Accounting

• 1. Financial Accounting Page 1

2. DefinitionAccounting is the process ofidentifying,measuringand communicatingfinancial information about an entityto permit informed judgments and decisionsby users of the information.Page 2 3. The Accounting EquationAssets minus Liabilities equals EquityA -L =EAssets equals Liabilities plus EquityA = L +EEquityCapitalOwnership claim Shareholders funds Page 3 4. Power of AccountingAccounting provides a very selective but powerfulrepresentation of the corporate identity.. The detailed language of assets, liabilities, costs, profits provide a range of corporate imagery and vocabulary .Accounting provides the categories through whichorganisational participants perceive both themselves andthe organisation. Mike Powers Page 4 5. Creative Accounting?Things may exist independently of our accounts, but theyhave no human existence until they become accountable.They may not exist, but they take on human significance bybecoming accountable..Accounts define reality and at the same time they are thatreality.Accounts do not more or less accurately describe things.Instead they establish what is accountable in the setting inwhich they occurWhether they are ACCURATE OR INACCURATE by some otherstandards, accounts define reality for a situation in the sensethat people act on the basis of what is accountable in thesituation of their action.Ruth HinesPage 5 6. You will discoverThat accounting is subjective, partial and potentiallymisleadingAccountants use language / numbers in a highly technicalwayAccounts are a highly stylised story, representation,description of organisational eventsDifferences between the Accounting World and theOrganisational WorldProblematic nature of accounting numbers Page 6 7. And theres more.The tribe of accountants takes many forms and liveswithin all organisationsNo such thing as a correct cost, value, profit..itall depends on contextThe value of accounting in managingorganisations Page 7 8. Roles of AccountingImprove problem solving / decision makingManage risksTrust, AssuranceEducational - learn about organisationsLanguage of businessConstruct, define, measure success/failure Page 8 9. Roles of AccountantsAssisting the internal management of organisationsComplying with external financial reporting, controls and with taxation regulationsExpert consultants on financial and organisational performance Page 9 10. Financial Accounting Accounting conceptsProfit and Cash distinctionFinancial statementsOrganisational impactPage 10 11. Hierarchy of Accounting Qualities Decision Makers and their characteristicsBenefits > CostsUnderstandability Decision-UsefulnessRelevanceReliabilityPredictiveTimelinessVerifiabilityRepresentationalvalue FaithfulnessComparability & Feedback consistency Neutrality Value MaterialityPage 11 12. TransactionsBuy materials on creditfrom suppliers Sell goods or services on credit to customersPay suppliersReceive cash Page 12 13. When is profit reported?When goods or services are soldNOTwhen cash is paid or receivedPage 13 14. Example: Antiques dealerBuy 10 chairs for cash Rs 200 eachSell 6 chairs on credit Rs 300 each Profit 6 x 100 each = Rs.600Cash flow = minus 2,000Page 14 15. Profit, not cashMatching Concept match revenues received withthe costs incurred to generate them Goods received but not paid for Creditors (Payables) Goods or services supplied but no cash yet - Debtors (Receivables)Prudence concept providing for known / probablelosses e.g. Doubtful debts, Depreciation of fixed assets Page 15 16. Profit, not cash contdCustomers pay in advance for services extendingbeyond the accounting periodCompany agrees with supplier to buymaterials at fixed price for 5 yearsHome currency euros, borrow in dollars Increase in valuation of fixed assetsPage 16 17. Change over a periodstart Assets - Liabilities = EquityDuring the period Profit/loss endAssets - Liabilities = EquityPage 17 18. Contents of annual report Financial highlights Company overview Chairmans statement Chief Executives review Audit report Financial statementsNotes to the accountsPage 18 19. The main financial statementsBalance Balance BalanceSheet 1 Sheet 2 Sheet 3AS AT AS AT AS AT31 Dec Year 1 31 Dec Year 2 31 Dec Year 3 Profit and LossProfit and LossAccountAccount For period For period Cash Flow Report Cash Flow ReportPage 19 20. Balance sheet horizontal Fixed assets Liabilities Current assets Shareholders fundsPage 20 21. Balance sheet verticalFixed assetsCurrent assetsLessCurrent liabilitiesLess long term liabilitiesEqualsShareholders funds Page 21 22. Profit and loss accountRevenue (sales)Less Expenses (costs)Equals Profit Page 22 23. Cash flow