Introduction to management accounting
Definition of Management Accounting
In any organization, managers and other leaders need to have a comprehensive understanding of the various events and operational metrics, which gives them the necessary information to leverage in their decision-making processes. However, this information is only achievable through managerial accounting, a branch of accounting that focuses on internal reporting to aid in decision-making processes. Also known as managerial accounting, this is a branch of accounting that involves the identification, measurement, analysis, interpretation, and communication of financial information to the organizational leaders or managers in the process of pursuing organizational goals (Franklin, Graybeal, and Cooper, 2019, p. 34).
Management accounting encompasses a variety of accounting facets whose aim is to improve the quality of information the managers receive about the metrics of their business operations. Specialists who perform these tasks, known as the managerial accountants, make use of information relating to the company’s sales revenue of goods and services (Franklin, Graybeal, and Cooper, 2019, p. 36). The idea is to capture the organization’s total costs of production through an assessment of the variable costs of each stage of production as well as the fixed costs. In this way, managers can identify and reduce unnecessary spending and strive to maximize profits.
It is worth noting that management accounting involves analyzing both financial and non-financial data. This means that it captures both quantitative and qualitative (non-quantitative) data. This implies correlating all data types in an organization to examine their association costs, quality, quantity, and flow throughout the operational activity (Franklin, Graybeal, and Cooper, 2019, p. 47). In this case, financial information includes the aspects of revenue and costs and their effect on the overall profitability.
On its part, non-financial information includes the effect on employee turnover, overall company image, and the business environment. It is also worth noting that quantitative data include financial statements, economic indicators, trade reports, regulatory filings, and industry statistics. On the contrary, qualitative data includes the company’s vision and mission statement, press releases, management discussions and analysis, chairman’s letter, and websites.
The term management accounting system (MAS) refers to the systems used to provide critical information to the organizational managers for operational decision-making. This is the information that results from the identification, measurement, analysis, interpretation, and communication of information to managers to enhance their decision-making processes. Managerial accountants generate the information through management accounting and then send it to the managers through the management accounting systems (Franklin, Graybeal, and Cooper, 2019, p. 62).
Noteworthy, even though the management accounting systems have the same function, they vary across different organizations and industries. For manufacturing industries, organizations use management accounting systems to facilitate costing and managing their business processes. On the contrary, in the healthcare industry, organizations like hospitals can use these systems to facilitate the process of insurance billing.
The Important of Integrating Management Accounting and MAS in an Organization
Integrating both management accounting and MAS within an organization is an important play a significant role in the achievement of organizational aims and objectives. First, integrating managerial accounting and MAS implies that there is an effective method of information sharing and communication between the managerial accountants and the organizational managers (Franklin, Graybeal, and Cooper, 2019, p. 67). In essence, managers want to understand the metrics that affect their organization when making decisions. They can only acquire this information from the managerial accountants, who in turn use managerial accounting processes to acquire the information. Then, the managerial accountants send and share this information with the managers.
In essence, integrating management accounting and MAS facilitates decision-making. Second, the integration of managerial accounting and MAS implies that managers have the necessary information and knowledge of their organization when planning at all times. Indeed, it is worth noting that, unlike financial accounting, managerial accounting is continuous throughout the fiscal year. Therefore, financial and other types of information are available to the managers at all times, which in turn facilitates the planning of organizational activities (Franklin, Graybeal, and Cooper, 2019, p. 71).
For instance, unlike financial accounting, managerial accounting can identify a rise or fall in sales or revenue in a certain line of business, which can help the relevant manager to plan for responsive action. Third, the integration facilitates the identification of areas of the business process with issues and problems. Given that managerial accounting is continuous, it is possible for managers to identify such issues as the causes of poor performance in the sale of certain products within a given time such as a week or a month. Therefore, the integration gives managers the ability to take control of the business system and correct problems at all times. In the same manner, the integration of MAS and managerial accounting in an organization facilitates strategic management.
