Management accounting and Cost accounting have for a while been topics of discussion amongst accountants. While the accountants understand the subtle difference between the two topics, most non-accounting professionals do not. This literature examines the basic difference between cost accounting and management accounting. The paper discusses the concept of lean production and aims to contrast the differences in accounting principles between lean production and typical mass production. The literature also advises Dr Stephanie White on areas of cost optimization for the Uptown Clinic.
It is a widespread practice to use the terms “Management Accounting” and “Cost Accounting” interchangeably. But it is important to note that there are certain fundamental differences between management and cost accounting, both conceptually and while being used in practice. Cost accounting predominantly focuses on the calculation and usages of costs and resources geared towards different products or services functions.
Management accounting on the other hand absorbs the information provided by cost accounting for strategic decision-making purposes. It may be appropriate to state that cost accounting feeds and supports management accounting for decision making. Indeed, it is a well-known fact that if the management requires more information to support its decision-making process, it will reach out to the cost accountants to deep dive into costs.
Costs are one of the major drivers of pricing for any product or service. While cost accounting could be used for evaluation and optimization of costs within an organization, management accounting would provide insight to managers to effectively control and manage an organization (Brewer, P., Garrison, R., & Noreen, E., 2008). The use of cost information varies between cost accounting and management accounting. A cost accountant could use the cost information to perform cost analysis on product mix and support pricing decisions. The same cost information could be used by a management accountant to compare the variance of the cost between what was budgeted, and the actual cost incurred.
Cost accounting is often used in production planning and optimization. A key concept in the world of production is Lean Production. Originally conceived for Toyota, the concept of lean production is also popularly known as the Toyota production system or Just in time production. The lean philosophy of production focuses on improving worker productivity by reducing inventory, eliminating wastage in production.
In simple terms, lean production is doing more with less. The concept is also called Just in Time production as it aims at optimizing processes specifically in production by constantly monitoring and optimizing waste reduction (Adam, Jr, E.E, & Ebert, R.J., 1995). While the concept initially started with the automobile industry, lean production as a concept has been applied to many industries including software development.
It is not surprising that as the lean production concept evolved, the accounting concept of Lean accounting evolved too. Lean accounting is an accounting practice designed exclusively for companies that follow lean production philosophy. While traditional cost accounting concepts focus on cost items and accurate presentation of accounting reports to external stakeholders, lean accounting concepts focus more on capturing the actual performance of the manufacturing operations/process by including concepts of value streaming, changing inventory valuation methodology etc. Value streaming is the process of organizing costs into activities that create value for the end customer.
Traditional cost accounting focuses on allocating costs to departments whereas the lean accounting concept advises on allocating costs to all activities directly attributable to creating value to a customer in a product. Another lean accounting principle that has a direct contrast to traditional accounting is “Inventory Valuation”. Traditional accounting believes inventory to be an asset and records books in accordance to reflect in the balance sheet. In lean accounting, inventory is not considered an asset as the lean principle takes into account all the costs associated with maintaining inventory such as handling costs, floor space to stock up inventory.
The lean principle of accounting treats these associated costs of inventory as an expense creating a negative impact on the organization’s cash flow. Under the lean accounting principle, inventory is an asset only if it is a guaranteed sale. In most cases, unsold stocked up inventory are not sold or sold at less than market value. Let us take the example of inventory. Under the lean principle, costs associated with inventory such as deferred labour costs and associated overheads are moved from the value of inventory to be reflected in the income statement as expenses, thereby impacting profitability. Indeed, practising lean accounting is not simple or easy as it has a direct bearing on the financial statements. While a lot of accountants do support the transition from traditional accounting to lean accounting, the process is cumbersome and challenging as discrepancies with traditional accounting always will exist and is hard to solve.
In our case study, the direction to Dr Stephanie White of the uptown clinic is to move from mass management of the organization to lean management. Dr Stephanie could optimize some of the costs of the administrative resources. The clinic currently seems to have one full-time assistant and two full-time secretaries. While a large part of the role between an assistant and secretary overlaps, it may be prudent to retain one full-time secretary who could effectively manage the administrative tasks.
This could result in savings of $56000 per year (59% saving achieved against the target of $94000). Assuming the clinic is running at a fully optimized capacity, we recommend stopping advertising and promotional activities thereby saving $9000 per annum. While we see some scope for reduction in the purchased services such as accounting and billing function, the scope of services rendered is unknown. So, we do not at the current point in time recommend optimizing the costs of the purchased services.
We also recommend that salaries of key staff such as Psychiatrist remain untouched. However, we do recommend optimizing the full-time employee count of social workers in the community mental health services and outpatient mental health treatment wings. We believe optimizing the social worker count to 2 full-time social workers and 1 part time social worker facilitating rotation between both outpatient and community health wings, would result in a net saving of $29000. If these lean organization measures are implemented effectively it would result in a net saving of $94000 per annum yet enable the organization to serve its customers without compromising quality.
Adam, Jr.,E.E & Ebert, R J. (1995). Production and Operations Management; Concepts, Models and Behavious (5th ed.). India: Prentice-Hall of India.
Brewer, P., Garrison, R., & Noreen, E. (2008). Managerial accounting (11th ed.). New York: McGraw-Hill/Irwin.