statementOperating cash flowsplus Investing cash flows plusFinancing cash flowsEquals change in cash and bank loans Page 23 24. Creative accounting What do we want to create?More profit? Less profit?More assets?Fewer assets?More liabilities? Fewer liabilities? Page 24 25. Creative Accounting PracticesIncome smoothing move profit from one year toanotherChanging accounting policies, particularlydepreciation, asset valuationsOverstating costs, particularly in regulated industriesMaking expenses into Assets - capitalisationPage 25 26. Off-balance sheet financing , e.g leasing, Saleand buyback, special purpose vehicles Recognising profits that arent really there foreign exchange rates affecting values of assets and loansCorporate takeovers ACCOUNTINGMINEFIELD adjusting policies, fair values,goodwill, brands, reorganisation costs...Page 26 27. Corporate crime / fraudDirectors are responsible for preventing crime andfraud They are required to have a system of internal controlsWho controls executive directors for honesty/?Audit committees, Non-executive Directors,Supervisory BoardPage 27 28. Corporate crime/ fraud contd. Creating fictitious contractsFictitious Assets, inaccurate valuationsOmitting Liabilities, misleading valuationsRaid the employees pension fund Page 28 29. Analysis and Interpretation ofFinancial Statements Page 29 30. First Steps BC(before calculation) Why are you analysing accounts? Who are you interpreting for? When are you interpreting? What are you intending to interpret? Limitations of Financial Accounts Page 30 31. Always bear in mind Preparers of accounts know how people will interprettheir accounts Be cynical assume the accounts are the best possiblepicture Analysis only as good as original data Never just use accounts check from many differentsources Accounting terms are different from generalunderstandings Page 31 32. However. Accounts are main source of systematically producedregulated information Good as it gets Usually reliable 3rd party verified Follow the same basic rules Most of the information is there (in the small print) You can never eliminate the risk of fraud / criminalmisrepresentationPage 32 33. Analyse Accounts to determineIs the company:Growing?Profitable?Managing its assets effectively?Sufficiently liquid? Financed properly? Able to meet its financial obligations? Viewed favourably by financial markets? Page 33 34. Financial ratios Quick and simple check on financial health Small number of ratios gives a picture of thebusiness. Easy to calculate, harder to interpret. Provide a starting point for further investigation.Page 34 35. Key areas for analysis Profitability Liquidity Asset management Debt management (financial structure) Market valuePage 35 36. Success in making profitReturn on capital employedprofitsalesProfit_____x _______= __________salestotal assetstotal assetsprofitability x efficiency = ROCEPage 36 37. Managing liquidity Can we pay the bills as they fall due? Can we pay the wages of employees? Buy stock (inventory) on credit Sell on credit = accounts receivable Pay suppliers = accounts payable Ideally, match cash flows in and out Page 37 38. Asset management Use fixed assets to earn sales revenue Manage working capital stocks (inventory) debtors (accounts receivable) creditors (accounts payable) working capital cycle Page 38 39. Financial structure Is it a good idea to borrow? Creates greater risk - interest payments andcapital repayments Benefits to shareholders when profits are rising Risks to shareholders when profits are falling Page 39 40. Advantages of ratios Comparisons are relative to other figures Compare businesses of different size Gives picture of company strategy Financial and trading performance Compare with industry averages Simple summary of complex informationPage 40 41. Reasons for using ratios Gives summary statistics Helps identify industry benchmarks Input to formal decision model Standardise for size Page 41 42. Applications of analysis Predictions of corporate earnings Construct projected financial statements Predict corporate failure Indicators of financial distresse.g. Altmans models, combination of ratiosPage 42 43. Problems with ratio analysis No agreement on definitions or specific set ofratios Accounting estimation Data not available Timing of data does not match Differing accounting policies Negative numbers and small divisors Page 43 44. Limitations of ratio analysis Diverts attention from the underlying information May not give sufficient attention to the notes tothe accounts Accounting policies may affect comparison Industry differencesPage 44 45. Creative accountingCould involve: Inflating reported profits and EPS