions and the risks.
Pricing a product, quoting for a job, choosing between making a component and buying it, deciding which product to favour when a machine or a material is scarce, accepting a one-off order below normal price, closing a branch, replacing a machine and setting a budget are all decisions the later chapters equip the accountant to analyse. The role is advisory: the accountant frames and quantifies, the line manager decides and is accountable.
Worked scenario: what the management accountant prepares (not a decided case)
Mwangi's Bakery Limited is considering a second outlet in Kilifi town. Otieno, the management accountant, prepares: a forecast of the outlet's sales by product from the first outlet's records adjusted for the new location; the additional costs the outlet would cause (rent, staff, delivery, energy) and the costs that would not change (head office, the existing bakery's fixed costs, which are irrelevant to the decision); the contribution the outlet must earn to cover its own fixed costs (the break-even sales, covered under CVP analysis); a cash budget for the first year showing the funding needed before the outlet pays its way (covered under budgetary control); and a list of what the numbers do not capture (the effect on the first outlet's sales, the manager's time, the risk that the landlord raises the rent).
The board decides. Otieno's report makes the decision informed; it does not make it.
Who uses the information
Management accounting information is for internal users, at every level of the organisation:
- The board and senior management: use budgets, forecasts, investment appraisals and segment results to set strategy and allocate resources.
- Middle managers (the production manager, the sales manager, the branch manager): use cost reports, budget comparisons and variance analyses to run their functions and are judged on them.
- Supervisors and team leaders: use daily and weekly operating figures (output, scrap, hours, overtime) to control the shop floor.
- Employees: see the measures on which their bonuses depend.
Owners of a small business use it as their main decision tool. External parties (shareholders, lenders, the Kenya Revenue Authority, regulators) are the users of financial accounting; they may receive management information only where a contract or a lender's covenant requires it, and it is never published.
Cost accounting's place
Cost accounting is the engine inside management accounting. It collects the raw data (material requisitions, timesheets, overhead invoices), classifies it, and accumulates it into the cost of cost units and cost centres by the methods of the costing chapters; its output is a cost, actual or standard, for every product, job, process and department. Management accounting takes those costs and adds what cost accounting does not supply: the behaviour of costs with volume, the distinction between costs that matter for a decision and costs that do not, budgets and standards to compare against, and non-financial measures.
Historically cost accounting came first, serving the pricing and stock valuation needs of manufacturers, and management accounting grew out of it as managers asked more of the numbers; today the cost accountant's work is the foundation on which every management accounting report stands, and a wrong cost produces a wrong decision however elegant the analysis.
How the two relate
The two are branches of one discipline, drawing on the same underlying records of transactions: the purchase invoice that financial accounting posts to purchases and creditors is the document from which cost accounting charges material to a job. Financial accounting summarises those records into the statutory financial statements for the period, prepared under International Financial Reporting Standards for people outside the business; management accounting analyses the same records, and much else, for people inside it. They meet at several points:
- The closing inventory in the statement of financial position is valued by the costing methods of later chapters.
- The cost of sales in the income statement is the product of the cost accumulation system.
- In an integrated accounting system a single ledger serves both.
Each needs the other: financial accounting supplies the verified totals that keep management accounting honest, and management accounting supplies the analysis that makes the totals useful.
How the two differ
The differences between management accounting and financial accounting
| Basis | Management accounting | Financial accounting |
|---|---|---|
| Users | Internal: managers at every level | External: shareholders, lenders, tax authority, regulators, public |
| Legal requirement | None; prepared because it is useful | Required by the Companies Act, 2015 and the Income Tax Act |
| Rules | No prescribed format or standards; whatever the manager needs | IFRS, the Companies Act formats, audit |
| Time orientation | Future (budgets, forecasts, decisions), with the past as a guide | Past: the period just ended |
| Frequency | As often as needed: daily, weekly, monthly | Annually, with interim reports for listed companies |
| Level of detail | Segments: products, jobs, departments, branches, customers | The whole entity, or major segments only |
| Precision | Timely estimates and approximations accepted | Verified, precise, historical amounts |
| Nature of information | Monetary and non-monetary (units, hours, defects, market share) | Monetary only |
| Confidentiality | Confidential to the business | Published; filed with the Registrar of Companies |
Working with other managers
The management accountant holds a staff position, advising and serving the line managers who hold authority over production, sales, purchasing, human resources and operations, and reports to the finance director or chief financial officer. The relationship works in both directions. The accountant supplies each manager with the cost and performance information that manager needs, in that manager's language: unit costs and efficiency variances to the production manager, contribution by product and customer to the sales manager, price and usage variances to the purchasing manager, labour cost and productivity to the human resources manager, cash forecasts to the treasurer.
The managers supply the accountant with the operational knowledge, forecasts and explanations without which the numbers mean nothing, and they own the budgets and standards the accountant helps them set. Increasingly the management accountant is expected to act as a business partner, sitting in the planning meeting rather than sending a report to it, while keeping the independence the profession requires: under the Accountants Act, 2008 and ICPAK's code of ethics the accountant must report what the figures show, not what a colleague would prefer, and must keep confidential what the role reveals.
Limitations
Definitions with a business example
For this chapter learn each definition in one sentence and pair it with the bakery: cost accounting finds the cost of a loaf; management accounting decides whether to bake more of them. Answer 'distinguish' questions in a two-column table with the basis of distinction in a third column, and 'role' questions by naming the decisions and the reports, not by describing accounting in general.
Self-check
(a) Define cost accounting and management accounting, and explain how the first is a subset of the second. (6 marks)
(b) Distinguish management accounting from financial accounting on five bases. (10 marks)
(c) Describe the relationship between the management accountant and the production manager, giving two reports the accountant would provide. (4 marks)
Show worked answer
(a) Cost accounting ascertains, records and analyses the costs of products, services, activities and departments; management accounting uses cost and other financial and non-financial information to help managers plan, control and decide. Cost accounting supplies the cost data (unit costs, departmental costs, inventory values) that management accounting then analyses by behaviour, relevance and responsibility for planning, control and decision purposes, so it is the data-gathering component within the wider discipline (6 marks).
(b) Any five, two marks each: users (internal against external); legal requirement (none against the Companies Act and Income Tax Act); rules (none against IFRS); time orientation (future against past); frequency (as needed against annual); detail (segments against the entity); precision (estimates against verified amounts); nature (monetary and non-monetary against monetary); confidentiality (internal against published) (10 marks).
(c) The accountant is a staff adviser to the line manager: the production manager supplies operating data, forecasts and explanations and owns the production budget and standards; the accountant supplies information in the manager's terms and challenges it independently. Reports: unit and departmental cost statements; the monthly budget-versus-actual comparison with material, labour and overhead variances and their causes (4 marks).