The integration of management accounting and MAS helps to facilitate and enhance strategic management in an organization. Strategic management is the process of formulating and implementing the major goals and initiatives that an organization takes on behalf of its stakeholders to improve value. Specifically, strategic management is an ongoing process of planning, analysis, monitoring, and assessment of the necessary aspects that the organization needs to achieve its goals and objectives. This process is achievable when management accounting and MAS are integrated and requires a constant supply of information regarding the company’s business processes. Therefore, it is easy to facilitate strategic management because the managers already have the necessary information supplied to them by managerial accountants through the integrated system.
Origin, Role, and Principles of Management Accounting
Various researchers have attempted to examine the history of management accounting, which has been a research problem over the years. However, researchers generally agree that management accounting originates from two perspectives- the economic approach, and the non-economic approach. Proponents of the economic approach argue that management accounting originated from the private sector as a means of supporting business operations.
This approach states that practices of management accounting emerged in the early 19th century when managed and hierarchical enterprises arose in Europe and North America. Business owners, especially factory lords, realized the need to gain more efficiency in the process of production. In response, they would hire more workers long-term basis in a single, centralized workplace. This practice resulted in the emergence of hierarchical organizations. Since most of the factories were located away from the owners’ residences and head offices, an information system was necessary to monitor, judge, and improve the efficiency of managers and workers within the factory premises. In addition, the factory owners, their suppliers, and customers started massive use of the emerging rapid railway systems.
Therefore, they needed to understand such measures as the cost of transport in cost/tone/mile, cost/passenger/mile, and ratio of expenses to revenue. Moreover, management accounting systems emerged as a means of motivating and evaluating the efficiency of internal business processes rather than measuring the overall profits. Therefore, organizations and their owners felt the need for a separate financial accounting system for recording transactions and processing information that would then be used to make the annual financial statements.
From a non-economic perspective, managerial accounting must have originated from the practices adopted in the 19th century and early 20th century to measure individual performance and compare it with standards and norms in government institutions, especially the military. In this case, agencies and departments that collected national statistics were pressurized to adopt similar practices. Later on, organizational owners and operators realized the importance of measuring individual performance, especially in factories where workers were paid per the work done and time spent working.
Management accounting once adopted and integrated with an organization plays significant role in the management and execution of processes that help achieve organizational goals and objectives. For example, management accounting helps managers in the decision-making process. As previously outlined, management accounting generates information from the identification, measurement, analysis, interpretation, and communication of information to managers to enhance their decision-making processes. Managerial accountants generate the information through management accounting and then send it to the managers through the management accounting systems.
On their part, the managers use this information to make informed decisions that help an organization proceed smoothly towards the achievement of its goals and objectives. For example, without management accounting, managers cannot detect and correct areas of weaknesses or problems such as a fall in sales of certain products in a given period such as a week or month. In such a situation, managers will rely on the statistical process of developing the final financial reports, which means that damage will have already occurred. Therefore, it is the role of management accounting to fix these problems because it is a continuous and ongoing process.
Secondly, management accounting plays an important role in the planning process. When an organization adopts management accounting, it implies that managers have the necessary information and knowledge of their organization when planning at all times. Since managerial accounting is continuous throughout the fiscal year, financial and other types of information are available to the managers at all times. In turn, this information facilitates the planning of organizational activities. Unlike financial accounting, managerial accounting can identify a rise or fall in sales or revenue in certain areas of the business, which can help the relevant managers to plan for responsive action.
Third, management accounting plays a critical role in budgeting and budget making. Specifically, the data that management accountants collect include all types of information that informs the managers about the operations relaying to such aspects as the cost of products and services that the company incurs. This kind of information is necessary for budgeting and planning for future budgets. At the same time, this information is also important in developing performance reports, which are then used to compare the actual results and the budget expectations in a business process.
Management accounting principles (MAP), also known as managerial costing principles, serve and define the core needs of an organization’s internal management. The aim of MAP is to improve decision support systems, resource application, capacity utilization, internal business processes, and customer value for the purpose of achieving corporate goals and objectives in the desired way. Specifically, there are two management accounting principles- the principle of causality and the principle of analogy.
The principle of causality implies the need for cause-and-effect insights. This is the actual modeling of organizational operations in which the accountants establish and build causal relationships. On the contrary, the principle of analogy implies the need for the management to apply causal insights in their practices. This requires the analysis of information in light of at least one alternative decision for the managers to arrive at the optimum decision.
