CMA302 Management Control Issues 1-1. On completion of the successful study of this topic you will be able to:

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1 CMA302 Management Control Issues 1-1 Topic 1 Introduction Objectives On completion of the successful study of this topic you will be able to: Recall your management accounting studies in CMA101 (CMA100) and CMA202; Relate management control to the development and implementation of strategies; Explain the relevant basic concepts: control, management, and systems; Delineate the boundaries of management control; Compare and contrast management control with strategy formulation and task control; Discuss the developments in communication over the last 150 years and their impact on the requirements of a management control system. Anthony, R. and Govindarajan, V. (2007). Management Control Systems, 12th ed., McGraw-Hill Irwin, NY, Chapter 1. Review Langfield-Smith, K; Thorne, H; and Hilton, R. (2012). Management Accounting: Information for managing and creating value, 6th ed., McGraw- Hill Irwin, North Ryde Chapters 1 12, 19 and 20 You should listen to the Topic01 presentation after pre-reading this topic study guide and the text (refer to the reading above) and then read the required reading again to reinforce the concepts.

2 CMA302 Management Control Issues 1-2 Introduction As in CMA202, you will find that the study guide for this unit is occasionally fairly brief because the explanations in your textbook are often relatively simple and do not need further explanation. For some topics you will be using a more advanced book that draws heavily on Harvard case studies. Sometimes we will feel that you might need some help with understanding the textbook, or we may wish to extend or discuss the textbook material. Then the study guide topic will be a little longer. This introduction serves to remind you of management accounting techniques that you have already covered, since CMA302 builds upon that knowledge. This topic then considers what we refer to as management control. Cost Behaviour and Cost Categories You should recall that in CMA101 (CMA100) and CMA202 the behaviour of costs was analysed to determine what costs would apply to different decisions and what the likely change in costs would be if various actions were taken. So, for example, we worked out which costs were fixed over a range of activity and which costs changed with the level of activity. Thus we had fixed costs and variable costs. Using these categories of costs we were able to apply cost-volume-profit (CVP) analysis to find break even point and the required sales level to meet target profit in a variety of circumstances. This was a form of relevant costing. We later took these cost categories further by distinguishing between engineered costs, discretionary costs and committed costs. These cost categories were useful in understanding the likely unfavourable outcomes that can result from some management decisions such as blanket budget cuts. Discretionary costs were found to be the costs that can be cut most easily in the short term but can have significant long term detrimental effects. With this knowledge managers may identify these detrimental outcomes and trace them back to poor decisions made in the previous year or two. This can be useful as a learning exercise so that fewer errors of judgement occur in the future, and also so that line managers are not unfairly censured. Further cost categories were identified when manufacturing costs were considered costs such as: direct material, direct labour, manufacturing overhead, fixed overhead, variable overhead, indirect material, indirect labour, work in process, finished goods inventory and cost of goods sold. In this context we distinguished between product costs and period costs. If you do not recall the meaning of any of these terms you are strongly advised to refer back to your studies in previous units to clarify what they are. Costing In a costing exercise we bring together different elements of costs to find how much cost should be attributed to particular cost objects. There are various techniques for this. The variety of techniques and criteria for cost accumulation is affected by (a) circumstances, such as the nature of the cost object, and (b) the use to which the costing is to be put, such as the kind of decision it is going to inform. A key issue in product costing is the treatment of overhead costs. A common way to deal with overhead costs is to aggregate them and divide by a measure of production such as units, direct labour hours or machine hours, to derive an allocation rate. This overhead allocation rate can then be used to allocate overhead to product based on the cost object s consumption of the allocation base, such as direct labour hours or machine hours. We considered two extremes for the sake of learning the principles relating to job costing and process costing. You were then equipped to apply these principles in a composite way to

