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Accounting For Managers: Interpreting Accounting Information for Decision-Making / Edition 4

Accounting For Managers: Interpreting Accounting Information for Decision-Making / Edition 4

by Collier
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Product Details

ISBN-13: 2901119979677
Publisher: Wiley
Publication date: 02/14/2012
Edition description: Older Edition
Pages: 580
Product dimensions: 6.00(w) x 1.25(h) x 9.00(d)

About the Author

Paul M. Collier is Professor of Accounting at Monash University in Melbourne, Australia. He was previously at Aston Business School in Birmingham UK. Before becoming an academic, Paul was chief financial officer of a listed printing company and has worked in senior financial and general management positions in the UK and Australia. He has also conducted numerous executive education courses. Paul has been a board member and chair of the audit committee of a large UK housing association and an examiner for CIMA. This book is a result of his practical experience as a producer and user of accounting information as well as his teaching and training experience in the UK and Australia.

A comprehensive package of supplementary material is available on the book companion website at, including PowerPoint slides, additional questions and solutions to the book and case study questions and solutions.

Read an Excerpt

Accounting for Managers

Interpreting Accounting Information for Decision-Making
By Paul M. Collier

John Wiley & Sons

ISBN: 0-470-84502-3

Chapter One

Introduction to Accounting

This chapter introduces accounting and provides a short history of management accounting. It describes the early role of the management accountant and recent developments that have influenced the role of non-financial managers in relation to the use of financial information. The chapter concludes with a critical perspective on accounting history.

Accounting, accountability and the account

Businesses exist to provide goods or services to customers in exchange for a financial reward. Public-sector and not-for-profit organizations also provide services, although their funding comes not from customers but from government or charitable donations. While this book is primarily concerned with profit-oriented businesses, most of the principles are equally applicable to the public and not-for-profit sectors. Business is not about accounting. It is about markets, people and operations (the delivery of products or services), although accounting is implicated in all of these decisions because it is the financial representation of business activity.

The American Accounting Association defined accounting in 1966 as:

The process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of theinformation.

This is an important definition because:

it recognizes that accounting is a process: that process is concerned with capturing business events, recording their financial effect, summarizing and reporting the result of those effects, and interpreting those results (we cover this in Chapter 3);

it is concerned with economic information: while this is predominantly financial, it also allows for non-financial information (which is covered in Chapter 4);

its purpose is to support 'informed judgements and decisions' by users: this emphasizes the decision usefulness of accounting information and the broad spectrum of 'users' of that information. While the primary concern of this book is the use of accounting information for decision-making, the book takes a stakeholder perspective that users of accounting information include all those who may have an interest in the survival, profitability and growth of a business: shareholders, employees, customers, suppliers, financiers, government and society as a whole.

The notion of accounting for a narrow (shareholders and financiers) or a broad (societal) group of users is an important philosophical debate to which we will return throughout this book. This debate derives from questions of accountability: to whom is the business accountable and for what, and what is the role of accounting in that accountability?

Boland and Schultze (1996) defined accountability as:

The capacity and willingness to give explanations for conduct, stating how one has discharged one's responsibilities, an explaining of conduct with a credible story of what happened, and a calculation and balancing of competing obligations, including moral ones. (p. 62)

Hoskin (1996) suggested that accountability is:

more total and insistent ... [it] ranges more freely over space and time, focusing as much on future potential as past accomplishment. (p. 265)

Boland and Schultze argued that accountability entails both a narration of what transpired and a reckoning of money, both meanings deriving from the original meanings of the word account.

Accounting is a collection of systems and processes used to record, report and interpret business transactions. Accounting provides an account - an explanation or report in financial terms - about the transactions of an organization. It enables managers to satisfy the stakeholders in the organization (owners, government, financiers, suppliers, customers, employees etc.) that they have acted in the best interests of stakeholders rather than themselves. This is the notion of accountability to others, a result of the stewardship function of managers that takes place through the process of accounting. Stewardship is an important concept because in all but very small businesses, the owners of businesses are not the same as the managers. This separation of ownership from control makes accounting particularly influential due to the emphasis given to increasing shareholder wealth (or shareholder value). Accountability results in the production of financial statements, primarily for those interested parties who are external to the business. This function is called financial accounting.

Accounting is traditionally seen as fulfilling three functions:

Scorekeeping: capturing, recording, summarizing and reporting financial performance.

Attention-directing: drawing the attention of managers to, and assisting in the interpretation of, business performance, particularly in terms of the comparison between actual and planned performance.