The Distinction between Management and Financial Accounting
There exist several differences between management accounting and financial accounting. Noteworthy, while management accounting is an ongoing and continuous process, financial accounting is rigid as it is periodical such as quarterly and annually. Therefore, financial accounting cannot detect and help correct areas with problems such as a fall in sales of certain products in the distribution channel.
Financial accounting produces reports for the purpose of external reporting. Balance sheets, profit and loss accounts, statements of cash flows, income statements, and statements of changes in stakeholders’ equity are all meant to report the financial performance of the business to the stockholders, auditors, and industry regulators. It is worth noting that all these parties are external to the business. On the contrary, management accounting is an internal process that takes place as an ongoing process of business. Indeed, the reports from the management accounting are sent to the managers as the final destination, and external parties do not access these reports.
While financial accounting is enforceable by law, management accounting is not mandatory but an internal business process for managers to improve performance. Governments across the world require companies and other organizations to provide their financial reports, mostly at the end of the fiscal period. External auditors must be involved to ensure that the reports are correct and accurate and that they reflect the actual financial status of the firm. In addition, governments establish laws, standards, and regulations that companies and other organizations must always follow when reporting their financial status at the end of the fiscal period.
On the contrary, there are no such regulations, laws, and standards that enforce management accounting. Indeed, companies have the freedom to adopt management accounting or disregard it altogether. In most cases, companies develop their own rules on how to conduct management accounting. Therefore, there is no need for external and internal auditing for management accounting, which is mandatory in financial accounting.
The two types of accounting have different purposes, aims, and objectives. While financial accounting aims to inform creditors, investors, and regulators about the financial performance of the organization, management accounting aims to help the internal management in making decisions for their business processes. Creditors, regulators, and investors are not interested in the management financial reports because all they want to know is the end results. Therefore, in financial accounting, non-financial information and data are irrelevant because the external parties are not concerned with this kind of result. On the contrary, managers within the organization are interested in both financial and non-financial information and data because they need to make decisions and plans for improving performance as the business process continues.
Types of Management Accounting Systems
The major types of MAS are cost, inventory management, job-costing, and price-optimization systems. A cost accounting system (CAS), also known as product costing or costing system is a framework for estimating the cost of products for cost control, inventory valuation, and profitability analysis. The two main accounting systems in CAS are job order costing and process costing. In a cost accounting system, organizations base their cost allocation on the traditional costing system or activity-based system.
An inventory management system (IMS), also known as a stock management system, represents the stocked goods or materials in an organization. This type of management accounting concerns the inputs in a production process, products sold, and products used to complete processes. The inventory management systems combine the use of computer desktop software, barcode scanner and printers, and mobile devices. The idea is to streamline the management of such inventories as stock, supplies, goods, and consumables.
These systems have a number of benefits to the organization. For instance, an inventory management system enables inventory control, which implies having the accurate levels of inventory at a given time and automatically preventing both overstock and lower than minimum stock situations. Applying these management accounting systems allows managers to efficiently track quantities across stocking levels, which in turn gives them insight and the ability to make the appropriate decisions. In essence, inventory management systems improve a firm’s bottom line, inventory accuracy, and workflow.
Job-costing systems involve the process through which firms accumulate information about the costs of a specific service job or production process. The information necessary for a job-costing system includes overhead costs, direct labor costs, and direct materials costs. It is worth noting that the job-costing system is tailored to the customer’s needs and requirements. With a job-costing system, a manager can keep track of the cost of each job. It has some benefits to an organization such as tracking the expense of creating a unique product or service. Such information is important when developing analysis and tax requirements.
Price-optimization system is a type of MAS that companies use to control the prices of resources. By definition, price optimization systems are mathematical models or programs that organizations use to find out how demand varies with varying price levels. Then, these programs use that information in combination with data on inventory and cost levels to estimate the price tags for products that will improve sales and profitability.
Apart from taking control of the prices, price optimization systems have a number of benefits to an organization. For example, these systems help in deciding the most appropriate prices for multiple products at a given time. An organization can also use these systems to predict the behavior of demand at different price levels. Moreover, an organization can apply price optimization systems to tailor prices for different customer segments through simulation of customer responses to different price levels. Besides, the method can help an organization determine price structures for promotional, initial, and discount pricing to improve sales.