Accounting for losses via balance sheet reservesand all profits through P & L Reporting profits without generating equivalentcash Reporting lower borrowings Page 45 46. Survival Tips for Accounting Jungle Read the accounts backwards Read the accounting policies and compare Screen accounts using filters e.g. high profitlow tax, changing depreciation policies Cash is King (or Queen) Assess risk: If in doubt, keep out (or get out) Page 46 47. Return on Capital EmployedProfit before interest and taxation x 100Shareholders funds plus long term debt Often called Operating profitAssets minus Liabilities = Equity Total assets minus current liabilities equalsShareholders funds plus long term loansPage 47 48. Return on Capital EmployedTop line questions What increases/ decreases profit? Sales? Operating Costs?Bottom line questions Recent increases in assets may not yet havecreated profit Is there any debt off balance sheet?Page 48 49. Return on Shareholders Funds(also called Return on Equity) Net profit after taxes x 100Shareholders fundsPage 49 50. Return on Shareholders FundsTop line questions What increases/ decreases profit? Sales? Operating Costs? Interest charges? Taxes?Bottom line questions Is the company high/ low geared?Page 50 51. Net Profit PercentageNet profit after taxes x 100Sales Often shown as Profit attributable toordinary shareholders Sales also called turnover Page 51 52. Net Profit PercentageTop line questions Is gross profit high or low? What are the admin and selling costs? What are the effects of interest and taxation?Bottom line questions Is the measurement of sales explained? Page 52 53. Gross Profit PercentageGross profit x 100SalesGross profit = Sales minus cost of salesCost of sales = making ready for sale Page 53 54. Gross Profit PercentageTop line questions Have sales volumes or prices changed? Have costs of sales changed? Are costs of sales mainly variable or fixed?Bottom line questions Is the measurement of sales explained? Page 54 55. Current RatioCurrent Assets Current LiabilitiesSolvency = Ability to meet obligations asthey fall dueWorking capital = CA minus CLPage 55 56. Current RatioTop line questions What affects levels of stocks, debtors, cashBottom line questions What affects levels of bank borrowing, tradecreditors, other short term creditorsOverall - How does the company manage itsworking capital? Page 56 57. Quick Ratio (Acid Test)Current Assets less Stock Current LiabilitiesSolvency = Ability to meet obligations asthey fall dueCash flow: How does the company manageinflows and outflows of cash?Page 57 58. Quick Ratio (Acid Test)Top line questions How is the company managing debtors and cash?Bottom line questions How is the company managing trade creditors andbank overdraft?Page 58 59. Stock Holding Period (days) Stock x 365 Cost of Sales Change 365 to 12 for a calculation in months. Sales minus cost of sales equals gross profitPage 59 60. Stock Holding Period (days)Top line questions Year-end stock or average stock? Use year-endfor ease of calculation but check there are nosignificant changes from start.Bottom line questions May have to make some approximations to getcost of sales Page 60 61. Debtor Payment Period (days) Trade Debtors x 365 Sales Debtors = Accounts receivable (customers who buy on credit terms)Use notes to the accounts to find trade debtors. Page 61 62. Debtor Payment Period (days)Top line questions Average or year-end? Year-end is lesstrouble but check there are no majorchanges.Bottom line questions Are all sales made for credit? Think about thenature of the business. Page 62 63. Creditor Payment Period (days)Trade Creditors x 365Purchases or cost of salesTrade creditors = Accounts payable(suppliers who provide goods on credit terms) Use notes to the accounts for detail.Page 63 64. Creditor Payment Period (days)Top line questions Average or year-end?Bottom line questions Opening stock + purchases - closing stock = Costof goods sold. Should be Purchases but Cost of goods sold is Okif stocks are constant. Page 64 65. Gearing Long Term DebtLong Term Debt plus Equity Look carefully at balance sheet and usenotes to accounts.Add Preference shares to DebtOmit ProvisionsPage 65 66. GearingTop line question What are the sources of finance that create fixedcommitments to pay interest and repay capital?Bottom line question What is the total long-term financing of thebusiness, based on borrowings and equity?Page 66 67. Interest Cover Profit before interest and tax Interest expense EBIT = Earnings Before Interest and Taxation Interest expense: either in profit and loss accountor in detailed notes. Page 67 68. Interest CoverTop line questions What is the