CHAPTER 1

MANAGERIAL ACCOUNTING: AN
OVERVIEW
This chapter explains why managerial accounting is important to the future
careers of all business students. It answers three questions: (1) What is
managerial accounting? (2) Why does managerial accounting matter to
your career? and (3) What skills do managers need to succeed? It also
discusses the importance of ethics in business and corporate social
responsibility.

i. Comparison
of financial
and
managerial
accounting
2. Seven key differences
ii.

Users
1. Financial accounting reports are prepared
for external parties, whereas managerial
accounting reports are prepared for internal
users.

iii.

Emphasis on the future

1. Financial accounting summarizes past
transactions. Managerial accounting has a
strong future orientation.

iv.

Relevance of data
1. Financial accounting data should be
objective and verifiable. Managerial
accountants focus on providing relevant
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data even if it is not completely objective or

verifiable.
v.

Less emphasis on precision

1. Financial accounting focuses on precision
when reporting to external parties.
Managerial accounting aids decision makers
by providing good estimates as soon as
possible rather than waiting for precise data
later.

vi.

Segments of an organization
1. Financial accounting is concerned with
reporting for the company as a whole.
Managerial accounting focuses more on the
segments of the company. Examples of
segments include:
a. Product lines, sales territories,
divisions, departments, etc.

vii. Generally Accepted Accounting Principles

(GAAP)
1. Financial accounting conforms to GAAP.
Managerial accounting is not bound by
GAAP.
viii. Managerial accounting not mandatory
1. Financial accounting is mandatory because
various outside parties require periodic
financial statements. Managerial accounting
is not mandatory.
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The work of management and the need for managerial

accounting information
Managers carry out three main activities planning,
directing and motivating, and controlling.
Planning
An important part of planning is to identify
alternatives and then to select from among
the alternatives the one that does the best
job of furthering the organizations
objectives.
Once alternatives have been identified, the
plans of management are often expressed
formally in budgets.
a. Budgets are usually prepared under the
direction of the controller, who is the
manager in charge of the accounting
department.
b. Typically, budgets are prepared
annually.
Directing and motivating

In addition to planning for the future,

managers must oversee day-to-day
activities to keep the organization
functioning smoothly.
Managerial accounting data, such as daily
sales reports, are often used in this type of
day-to-day decision making.
Controlling
In carrying out the control function,
managers seek to ensure that the plan is
being followed. Feedback, which signals
whether operations are on track, is the key to
effective control.
A performance report compares
budgeted to actual results. It suggests
where operations are not proceeding as
planned and where some parts of the
organization may require additional
attention.
The planning and control cycle
The work of management, which is known
as the planning and control cycle, can be
depicted as shown.
Organizational structure
2. Decentralization
ix.

Decentralization is the delegation of

decision-making authority throughout an
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organization by giving managers the authority

to make decisions relating to their area of
responsibility.
The functional view of organizations
An organizational chart shows how
responsibility is divided among managers and
it shows formal lines of reporting and
communication.
Line and staff relationships
An organization chart also depicts line and
staff positions in an organization.
1. A person in a line position is directly
involved in achieving the basic objectives of
the organization.
2. A person in a staff position is indirectly
involved in achieving those basic objectives.
Staff positions support line positions, but
they do not have direct authority over line
positions.
The Chief Financial Officer
The Chief Financial Officer (CFO) is the
member of the top management team who is
responsible for providing timely and relevant
data to support planning and control
activities and for preparing financial
statements for external users.
The controller reports to the CFO.
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Key definitions/concepts
A business process is a series of steps that are
followed in order to carry out some task in a
business.
A value chain consists of the major business
functions that add value to a companys
products and services.
Lean production
In a traditional manufacturing company, work
is pushed through the system in order to
produce as much as possible and to keep
everyone busyeven if products cannot be
immediately sold.
The push approach almost inevitably
results in large inventories of raw materials,
work in process and finished goods.
a. Raw materials are the materials that
are used to make a product.
b. Work in process inventories consist of
units of product that are only partially
complete and will require further work
before they are ready for sale to the
customer.
c. Finished goods consist of units of
product that have been completed but
have not yet been sold to customers.
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The Theory of Constraints (TOC)