Problem-solving: identifying the best choice from a range of alternative actions.

In this book, we acknowledge the role of the scorekeeping function in Chapters 6 and 7, while emphasizing attention-directing and problem-solving as taking place through three inter-related functions, all part of the role of functional as well as financial managers:

Planning: establishing goals and strategies to achieve those goals.

Decision-making: using financial information to make decisions consistent with those goals and strategies.

Control: using financial information to maintain performance as close as possible to plan, or using the information to modify the plan itself.

Planning, decision-making and control are particularly relevant as increasingly businesses have been decentralized into many business units, where much of the planning, decision-making and control is focused. Managers need financial and non-financial information to develop and implement strategy by planning for the future (budgeting); making decisions about products, services, prices and what costs to incur (decision-making using cost information); and ensuring that plans are put into action and are achieved (control). This function is called management accounting.

This book is primarily concerned with the planning, decision-making and control aspects, i.e. management accounting. However, it begins by setting the role of the manager and the use of accounting information in the context of financial accounting.

A short history of accounting

The history of accounting is intertwined with the development of trade between tribes and there are records of commercial transactions on stone tablets dating back to 3600 BC (Stone, 1969). The early accountants were 'scribes' who also practised law. Stone (1969) noted:

In ancient Egypt in the pharaoh's central finance department ... scribes prepared records of receipts and disbursements of silver, corn and other commodities. One recorded on papyrus the amount brought to the warehouse and another checked the emptying of the containers on the roof as it was poured into the storage building. Audit was performed by a third scribe who compared these two records. (p. 284)

However, accounting as we know it today began in the fourteenth century in the Italian city-states of Florence, Genoa and Venice as a result of the growth of maritime trade and banking institutions. The first bank with customer facilities opened in Venice in 1149. The Lombards were Italian merchants who were established as moneylenders in England at the end of the twelfth century.

Balance sheetswere evident from around 1400 and the Medici family (who were Lombards) had accounting records of 'cloth manufactured and sold'. The first treatise on accounting (although it was contained within a book on mathematics) was the work of a monk, Luca Pacioli, in 1494. The first professional accounting body was formed in Venice in 1581.

Much of the language of accounting is derived from Latin roots. 'Debtor' comes from the Latin debitum, something that is owed; 'assets' from the Latin ad + satis, to enough, i.e. to pay obligations; 'liability' from ligare, to bind; 'capital' from caput, a head (of wealth). Even 'account' derives initially from the Latin computare, to count, while 'profit' comes from profectus, advance or progress. 'Sterling' and 'shilling' came from the Italian sterlino and scellino, while the pre-decimal currency abbreviation 'LSD' (pounds, shillings and pence) stood for lire, soldi, denarii.

Chandler (1990) traced the development of the modern industrial enterprise from its agricultural and commercial roots as a result of the Industrial Revolution in the last half of the nineteenth century. By 1870, the leading industrial nations - the United States, Great Britain and Germany - accounted for two-thirds of the world's industrial output. One of the consequences of growth was the separation of ownership from management. Although the corporation, as distinct from its owners, had been in existence in Britain since 1650, the separation of ownership and control was enabled by the first British Companies Act, which formalized the law in relation to 'joint stock companies' and introduced the limited liability of shareholders during the 1850s. The London Stock Exchange had been formed earlier in 1773 by stockbrokers, who had previously worked from coffee houses.

The second consequence of growth was the creation of new organizational forms. Based on his extensive historical analysis, Chandler (1962) found that in large firms structure followed strategy and strategic growth and diversification led to the creation of decentralized, multidivisional corporations like General Motors, where remotely located managers made decisions on behalf of absent owners and central head office functions. Ansoff (1988) emphasized that success in the first 30 years of the mass-production era went to firms that had the lowest prices. However, in the 1930s General Motors 'triggered a shift from production to a market focus' (p. 11).

In large firms such as General Motors, budgets were developed to co-ordinate diverse activities. In the first decades of the twentieth century, the DuPont company developed a model to measure the return on investment (ROI). ROI (see Chapters 7, 12 and 13) was used to make capital investment decisions and to evaluate the performance of business units, including the managerial responsibility to use capital efficiently.

The role of management accounting

The advent of mechanized production following the Industrial Revolution increased the size and complexity of production processes, which employed more people and required larger sums of capital to finance machinery. Accounting historians suggest that the increase in the number of limited companies that led to the separation of ownership from control caused the attention of cost accounting to shift from determining cost to exercising control by absent owners over their managers.