amount of profit available to coverinterest payments? Is the company generating sufficient wealth tomeet interest payments?Bottom line questions What is the cost of servicing borrowings?Page 68 69. Concepts, Cost and Costing Page 69 70. Management accounting Integral part of management identify, present and interpret information for strategy, planning and control, for decision taking and use of resources for disclosure to employees to safeguard assetsPage 70 71. Management accounting (contd) Internal use within organisation No regulation by law Projections for future Analysis of past Directing attention, planning and control Solving problemsPage 71 72. Measuring andanalysingperformanceImplementingExamining futureplans environmentAction plans and budgetsDevelopingobjectives Operating plans Formulating strategy Page 72 73. Importance of costing Many organisational decisions rely on costings Costing is complex but essential An accountant knows the cost of everything butthe value of nothing Oscar Wilde Page 73 74. Describing costs Direct (identified with a saleable unit) Indirect (spread across saleable units) Indirect costs = Overheads How to find a fair way of spreading theoverheads? Page 74 75. Confusing terminology Allocate = give all cost to one unit or centre Apportion = share across units or centres Absorb (Absorption) Soak up into the units ofoutputSee page 142 of text book Page 75 76. Terminology (contd) What are the direct costs? Allocate these to unitsof output What are the indirect costs? Allocate to costcentres if we know where they belong. Otherwise Apportion (share) across cost centres. Absorb costs from production centres intoproducts. Page 76 77. Absorption basesAbsorb as cost per unit cost per labour hour cost per of labour cost per kilo of material cost per machine hourDifferent bases give different answers Page 77 78. Cost behaviourPairs of classifications Direct or indirect? Fixed or variable? Period or product?Case: Bus company sends buses to 10 schools fortaking children home each day. How does thecompany describe the costs?Page 78 79. Direct or indirect?Direct for each school:Drivers working time, fuel for bus, bridge tollsIndirect to spread across all journeys:Insurance, repairs, maintenance, licences,depreciation, drivers idle time, holiday payPage 79 80. Fixed or variable?Variable change with activity levelFuel, repairs, bridge tollsFixed regardless of activity levelDrivers wages, Insurance, Licences,Maintenance checks, Depreciation Page 80 81. Period or product?What is the product?A person-mile.Product costsDrivers time, fuel, bridge tollsPeriod costsInsurance, Licences, routine maintenance,depreciationPage 81 82. Examples of decisions Price setting, tendering for contracts Product profitability analysis Product design modifications R & D management Value Engineering General Cost Management Contracting out / Buying in Plant / Department Closure Page 82 83. Short-term decisionsIn the short term business can continue if the sellingprice covers variable costs and makes acontribution to fixed costs.Contribution = Selling price - variable cost Page 83 84. Contribution analysisBreak even point =Fixed costs Contribution per unitPay 1,000 rent for market stall. Buy toys for 6each, sell for 8 each. What is breakevenvolume?1,000/2 = 500 toysPage 84 85. Contribution analysis (contd)Sell 500 at 8 = 4,000.Variable cost 500 x 6 = 3,000Add fixed costs 1,000Neither profit nor lossHow many toys to sell for profit of 4,000?(1,000 + 4,000)/2 = 2,500 toysPage 85 86. Scarce resourcesSell gardening services and house cleaning.Contribution per job 10 and 8.Gardening needs 2 hours per job, House cleaningneeds 1 hour per job.Shortage of labour. Which has priority?House cleaning 8 per hour, Gardening 4 per hour.Contribution per unit of limiting factor Page 86 87. Short term decisions Make internally or buy externally Hire own staff or pay agency for outsourcing Keep a business activity going Take on a special order at lower price Page 87 88. Other factors in decisionsNot just an accounting matter. Consider organisations objectives relationship with employees marketing corporate goodwill/ image customer reactions government policiesPage 88 89. Get the costs wrong and...Set prices too high - lose sales;too low - sell products at lossLose potentially profitable contracts, win lossmaking contractsDont know where we are making / losing moneyContinue with loss making products, cut profitmaking products, sub-optimal product mix Page 89 90. Get the costs wrong and...R & D to create better product when noneneededProduct Design Modifications not done whenneededContracting out production that costs more