In this post, we’ll look at management accounting and its objectives. What are the distinctions between management accounting and other forms of accounting? We’ll also briefly explore cost accounting and cost ascertainment.
The definition of management accounting
Management accounting is “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 authorities” (CIMA – Official Terminology).
The American Institute of Certified Public Accountants (AICPA) states that management accounting as a practice extends to the following three areas:
Strategic management – advancing the role of the management accountant as a strategic partner in the organization;
Performance management – developing the practice of business decision-making and managing the performance of the organization; and
Risk management – contributing to frameworks and practices for identifying, measuring, managing, and reporting risks to the achievement of the objectives of the organization
The Institute of Chartered Management Accountants (ICMA) states, “a management accountant applies his/her professional knowledge and skills in the preparation and presentation of financial and other decision-oriented information in such a way as to assist management in the formulation of policies and in the planning and control of the operation of the undertaking.”
Management accountants are therefore seen as the “value-creators” amongst the accountants. They are much more interested in forward looking and taking decisions that will affect the future of the organization, than in horizontal recording and compliance (scorekeeping) aspects of the profession. Management accounting knowledge and experience can therefore be obtained from varied fields and functions within an organization, such as information management, treasury, efficiency, auditing, marketing, valuation, pricing, logistics, etc.
The distinction between management accounting and other forms of accounting
Management accounting differs from financial, tax and generally other forms of accounting in the following ways:
Objective – whereas other forms of accounting are concerned with reporting to business owners, in terms of profit/loss, resulting from the use of resources; and reports are prepared for the use of external parties such as shareholders and creditors, cost and management accounting is concerned with the provision of regular and detailed information to management, structured and analyzed in such a way that resources may be acquired and used as economically, effectively and efficiently as possible in the pursuit of an organization’s objectives.
Type of information and/or emphasis on the future – a key distinction is between the past and the future. Whilst other forms of accounting are concerned with recording what has happened, management accounting has a forward looking aspect. Plans can only be made, and decisions taken, concerning the future; control can only be arranged for something that is going to happen since changes are constantly taking place in economic conditions and such changes demand that the manager’s job be based in large part on estimates of what will happen rather than on summaries of what has already happened.
Relevance of data – other accounting data are expected to be objective and verifiable. However, for internal use the manager wants information that is relevant even if it’s not completely objective or verifiable. By relevant, we mean appropriate for the problem at hand. For example, it’s difficult to verify estimated sales volumes for a proposed new store at Wal Mart, Inc., but this is exactly the type of information that is most useful for managers in their decision-making. The managerial information system should be flexible enough to provide whatever data are relevant for a particular decision
Method/Generally Accepted Accounting Principles (GAAP) – other forms of accounting have one purpose and one set of rules or generally accepted principles. This is a necessary condition of external reporting; objectivity and verifiability are essential to understanding. External users must have some assurance that the reports have been prepared in accordance with some common set of ground rules. These enhance comparability and help reduce fraud and misrepresentation, but they don’t necessarily lead to the type of reports that would be most useful in internal decision making.
Management accounting is not constrained in the same way by such rules. Information is arranged according to the needs of particular managers at particular time in particular organizations. Instead of being confined to following highly structured practices, the management accountant is expected to recognize information that is useful for specific managerial purpose. This may be referred to as ‘conditional’ truth approach, the principle of different cost for different purposes. This can be contrasted with the ‘absolute’ truth of other accounting branches, which follows clearly laid down rules in establishing costs.
Amount of information – other forms of accounting analyze expenditure according to the nature of outlays and not the activity for whose use the expense has been incurred, other than a broad functional classification for example; manufacturing, selling, distribution and administration. They merely record values at the interface between the organization and the outside world. Management accounting is concerned with internal movements of value, amplifying the analysis in, for instance, the financial accounts by giving an operational analysis relating outlays to departments and to products. It’s therefore of a more detailed nature than other forms of accounting.
Less emphasis on precision – timeliness is often more important than precision to managers. If a decision must be made, a manager would rather have a good estimate now than wait a week for a more precise answer. A decision involving tens of millions of dollars doesn’t have to based on estimates that are precise down to the penny, or even to the dollar. In fact, one authoritative source recommends that, “as a general rule, no one needs more than three significant digits, this means, for example, that if a company’s sales are in the hundreds of millions of dollars, then nothing on an income statement needs to be more accurate than the nearest million dollars.