Presenting Financial Information
Importance of Relevant, Understandable, Accurate, and Updated Information
Presenting accounting information is a critical process in any organization as it involves informing the relevant party within or outside the organization about the financial status. Consequently, the information presented must be relevant to the user, reliable, up to date, and accurate. First, information must be relevant to the user since that particular user has some specific interest or need. Presenting information that does not inform the user about his or her items of interest means not satisfying them. For instance, one cannot present information about promotions and sales to investors because they are only interested in financial performance such as profit and loss, statement of investor’s equity, and balance sheet. In the same way, one cannot present information about profitability to customers as it is irrelevant to them.
The presented information must also be reliable for the audience to achieve their specific objectives. For instance, investors want information that is reliable enough to inform them about the value of their shares at the end of a trading period. Such information about profit before tax, profit after tax, shareholders’ dividends and others must reliable enough for the investors to use it in making decisions on whether to invest or not. Indeed, unreliable information can lead to the loss of investors. Similarly, customers need to have reliable information about the expected prices of products, discounts, and others. If the information presented to them is not reliable, then they are likely to leave without considering purchasing from the company.
Moreover, the presented information should be accurate and updated. The level of accuracy is indeed a major factor that can heavily affect an organization. Each user of the information presented wants to use it to achieve some specific objective or goal. Customers, for example, want to know the exact discount they are to get on a given product or service. On their part, investors want to know the exact price per share before they can consider investing.
Managers would want to know the exact data on the performance of certain products and services in the market. In all these examples, accuracy is the key- failure to provide accurate data means that the users will not achieve their goals, which will heavily cause the organization. Even if the data is accurate but outdated, then it is irrelevant. Specifically, each user wants to achieve an objective at a particular point in time. For example, the investor wants accurate data about the expected cost per share at the end of a specific trading period. If the data is accurate but does not reflect the particular period of time of interest, then it is irrelevant and of no use to the investor.
It is also worth noting that the information presented must always be understandable to the users. The idea is that each user wants to learn something or obtain some new knowledge or insight about a specific business aspect. Indeed, users have a different levels of understanding about some economic and business activities or accounting. For example, most investors have a high level of understanding of the nature, trends, and other aspects of stocks, shares, and dividends. Therefore, the information provided to the investors can be somehow technical such as having percentages and ratios. On the contrary, such information cannot be presented to customers, most of which are less likely to have deep knowledge about business trends. Therefore, customers want to have simplified information such as expected prices and so on.
Types of Managerial Accounting Reports
Accounting reports are classified based on the use or purpose, period, and levels of management. In terms of purpose, accounting reports are either internal or external. Internal accounts are those whose information is to be consumed within the organization. For instance, inventory management, job costing, and price-optimization reports are internal because the information is used by managers, supervisors, and other members of the organization in making decisions, planning, budgeting, and other activities. On the contrary, external reports are those designed to inform parties outside the organization about various aspects of the business. For instance, reports about pricing, expected changes in prices, promotions, and others are meant to inform customers, suppliers, and others, which means that they are external.
Based on the period, managerial accounts can be routine or special. Routine accounts are those produced within a specified period such as the weekly demand for products, the monthly cost of sales, the quarterly supply of materials, and so on. On the contrary, special reports are those developed for a specific purpose rather than regularly such as reports on the poor performance of sales of a product in a specific market that needs immediate action. In terms of levels of management, managerial reports can be directed to the top, functional, or junior managers or for functional use.
Responding to Financial Problems
With benchmarks, a manager can compare and measure the workflow in the organization against those of other companies to obtain information about different measures, practices, processes, and other aspects. In this way, the manager can determine the best methods of boosting organizational performance. Benchmarking involves defining, collecting, analyzing, and making use of internal and external financial data to improve business processes, achieve a high level of cost-efficiency, and enhance productivity.
Responding to financial problems with a benchmark, a relatively young company like Tesla Motors can benchmark with the industry and large producers like Ford and Toyota. In this case, Tesla will use four vital steps from the Six Sigma- strategic objectives, metrics, benchmark performance, model operation excellence, and measuring, validating, and improving. The first step is to determine and understand the company’s current process performance gaps.