thaninternal productionMaking products that could be cheaper to buy inClose profit-making Plant / Keep open lossmaking plant Page 90 91. Different Costs for Different PurposesNot a single, universal true cost.Appropriate cost is governed by:Needs of management Specific organisational situations Specific problem to be solved Available information - pragmaticsPage 91 92. Different Costs for Different PurposesActivity Based Failure CostPlanned CostCostAverage Cost Full Cost Product CostAvoidable Cost Historic Cost Quality CostBudgeted CostIncremental Relevant Cost CostControllable Indirect Cost Step CostCostCurrent Cost Joint CostSunk CostDirect CostMarginal Cost Standard CostEnvironmentalOpportunity Total CostCost CostEngineered OverheadTransfer CostCost CostFixed Cost Period Cost Variable Cost Page 92 93. Costing ProblemIn contemporary organisations the fixed/variableclassification is not relevantLogical impossibility of attributing all costs toproductsWrong approach to the problemSolution based in the accounting world not theorganisational worldPage 93 94. Activity SolutionCosts dont drive activities, activities cause costsOrganisations do things that consume resourcesand (should) create valueCosting should start with what the firm does -activities in organisational world Page 94 95. Activity Based Costing What are the activities of the organisation? What resources are used by each activity? How much does each resource cost? Collect cost in cost pools How does each product or service make use ofeach activity? Share cost from the cost pools. Page 95 96. MoneycostResources consume Non-financialCollectDataActivities Performance AnalysisproduceOutputscreatesValuePage 96 97. Benefits of ABC Makes visible the activities that drive the costs Prevents misallocation of costs Links costs more closely to responsibility forcausing costsBUT does not save money or generate profit. Itonly gives more accurate informationPage 97 98. Activity costing is...Not based on accounting coding structuresNot based on accounting time framesNot based on techniques designed to makethe accountants life easierNot based on producing FinancialStatements Page 98 99. Short term planningBudgets andBudgetary ControlPage 99 100. What is a budget? Quantified formatmanagement plans and strategies for decision making communication medium Page 100 101. Mission/ goalsFinancial plansCorporate objectivesAssumptionsAssessed marketLong termon criticalopportunities/ strategy factorsorganisationalcapabilityLong term plans Page 101 102. Long term strategyLong term planningMarketopportunitiesForecasting assumptions Short term strategyOrganisationalcapability Budget/ short termModify planningassumptions Page 102 103. Budget process Formalises planning and control Defines goals Goal congruence - brings goals together Authority and responsibility are clear Framework to judge performancePage 103 104. operatingfinancialMaster budget Sales budget Capital budget+ Cost of goods sold budget+ Cash budgetDevelopment /design budget+ Marketing budget+ BudgetedDistribution budget+ balance sheetAdministration budgetBudgeted profit and lossBudgeted statementaccount of cash flow Page 104 105. Budget preparationStart with sales budget (demand driven)Then match with cost of salesIs this a production organisation?Plan: inventories of raw materials, finished goods purchases to cover sales and inventoriesPage 105 106. Budget preparation (contd) Is this a service organisation?Plan service programme, labour needs, materialsneeded Plan all other operating expenses Plan capital expenditure Bring together in cash budget, budgeted profitand loss account, balance sheet.Page 106 107. Cash budget Most important part of budget cycle Monthly, quarterly? Cash receipts from operations Cash payments for operations Other cash receipts (new finance, sale of fixedassets) Other cash payments (tax, dividends, interest)Page 107 108. Fixed and flexible budgets Fixed means that budget is not adjusted later ifvolumes start to vary Flexible budgets means that budget is adjusted totake account of change in volumes of activityover the period Page 108 109. Fixed and flexible (contd)Budget variable costs of 200,000 for 5,000 units of outputActual variable costs are 195,000 for 4,500 units of outputHow has manager performed against budget? Page 109 110. Fixed and flexible (contd)Appears to have saved 5,000But budgeted cost = 4 per unitSo flexible budget for 4,500 is 180,000Performance is 15,000 worse than flexible budget. Page 110 111. Alternative approachesEasy approach = Last year plus inflationZero-based budgeting Start with a clean sheet Justify every item Focus on goals and objectives