Key definitions/concepts
A constraint (also called a bottleneck) is
anything that prevents you from getting
more of what you want.
The constraint in a system is
determined by the step that has the
smallest capacity.
The Theory of Constraints (TOC) is based
on the insight that effectively managing the
constraint is the key to success.
The goal is to manage the constraint
with the intent of generating more
business rather than cutting the
workforce.
The TOC offers a four step approach to
process improvement:
First, identify the weakest link in the chain,
which is the constraint.
Second, do not place a greater strain on the
system than the weakest link can handle if
you do, the chain will break.
Third, concentrate improvement efforts on
strengthening the weakest link.
Fourth, if the improvement efforts are
successful, eventually the weakest link will
improve to the point where it is no longer
the weakest link.
At this point, the new weakest link
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must be identified and the

improvement process starts over again.
Six Sigma
Key definitions/concepts
Six Sigma is a process improvement method
that relies on customer feedback and factbased data gathering and analysis
Techniques to drive process improvement.
The term Six Sigma refers to a process that
generates no more than 3.4 defects per
million opportunities.
Because this rate of defects is so low,
Six Sigma is sometimes associated
with the term zero defects.
The DMAIC (Define, Measure, Analyze,
Improve, and Control) framework
The define stage defines the scope and
purpose of the project, the flow of the
current process, and the customers
requirements.
The measure stage gathers baseline
performance data concerning the existing
process and narrows the scope of the project
to the most important problems.
The analyze stage identifies the root causes
of the problems that were identified during
the measure stage.
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The analyze stage often reveals nonvalue-added activities that should be

eliminated wherever possible.
The improve stage is where potential
solutions are developed, evaluated, and
implemented to eliminate non-value-added
activities and any other problems uncovered
in the analyze stage.
The control stage ensures that problems
remain fixed and that the new methods are
improved over time.
The importance of ethics in business
The IMAs Statement of Ethical Professional
Practice has two main parts guidelines for ethical
behavior and guidelines for resolution of an ethical
conflict.
Guidelines for ethical behavior
3. Competence
a. Maintain professional competence.
b. Follow applicable laws, regulations,
and standards.
c. Provide accurate, clear, concise, and
timely decision support information.
d. Recognize and communicate
professional limitations that preclude
responsible judgment
4. Confidentiality
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a. Do not disclose confidential

information unless legally obligated to
do so.
b. Ensure that subordinates do not
disclose confidential information.
c. Do not use confidential information for
unethical or illegal advantage.
5. Integrity
a. Mitigate conflicts of interest and
advise others of potential conflicts.
b. Refrain from conduct that would
prejudice carrying out duties ethically.
c. Abstain from activities that might
discredit the profession.
6. Credibility
a. Communicate information fairly and
objectively.
b. Disclose all relevant information that
could influence a users understanding
of reports and recommendations.
c. Disclose delays or deficiencies in
information timeliness, processing, or
internal controls.
Guidelines for resolution of an ethical
conflict
Follow the organizations established
policies for resolving ethical conflict. If this
does not work consider the following
steps/advice:
a. Discuss the conflict with immediate
supervisor or next highest uninvolved
managerial level.
b. If immediate supervisor is the CEO,
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c.

d.

e.
f.

consider the board of directors or the

audit committee.
Remember that contact with levels
above immediate supervisor should
only be initiated with supervisors
knowledge, assuming the supervisor is
not involved.
Except where legally prescribed,
communication with individuals not
employed by the organization is not
appropriate.
Clarify relevant ethical issues with an
objective advisor such as a member of
the IMAs Ethics Counseling Service.
Consult an attorney regarding your
legal obligations.

Why have ethical standards?

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, and
higher prices. In short, ethical standards are
essential for the smooth functioning of an
advanced market economy.
Company codes of conduct
Many companies have a formal code of
conduct. These codes are generally broad12

based statements of a companys

responsibilities to its employees, its
customers, its suppliers, and the
communities in which the company operates.
Codes of conduct on the international level
The Code of Ethics for Professional
Accountants, issued by the International
Federation of Accountants (IFAC), governs
the activities of all professional accountants
throughout the world.
In addition to outlining ethical requirements
in matters dealing with integrity and
objectivity, resolution of ethical conflicts,
competence, and confidentiality, the IFACs
code also outlines the accountants ethical
responsibilities in matters relating to:
7. Taxes.
8. Independence.
9. Fees and commissions.
10.
Advertising and solicitation.
11.
The handling of monies.
12.
Cross-border activities.

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Case study
The Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 was
intended to protect the interests of those who
invest in publicly traded companies by
improving the reliability and accuracy of
corporate financial reports and disclosures.
Six key aspects of the legislation include:
The Act requires both the CEO and CFO to
certify in writing that their companys
financial statements and disclosures fairly
represent the results of operations.
The Act establishes the Public Company
Accounting Oversight Board to provide
additional oversight to the audit profession.
The Act places the power to hire,
compensate and terminate public
accounting firms in the hands of the audit
committee.
The Act places restrictions on audit firms,
such as prohibiting public accounting firms
from providing a variety of non-audit
services to an audit client.
The Act requires that a companys annual
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report contain an internal control report

that is accompanied by an opinion from the
companys audit firm about the fairness of
that report.
The Act establishes severe penalties for
certain behaviors, such as:
a. Up to 20 years in prison for altering or
destroying any documents that may
eventually be used in an official
proceeding.
b. Up to 10 years in prison for retaliating
against a whistle blower.

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