3 CMA302 Management Control Issues 1-3 account for manufacturing that had elements of job production and elements of processing. This composite is called operations costing. In process costing you learned how to allow calculate and use equivalent units to work out unit costs, costs of production, cost of goods manufactured, ending finished goods inventory, work in process inventory, and cost of goods sold. Two approaches to this were the weighted average method and the FIFO (first in first out) method. The allocation of overhead costs using an allocation rate is useful when dealing with actual costs after the completion of production. However, there is usually a need to record costs passing through a production system, predetermine sales prices or contract prices, and set standards with which to compare and evaluate actual costs. You therefore became familiar first with actual costing, then with normal costing, followed by standard costing and activity based costing. Again, if you do not recall what these expressions mean you should revise your prior topics in management accounting. Using Standard Costs Standard costs are the basis for preparing a plan of the resource consumption required to achieve the objectives laid down for future operations. The resource consumption plan is usually referred to as the budget. The most common and most detailed budgets apply to the next operating period, which is usually a 12 month period. An evaluation of performance involves the comparison of actual costs with standard costs. This approach is called variance analysis. Variance analysis does not give answers to as many questions as it does questions to ask. It serves as a way to highlight problems and indicate what should be investigated. It is often said that motivation can be increased by rewarding favourable variances, but this is not always the best approach since managers can achieve favourable variances while making it difficult for others to do the same, in the process reducing profits for the organisation as a whole. An example is the purchase of poor quality materials to achieve favourable price variances. This is often followed by a range of unfavourable manufacturing variances such as wastage and other inefficiencies. The analysis of the variances, when undertaken appropriately, is a strong weapon in the exercise of control in an organisation. This will become clearer in this unit. Pricing, Mix and Tactical Decisions Product costs can play a major role in determining the transfer price that should apply to the transfer of goods and services between different operating units in the organisation. When transfer prices are based on costs it is important to carefully consider whether to use actual cost or standard cost, and whether to use absorption costs or variable costs. The transfer between profit centres can take the cost and add a margin for profit sharing, whereas transfers between cost centres need only be transferred at standard cost to achieve cost recovery and leave the variances in the operating unit where they occurred. Cost based transfers can take place when there is not a suitable market in which to establish the competitive price for the product, or when the source department has excess capacity (and hence will not forgo external sales to be the internal provider). When there is such a market and no excess capacity the transfer price can be based on the market price, adjusted for any costs that will not apply to internal transfers. An important issue is whether the organisation will benefit form internal transfers or whether it might be preferable for both units to deal with external parties. This was also covered in CMA202. Decisions about which products to produce are called product mix decisions. They utilise a variety of relevant costing. Other decisions that use relevant costs include those in which the choice is made between (a) insourcing and outsourcing; (b) whether to process a joint product

4 CMA302 Management Control Issues 1-4 further before selling it; (c) whether to close a plant or retail outlet; and (d) whether to upgrade or replace equipment. If you are unsure about any of the material in the preceding overview of what have studied in CMA101 (CMA100) and CMA202 you should refer to your previous study guide and textbook, Langfield-Smith et al (2012). You should listen to the Topic01 presentation after pre-reading this topic study guide and the text (refer to the reading above) and then read the required reading again to reinforce the concepts. From Costing to Cost Management and Management Control When you studied budgeting in CMA100 you were introduced to the idea of planning and control. In CMA202 you found further references to control through performance evaluation, motivation and other approaches. In this unit you will be exposed to more managerial techniques for managing costs and also the key elements of a good management control system. You are now asked to understand control in the context of strategies. The reading differentiates between strategy formulation, management control, and task control. You may find it easier to scan the reading very quickly to gain a grasp of where it is going, then go back to the beginning and read the chapter more carefully. You should now read chapter 1 of Anthony et al (2007).

5 CMA302 Management Control Issues 1-5 Your learning in this unit will use case studies that offer descriptions and data of organisational situations. When you work with case studies individually or in groups you appraise situations, analyse problems and use a range of ideas and models in doing so. You develop solutions and practice in safe, low risk ways. There are several reasons you are required to use case studies. Case studies are an effective way of applying your understanding of various accounting concepts. Case studies are also a useful way to expose students to the types of situations and problems faced by practicing accountants. But perhaps the most important reason for using case studies is to develop the skills necessary for critical analysis, problem solving and the types of decision making that is the hallmark of an effective accountant. You should now peruse the various readings provided with this topic on Learnline. There are several readings related to analysing case studies, root cause analysis, developing effective search strategies, working in groups, presenting your analysis, and other study guides. These supplementary readings may confirm what you already know and/or may provide useful insights on how best to undertake the required case analysis assessment. You should listen to the brief presentation related to case study analysis after perusing the supplementary readings and then read the supplementary readings again to reinforce the concepts. Task for tutorial class Read and analyse Case 1-2, Wal-Mart Stores Inc (p31-33) of Anthony and Govindarajan As you prepare this case take notice of the firm s strategy and how it views it s competitive advantage and role of the control system in executing it s strategy. Another purpose for preparing a response to this case is to apply what you have learned in respect to case study analysis and to gain some experience in applying that knowledge, in preparation for the case analysis that you will need to undertake for your group s case presentation assessment. Record your response in the Learnline Journal set up for this purpose. and be prepared to discuss this case in your tutorial in study week 3. Note that the cases in this unit can be the subject of examination questions or other assessment tasks. Summary In this topic you have been asked to revise material that you studied previously and have been introduced to some new concepts with regard to control. After studying this topic you are expected to have a solid foundation for looking at management control mechanisms and techniques in the rest of this unit.

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