Page 111 112. Alternative approaches (contd)Activity based budgeting Extension of activity based costing Focus on cost of each activityKaizen budgeting continuous improvement budget is achieved if improvements are met Page 112 113. Not-for-profit organisations Goals and objectives measured differently Need to be cost effectivePlanning programming budget system Focus on outputs rather than inputs joined-up governmentPage 113 114. Behavioural aspectsBudgets can motivate employees to achieve goals ofthe organisation. What helps? degree of difficulty top management participation perceived fairness feeling of ownership avoid discontent about preparation Page 114 115. Not foolproofWhy might budgets fail? Fail to understand changing environment using unsuitable existing structures fail to understand business systems lack of senior management support fail to understand central role of budgeting Page 115 116. Are budgets necessary?What matters is PLANNINGThis does not have to use budgets. Essential: Set targets: to maximise long term value Strategy: Make development continous Growth and improvement: challenge staff Resource management: wealth creationPage 116 117. Are budgets necessary? Co-ordination: manage cause and effect Cost management: challenge all costs Forecasting: use rolling forecasts Measurement and control: key indicators Rewards: unit rewards not individuals Delegation: give managers freedom to act Page 117 118. Performance MeasurementPage 118 119. Strategic planningFive year plan, rolling forward. Profitability Growth of sales, profit Market share Customer satisfaction Rate of innovationHow to measure achievement of strategy?Page 119 120. Accounting-based performancemeasuresProfit? Could compare actual profit against budget, butcompanies dont give information An absolute measure, needs ratios forcomparison. Affected by choice of accounting policies Measured differently in different countriesPage 120 121. Accounting-based performancemeasures (contd)Profitability A relative measure, better for comparison. Calculate for subdivisions of an organisation.Methods Return on capital employed Residual income Economic value added Page 121 122. Return on capital employedProfit before interest and taxesFixed assets plus current assets less currentliabilitiesCan be used for divisions of a company if assets and liabilities can be allocated.Page 122 123. Return on shareholders fundsNet profit after interest and taxation Shareholders fundsCan only be calculated for the company as a whole, not subdivided for divisions of organisation. Page 123 124. Residual incomeAsk: What is the income (profit) remaining after deducting a notional interest charge for the use of capital?X Z 000sOperating profit (EBIT) 181,500Capital employed 100 10,000ROCE 18%15% Page 124 125. Residual income (contd)Suppose cost of capital is 10% for both. X Z 000sOperating profit (EBIT) 18 1,500Less interest charge(10) (1,000)Residual income8 500Company Z gives higher income to shareholdersPage 125 126. Economic Value Added (EVA)Companies should deliver value that exceeds thecost of capital.XZProfit after tax (before interest) 13 1,050Interest charge (net of tax) (7) (700)EVA 6350Z gives higher EVA than does XPage 126 127. Performance of a divisionDivisions are created by decentralisation Gives greater responsiveness Allows faster decisions Motivates managers Uses specialist experience of managersBut needs a measure of performancePage 127 128. Performance of a division (contd)Problems of decentralisation Focus on division, not on total organisation(Called dysfunctional decision making) More information is needed, cost involved Duplication of activities Page 128 129. Performance of a division (contd)Cost centre Manager is responsible for costsDiscretionary cost centre Manager has some choices in cost budgetRevenue centre Manager is responsible for generating plannedsalesPage 129 130. Performance of a division (contd)Profit centre Manager is responsible for revenues and costs Target profit is setInvestment centre Manager is responsible for resources and profit,target return to be achieved Page 130 131. Transfer pricingWhat price is charged for transfers betweendivisions within an organisation? Variable cost? Variable cost plus a profit margin? Variable cost plus portion of fixed cost? Variable + fixed + profit margin? Negotiated price? Reflect market?Page 131 132. Financial PerformanceMeasurement Success / Failure often determined by accountingnumbers Growth in profit, ROCE, Sales Reduction in costs, headcount, errors, stock Financial Ratio AnalysisPage 132 133. Financial Performance Measurement (contd) Achieving outcome at or under budget