CHAPTER
TWO
LITERATURE REVIEW
2.1 Conceptual Framework
The
chartered institute of Management Accounting (CIMA) defines management
accounting as “The process of identification, measurement, accumulation,
analysis, preparation, interpretation and communication of information used by
management to plan, evaluate and control within an entity and to assure
appropriate use of and accountability for its resources”.
Management
accounting also comprises the preparation of financial reports for non-management
groups such as shareholders, creditors, regulatory agencies and tax
liabilities. The American Institute of Certified Public Accountants (AICPA)
states that management accounting practice extends to the following areas:
ØStrategic Management:
Advancing the role of the Management accountant as a strategic plan in the
agricultural industry.
ØPerformance Management:
Developing the practice of business decision making and managing the
performance of the agricultural industry.
ØRisk Management:
Contributing to frameworks and practices for identifying, measuring, managing
and reporting risk to the achievement of the agricultural industry
2.1.1 Decision and Decision Making
Decision
making is identifying and selecting a course of action to deal with a specific
problem or take advantage of an opportunity (‘’Managerial Economics for
Decision Making” by John Adams and Linda Juleff, published by Palgrave 2003,p. 160,
ISBN0-333-96111-0). Decision making is particularly an important part of a
manager’s job . Manager’s decisions provide a framework with which other
organizational members make their decisions and act. The various categories of
decisions according to(Jerold L. ZImmermann: ‘’Accounting for Decision Making
and Control’’ ,McGraw-Hill, 2000) are as follows:
ØProgrammed Decision:
These are decisions made in accordance with some habits, rules or procedures.
Every organization has written or unwritten
Policies
that simplify decision making in recurring situations or alternatives. These
programmed decisions are used to solve both complex and complicated isses.
ØNon Programmed:
These are those decisions that deal with unusual or exceptional problems. If
the problems do not come up often enough to be covered by a policy or is so
important that it deserves special treatment, it must be handled by
non-programmed decisions
2.1.2 Make or Buy Decision
Larry
M. Wlther (2010) states that, these are decisions made by industries in other
to produce a particular component or product internally or to buy from an
outside manufacturer. The decision to buy or produce a product is based on the
analyses that have been calculated to see the relevant cost of producing and
that of buying from an outside manufacturer. When the analyses have been
collected, they are compared using marginal cost and the variable cost
component before a conclusion is made. The conclusion made is based on the
various investment appraisal techniques.
2.2 Theoretical Framework
2.2.1 Capital Expenditure Decisions
Carl
S.Warren, James M. Reeve and Jonathan E.Duchac (MANAGERIAL ACCOUNTING , 10th
Edition) states that , capital expenditure decisions are faced by
management about when and how much to spend on capital facilities for the
company. This involves comparing between two or more alternatives. The one with
the most profitable return is maintained.
The
capital budget is a process of considering alternative capital projects by
selecting among alternatives that provide the most return on the available
material within the framework of the industry’s goals and objectives. R.Cooper
and R.Kaplan, ‘’The design of cost Management Systems’’, Prentice Hall 1991
states that , the maintenance and acquisition of capital facilities like
building, machinery and plants are done using the following methods of
investment appraisal;
ØReturn on Capital
Employed (ROCE); The return on capital employed
which is also called the accounting rate of return (ARR) expresses the profit
from the project as a percentage of capital cost. However, the profit figure
for capital cost used may vary. The most common approach in determining it is
as follows;
ROCE=
(Net AssetsFixed Assets –Current Liabilities) 100
This
method does not make use of cash flow and it also do not take into account or consideration
the time value of money. It is easily understood by manager since it is a rate.
Net Present Value does not give the absolute amount by which it give
profitability.
ØPay Back Period (PBP):
It is a technique used in evaluating investment decisions. This is the amount
of time that is expected to take for the cash inflow for a capital investment
project to equal the cash outflow. At the end of the payback period, usually
expressed in years, the cash inflows from capital investment project will equal
to the capital outflows. The payback period is a rough measure of liquidity and
not profitability. It must take into account or consideration the risk of
investment and the time value of money. It focuses on cash flows, it must rank
the project appropriately before selecting and must choose project in favour of
shareholders wealth maximization objectives, it is good for project that are
affected by technologies. Accepting criteria for payback period is the project
with a shorter pay back period.
ØNet Present Value(NPV):
It is the value obtained by discounting all cash outflows and inflows for the project
at the cost of capital and adding them up. The NPV is the sum of present values
of all cash inflows from the project minus the present value of cash inflows.
It should be noted that the present value is calculated on the expected inflow
and cash outflows.
The
purpose of discounting is to establish whether the tools of the present value
of cash inflows are greater than that of the present outflows.
The
discount rate is the cost of capital investment of the industry. The project is
accepted when the NPV is positive and rejected when the NPV is negative. It
takes into account or consideration the time value of money, it makes use of
all cash flows and it is a major of profitability
2.2.2 Decision Making Techniques
Larry
M. Walther, Christopher J . Skousen (Management and Cost Accounting) states
that, Businesses all over the world do carry out investment projects but some
of these projects fails before they start or in the middle of their execution.
This is because some mangers fail to look into the future and the business
environment in a very critical way to be able to see the risk and uncertainty
involved. The position of the management accountant is in the provision of
relevant, accurate and precise information that will help improve management
decisions. They also state that the following techniques are being used:
a) Absorption or full
costing: This is a method of costing products
which is aimed at including the total cost of the products as an appropriate
share of an industry’s total overhead which is generally taken to be the amount
which reflects the amount of time and
effort that has gone into the production of the products. Production cost is
built using absorption costing by a process of allocation, apportionment and
overhead absorption. Opening and closing inventory are valued at full
production cost under the absorption costing. It include an element of fixed
overheads in inventory value in accordance with the statement of standard
accounting practices (SSAP9) and it also analyses under/over absorption of
overhead is a useful exercise in controlling cost of an organization. It is
calculated as follows:
Element
Calculation
Amount (FCFA)
Amount (FCFA)
Sales
xxx
Less cost of sales(variable full production cost)
xxx
Opening stock
&am