The predecessor of management accounting, 'cost accounting', was reflected in the earlier title of management accountants as cost or works accountants. Typically situated in factories, these accountants tended to know the business and advise non-financial managers in relation to operational decisions. Cost accounting was concerned with determining the cost of an object, whether a product, an activity, a division of the organization or market segment. The first book on cost accounting is believed to be Garcke and Fell's Factory Accounts, which was published in 1897.

Historians have argued that the new corporate structures that were developed in the twentieth century - multidivisional organizations, conglomerates and multinationals - placed increased demands on accounting. These demands included divisional performance evaluation and budgeting. It has also been suggested that developments in cost accounting were driven by government demands for cost information during both World Wars. It appears that 'management accounting' is a term used only after the SecondWorld War.

In their acclaimed book Relevance Lost, Johnson and Kaplan (1987) traced the development of management accounting from its origins in the Industrial Revolution supporting process-type industries such as textile and steel conversion, transportation and distribution. These systems were concerned with evaluating the efficiency of internal processes, rather than measuring organizational profitability. Financial reports were produced using a separate transactions-based system that reported financial performance. Johnson and Kaplan (1987) argued that by 1925 'virtually all management accounting practices used today had been developed' (p. 12).

They also described how the early manufacturing firms attempted to improve performance via economies of scale by reducing unit cost through increasing the volume of output. This led to a concern with measuring the efficiency of the production process. Calculating the cost of different products was unnecessary because the product range was homogeneous.

Over time, the product range expanded and businesses sought economies of scope through producing two or more products in a single facility. This led to the need for better information about how the mix of products could improve total profits. However, after 1900 the production of accounting information was largely for external reporting to shareholders and not to assist managerial decision-making.

Johnson and Kaplan (1987) described how a management accounting system must provide timely and accurate information to facilitate efforts to control costs, to measure and improve productivity, and to devise improved production processes. The management accounting system must also report accurate product costs so that pricing decisions, introduction of new products, abandonment of obsolete products, and response to rival products can be made. (p. 4)

The Chartered Institute of Management Accountants' definition of the core activities of management accounting includes:

participation in the planning process at both strategic and operational levels, involving the establishment of policies and the formulation of budgets;

the initiation of and provision of guidance for management decisions, involving the generation, analysis, presentation and interpretation of relevant information;

contributing to the monitoring and control of performance through the provision of reports including comparisons of actual with budgeted performance, and their analysis and interpretation.

One of the earliest writers on management accounting described 'different costs for different purposes' (Clark, 1923). This theme was developed by one of the earliest texts on management accounting (Vatter, 1950).