Adverse / Favourable variance analysis Project NPV cost overruns OBJECTIVE APPROACH TO Performancemeasurement Page 133 134. Problem with financial measuresA Simple Scenario.Division in large company enjoyed major growth in profitability over two years ..manager promoted.New manager .drop in profits.WHY ? Page 134 135. Financial measures (contd)Top line answer Divisions market share dropped Costs were reduced by reducing maintenance of cuttingmachine, reducing staff trainingbuild up of stocks (inventory) of unsold goodsBottom line answer Reduced investment in new technologyFinancial System did not pick up the BAD EventsPage 135 136. Problems with financial information Complexity /mystery and the method ofcalculation Arbitrary treatment of some cost items Time lag between event and the financial ledger No direct observable relationship betweenactivities and reported costs Irrelevant to managersPage 136 137. Problems with financial information (contd) Managers need to convert data into meaningfulinformation. Implied assumption that control costs will controlactivities. Focus on cost minimisation, not on effectiveness or value-adding. Could be valid reasons for costs increasing. Simplification of organisational activities, by reducingeverything into a single value.Page 137 138. Value of Financial PerformanceMeasurement Managers accept importance of financial outcomeof their function (especially if linked to pay /prospects). Managers will try to increase their profitability. Managers often devise their own budgetsystems. Page 138 139. Value of Financial PerformanceMeasurement (contd) Need information on relationships betweenactivities they control and financial outcome Ignore formal budget reports / spend time andeffort proving official budget is wrong Do not assume that managers can "translate" sinto actual activities Page 139 140. Information Managers UseUS study concluded information used for dailyoperating control did not come from the budgetingsystem.Managers information needs are affected by:the resources most significant to their process, interms of cost, quality, availabilitythe time frame in which this information is needed Page 140 141. Indicators for managers level of finished goods level of orders (demand) key production limiting factors simple counts of output per hour / shift / day, physical quantities of materials / labour used, down-timePage 141 142. Indicators for managers (contd) scrap quantities, rework rates. capacity utilisation physical production requirements (long - mediumand short-term)Page 142 143. Non-Financial MeasuresNon-financial is any information not valued in s.It has the following advantages: Expressed in terms/language understandable tomanagers (non-accountants) Requires very little "translation" by managers Page 143 144. Non-Financial Measures (contd) Potentially quicker, relevant Relates to events, activities, actual observableperformance Can be used to make sense of financial budgets Better reflects the "reality" of the situation, notconfused by strange accountingrules/conventionsPage 144 145. Integrating Non- and measures Activity Based Accounting Benchmarking Performance Scoring Balanced Scorecard Strategic Management Accounting Many other multiple criterion decision making,data envelopment analysis, etcPage 145 146. Financial Perspectiveer Perspectiv e Vision and Internal B usinessStrategyPerspectiv e Learning & Growth Perspective Balanced Scorecard Page 146 147. Balanced Scorecard systematic attempt to design performancemeasurement system that integrates organisational objectives, co-ordination of individual decision making need for organisational learning. create an environment that facilitates continualimprovement Page 147 148. Balanced Scorecard (contd) reflect the organisations understanding of thecauses of successful performance. monitoring performance and what managersbelieve are drivers of good performance performance measure system should measure themost critical aspects of organisationalperformance. Page 148 149. Balanced Scorecard (contd)BS performance measures should be clearly understood by all employees link manufacturing performance and financialperformance be linked to ensure constancy of purpose. Page 149 150. Balanced Scorecard (contd)BS performance measures should be able to identify cause-effect relations to enableemployees to deal with poor performance andcontinue good practices. be based on critical success factors identify trends and rate of change Page 150 151. Not-for-profit organisations Economy Cost at which resources are acquired Efficiency Compare inputs and outputs Effectiveness How resources are usedValue for MoneyPage 151