Then the manager should obtain support and approval from the executive leadership team. Third, the manager should document benchmarking objectives and scope. The fourth step is to document the current process followed by an agreement on the primary metrics. The metrics should then be put in writing. After this, the managers should understand the gaps of low performers and then find the impact on customers, associates, and shareholders. After this, they should prioritize and select one to three metrics to benchmark. In the final three steps, Tesla managers should develop a data collection plan, identify research sources and initiate data gathering, and design a screening survey to assist with partner selection.
Key Performance Indicators (KPIs) are also useful in responding to financial problems in an organization. In this case, KPIs refer to the decision-making and monitoring tools used to track organizational performance in relation to strategic goals. They help to determine whether an individual, project, team, business unit or an entire company is on track to achieve its objectives. Like benchmarks, KPIs allow management to identify areas where the company excels as well as areas that need improvement (Franklin, Graybeal, and Cooper, 2019, p. 227). Again, a manufacturing company like Tesla can consider using KIPs to find financial problems in its business. In this case, the KPIs are production, gross margin, free cash flow, and profitability. By examining the performance of each indicator, it can find out if it needs to increase manufacturing scale.
If the gross margin expands by a given percentage, say 25%, then its profitability is increasing and sales are also expand. If the cash flow improves by say $ 430 million, then it is not making losses but profits. Therefore, it can be concluded that there is no financial problem at the moment.
Companies can also use budgetary variances to locate financial problems. By definition, a budget variance is a difference between the budgeted amount of revenue and the actual amount. A budgetary variance results from bas assumptions or poor budgeting. A company like Ford can decide to use this approach to locate financial problems in a given trading period such as a quarter. In this case, the idea is to calculate the actual amount of a process such as the amount of electricity used in the production of all sedans in a quarter, and then compare it with the budgeted costs. If there is a variance that makes the total amount more than the budgeted cost, then there is a problem that should be addressed.
Role of Financial Governance in Responding to Financial Problems
The term financial governance refers to how an organization collects, manages, monitors, and controls financial information. These activities include tracking financial transactions, controlling data, management of performance and compliance, operations, and disclosures. Organizations have policies and procedures for companies to manage business data and ensure that data is correct (Franklin, Graybeal, and Cooper, 2019, p. 231). When financial problems are detected, an organization can use financial governance in response. In this case, they can help produce compliant regulatory reports and disclosures. Also, financial governance allows managers to assume the ability to stay on top of compliance requirements, such as IFRS. Managers can respond by invoking the existing regulations under financial governance to ensure that collecting, calculating, and presenting financial data are done according to regulatory rules.
Role of Management Accountant in Responding to Financial Problems
Management accountants are the personnel responsible for management accounting and developing strategies to respond to financial problems. They are responsible for the identification, measurement, analysis, interpretation, and communication of information to managers to enhance their decision-making processes. Managerial accountants generate the information through management accounting and then send it to the managers through the management accounting systems. In responding to financial problems, management accountants prepare financial statements that may include monthly and annual accounts based upon the financial information that is compiled and analyzed. In addition, they work to ensure that all financial reporting deadlines are met, internally and externally.
From this analysis, it is clear that management is different from financial accounting in that their roles, processes, uses, and purposes are different. Yet, they play significant roles in an organization. The concept of management accounting is quite old, having emerged during the industrial revolution period. In modern times, managers and other leaders need to have a comprehensive understanding of the various events and operational metrics, which gives them the necessary information to leverage in their decision-making processes.
However, this information is only achievable through managerial accounting, a branch of accounting that focuses on internal reporting to aid in decision-making processes. The analysis shows that management accounting needs MAS to achieve its objectives. In addition, since it is an internal and ongoing process, it is a critical tool for improving the business process at any time during the trading period. Management accounting allows organizations to detect and correct issues and problems in their financial processes when the business is ongoing. Therefore, they help to ensure that the company can rectify problems and improve its final performance at the end of the period.
Franklin, M. Graybeal, P., and Cooper. (2019) Principles of accounting Volume 1 – Financial accounting. New York: 12th Media Services.