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Table of Contents

Preface to the Fourth Edition xvii

About the Author xxi

Acknowledgements xxii

PART I Context of Accounting 1

1 Introduction to Accounting 3

Accounting, accountability and the account 3

Introducing the functions of accounting 5

A short history of accounting 6

The role of financial accounting 7

The role of management accounting 8

Recent developments in accounting 10

The relationship between financial accounting and management accounting 12

A critical perspective 13

Conclusion 15

References 15

Questions 16

2 Accounting and its Relationship to Shareholder Value and Corporate Governance 17

Capital and product markets 17

Shareholder value-based management 18

Shareholder value, strategy and accounting 21

Company regulation and corporate governance 23

The regulation of companies 23

Corporate governance 23

Principles of corporate governance 24

Responsibility of directors 24

Audit 25

Audit committees 25

Stock Exchange Listing Rules 26

Risk management, internal control and accounting 26

A critical perspective 27

Conclusion 28

References 28

Websites 28

Questions 29

3 Recording Financial Transactions and the Principles of Accounting 30

Business events, transactions and the accounting system 30

The double entry: recording transactions 31

Extracting financial information from the accounting system 35

Basic principles of accounting 37

Accounting entity 37

Accounting period 37

Matching principle 38

Monetary measurement 38

Historic cost 38

Going concern 39

Conservatism 39

Consistency 39

Cost terms and concepts: the limitations of financial accounting 39

Conclusion 41

References 41

Questions 42

4 Management Control, Accounting and its Rational-Economic Assumptions 44

Management control systems 44

Planning and control in organizations 47

Non-financial performance measurement 51

A theoretical framework for accounting 55

Conclusion 56

References 56

Websites 58

5 Interpretive and Critical Perspectives on Accounting and Decision Making 59

Research and theory in management control and accounting 60

Alternative paradigms 62

The interpretive paradigm and the social construction perspective 65

Culture, control and accounting 67

The radical paradigm and critical accounting 68

Power and accounting 70

Case study 5.1: easyJet 71

Ethics and accounting 74

Case study 5.2: Enron 76

Case study 5.3: WorldCom 77

Conclusion 77

References 78

PART II The Use of Financial Statements for Decision Making 81

6 Constructing Financial Statements: IFRS and the Framework of Accounting 83

International Financial Reporting Standards (IFRS) 84

Framework for the Preparation and Presentation of Financial Statements 85

Objectives of financial statements 86

Qualitative characteristics of financial statements 86

Elements of financial statements 87

Concepts of capital maintenance 88

True and fair view 88

Reporting profitability: the Statement of Comprehensive Income 89

Reporting financial position: the Statement of Financial Position 92

Accruals accounting 94

Depreciation 95

Specific IFRS accounting treatments 97

Accounting for sales taxes 98

Accounting for goodwill and impairment testing 98

Accounting for research and development expenditure 99

Accounting for leases 99

Reporting cash flow: the Statement of Cash Flows 100

Differences between the financial statements 102

Illustration 102

A theoretical perspective on financial statements 103

Agency theory 104

A critical perspective on financial statements and accounting standards 105

Conclusion 105

Reference 106

Websites 106

Appendix: IFRS as at 1 January 2011 106

Questions 107

7 Interpreting Financial Statements 111

Annual Reports 111

The context of financial statements 113

Ratio analysis 113

Profitability 115

Return on (shareholders’) investment (ROI) 115

Return on capital employed (ROCE) 115

Operating margin (or operating profit/sales) 116

Gross margin (or gross profit/sales) 116

Overheads/sales 116

Sales growth 116

Liquidity 117

Working capital 117

Acid test (or quick ratio) 117

Gearing 117

Gearing ratio 117

Interest cover 117

Activity/efficiency 118

Asset turnover 118

Working capital 119

Managing receivables 119

Managing inventory 120

Managing payables 121

Managing working capital 121

Shareholder return 122

Dividend per share 122

Dividend payout ratio 122

Dividend yield 122

Earnings per share (EPS) 123

Price/earnings (P/E) ratio 123

The relationship between financial ratios 123

Interpreting financial statements using ratios 125

Profitability 125

Liquidity 126

Gearing 126

Activity/efficiency 126

Shareholder return 126

Using the Statement of Cash Flows 127

Case study 7.1: HMV Group – interpreting financial statements 127

Limitations of ratio analysis 135

Case study 7.2: Carrington Printers – an accounting critique 135

Alternative theoretical perspectives on financial statements 138

Intellectual capital 138

Institutional theory 139

Corporate social responsibility 140

Sustainability and the ‘triple bottom line’ 141

Global Reporting Initiative 142

Applying different perspectives to financial statements 142

Conclusion 143

References 144

Website 144

Questions 144

8 Accounting for Inventory 152

Introduction to inventory 152

Flow of costs 153

Cost formulas for inventory 153

Inventory valuation under the weighted average method 154

Inventory valuation under FIFO 155

Retail method 155

Net realizable value 156

Methods of costing inventory in manufacturing 156

Long-term contract costing 159

Management accounting statements 161

Conclusion 162

Questions 162

PART III Using Accounting Information for Decision Making, Planning and Control 167

9 Accounting and Information Systems 169

Introduction to accounting and information systems 169

Methods of data collection 170

Types of information system 171

Business processes 173

Internal controls for information systems 174

Developing information systems 176

Conclusion 177

References 177

10 Marketing Decisions 178

Marketing strategy 178

Cost behaviour 180

Costvolumeprofit analysis 181

Breakeven with multiple products 185

Operating leverage 186

Limitations of CVP analysis 187

Alternative approaches to pricing 188

Cost-plus pricing 188

Target rate of return pricing 189

Optimum selling price 189

Special pricing decisions 190

Transfer pricing 192

Segmental profitability 192

Case study 10.1: Retail Stores plc – the loss-making division 194

Customer profitability analysis 196

Case study 10.2: SuperTech – using accounting information to win sales 198

Conclusion 199

References 199

Questions 200

11 Operating Decisions 203

The operations function 203

Managing operations manufacturing 205

Managing operations services 207

Accounting for the cost of spare capacity 208

Capacity utilization and product mix 209

Theory of Constraints 211

Operating decisions: relevant costs 212

Make versus buy? 212

Equipment replacement 213

Relevant cost of materials 214

Total quality management and the cost of quality 217

Environmental cost management 218

Case study 11.1: Quality Printing Company – pricing for capacity utilization 218

Case study 11.2: Vehicle Parts Company – the effect of equipment replacement on costs and prices 220

Case study 11.3: Quality and waste at Planet Engineering 222

Conclusion 223

References 223

Questions 224

12 Human Resource Decisions 228

Human resources and accounting 228

The cost of labour 229

Relevant cost of labour 231

Case study 12.1: The Database Management Company – labour costs and unused capacity 234

Case study 12.2: Trojan Sales – the cost of losing a customer 236

Conclusion 238

References 238

Questions 238

13 Overhead Allocation Decisions 243

Cost classification 243

Product and period costs 243

Direct and indirect costs 245

The overhead allocation problem 247

Shifts in management accounting thinking 248

Alternative methods of overhead allocation 250

Variable costing 250

Absorption costing 251

Over- or under-recovery of overhead 255

Activity-based costing 256

Differences between absorption and activity-based costing 258

Contingency theory 260

International comparisons 261

Management accounting in Japan 262

Behavioural implications of management accounting 263

Case study 13.1: Tektronix Portables division 266

Case study 13.2: Quality Bank – the overhead allocation problem 267

Conclusion 269

References 269

Questions 271

14 Strategic Investment Decisions 276

Strategy 276

Capital expenditure evaluation 277

Accounting rate of return 279

Payback 281

Discounted cash flow 282

Net present value 282

Internal rate of return 284

Comparison of techniques 285

Case study 14.1: Goliath Co. – investment evaluation 286

Conclusion 288

References 288

Appendix: Present value factors 288

Questions 290

15 Performance Evaluation of Business Units 293

Structure of business organizations 293

The decentralized organization and divisional performance measurement 296

Absolute profit 296

Return on investment 297

Residual income 297

Controllability 298

Case study 15.1: Majestic Services – divisional performance measurement 299

Transfer pricing 302

Transaction cost economics 304

Conclusion: a critical perspective 305

References 306

Questions 307

16 Budgeting 310

What is budgeting? 310

The budgeting process 311

The profit budget 313

Case study 16.1: Superior Hotel – service budget example 314

Case study 16.2: Sports Stores Co-operative Ltd – retail budget example 316

Case study 16.3: Telcon Manufacturing – manufacturing budget example 317

Cash forecasting 319

Case study 16.4: Retail News Group – cash forecasting example 320

A behavioural perspective on budgeting 323

A critical perspective: beyond budgeting? 325

Case study 16.5: Svenska Handelsbanken – is budgeting necessary? 326

Conclusion 327

References 328

Questions 328

17 Budgetary Control 333

What is budgetary control? 333

Flexible budgeting 334

Variance analysis 335

Case study 17.1: Wood’s Furniture Co. – variance analysis example 336

Sales variance 338

Cost variances 339

Materials variance 340

Labour variance 342

Overhead variances 344

Reconciling the variances 345

Criticism of variance analysis 346

Cost control 347

Applying different perspectives to management accounting 348

Conclusion 349

References 349

Questions 350

18 Strategic Management Accounting 354

Strategic management accounting 354

Accounting techniques to support strategic management accounting 357

Value chain and supply chain management 357

Human resource accounting 358

Activity-based management 358

Lifecycle costing 360

Target costing 361

Kaizen costing 362

Just-in-time 362

Backflush costing 363

Lean production and lean accounting 363

Case study 18.1: TNA and strategic management accounting 365

Conclusion 367

References 368

Further reading 368

Books 369

Articles published in the following journals 369

PART IV Supporting Information 371

Introduction to the Readings 373

Reading A 375

Questions 375

Further reading 375

A Cooper and Kaplan (1988). How cost accounting distorts product costs 376

Reading B 388

Questions 388

Further reading 388

B Otley, Broadbent and Berry (1995). Research in management control: an overview of its development 389

Reading C 407

Questions 407

Further reading 407

C Covaleski, Dirsmith and Samuel (1996). Managerial accounting research: the contributions of organizational and sociological theories 408

Reading D 439

Questions 439

Further reading 439

D Dent (1991). Accounting and organizational cultures: a field study of the emergence of a new organizational reality 440

Glossary of Accounting Terms 471

Solutions to Questions 485

Index 543

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