Estimates that are accurate to the nearest million dollars may be precise enough to make a good decision. Since precision is costly in terms of both time and resources, managerial accounting places less emphasis on it than do other forms of accounting. In addition, management accounting places considerable weight on non-monetary data, for instance, information about customer satisfaction is of tremendous importance even though it would be difficult to express such data in monetary form.
Segments of an organization – other forms of accounting are primarily concerned with reporting for the company as a whole. In contrast, management accounting focuses much more on the parts, or segments of a company. These segments may be product lines, sales territories, divisions, departments, or any other categories of the company’s activities that management finds useful. For example financial accounting requires breakdowns of revenues and costs by major segments but this is of secondary emphasis. In managerial accounting, segment reporting is the primary emphasis.
Responsibility/controllability – management accounting is concerned with identifying costs and revenues not just with physical location but also with people. This is responsibility accounting and the aim is to assist and monitor decisions made. Due to interdependence and shared responsibilities arising inevitably in most organizational operations, consequences of actions in one area affect other areas. Care has to be taken in assigning responsibility for costs incurred. Responsibility should be consistent with controllability.
Work environment/communication – communication is a vital element in the management accountant’s work and he/she must work in close contact with managers throughout the organization in all other functional areas. Other accountants can work to a greater extent in isolation from the rest of the management team.
Management accounting is not mandatory – other forms of accounting especially financial are mandatory i.e. they must be done. Various outside parties such as revenue and tax authorities require periodic financial statements. Managerial accounting, on the other hand, isn’t mandatory. A company’s completely free to do as much or as little as it wishes. No regulatory bodies or other outside agencies specify what’s to be done, for that matter, whether anything is to be done at all. Since managerial accounting is completely optional, the important question is always, “is the information useful?” rather than, “is the information required?”
In summary, management accounting has gradually taken accounting from its concern with keeping an overall record of past events to a means of helping businesses determine their detailed future and in a variety of situations. The emphasis is on economic reality, relevance and timeliness more than objectivity and verifiability which are of particular importance in other form of accounting.
Cost accounting and cost ascertainment
Cost accounting is an expanded of the general or financial accounting of a business concern which provides management promptly with the cost of producing or selling each article or rendering a particular service (Neuner). In other words, cost accounting is a step further to and a refinement of financial accounting in which cost of manufacturing and selling a product or job or rendering a service is determined, not at the time of the accounting period but at the time when the product’s manufactured or any service is rendered. In simple words, costing is a systematic procedure for determining the unit cost of output or service rendered.
It provides for an analysis of expenditure which enables management to know not only the total costs but also its constituents. In short, it is the process of accounting for cost, which begins with recording and classifying of incomes and expenditures and ends with the preparation of periodical statements and reports for ascertaining and controlling costs. As predicted today, cost accounting may be defined as the process of measuring, analyzing, computing and reporting the cost, profitability and performance of operations.
In magnet accounting, cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company’s costs and improve profitability. As a form of managerial accounting, cost accounting need not follow standards such as GAAP, as its primary use is for internal managers, rather than outside users and what to compute is instead decided pragmatically. Costs are measured in units of nominal currency by convention. Cost accounting can be viewed as translating the supply chain (the series of events in the production process that, in concert, result into a product) into financial values.
Functions – Cost accounting ascertains the cost of production of each job, process, or work order by applying different methods such as job costing, process operation costing, contract costing etc. according to the suitability and needs of the organization.
Scope – cost accounting is very wide and includes both cost ascertainment (discussed below) and cost control. Cost control refers to guidance and regulation by executive action. The aim of control technique is the setting of standard cost before starting of production and compared with the actual at the end of production.
This refers to the process of determination of costs on the basis of actual data. Hence, the computation of historical cost is cost ascertainment while the computation of future costs is cost estimation; both cost ascertainment and estimation are inter-related and are of immense use to the management. In case a concern has a sound costing system, the ascertained costs will greatly help management in the process of estimation of rational accurate costs which are necessary for a variety of purposes: budgeting, measurement of performance efficiency, preparation of financial statements (valuation of stocks etc.) make or buy decisions and fixation of sales prices of products.
Moreover, the ascertained cost may be compared with the pre-determined costs on a continuing basis and proper and timely steps be taken for controlling costs and maximizing profits. The ascertainment of cost of product/service rendered is the main objective of cost accounting. It includes collection, analysis of expenses and measurement of production at different stages of manufacturing. The collection, analysis and measurement requires different methods of costing for different types of production such as historical costs, standard costs, actual cost, process cost and operation cost.
Objectives of management accounting
Management accounting has three main objectives that allow managers to make improvements and plan for the future: measuring performance, assessing risks and allocating resources.
Measuring performance – management accounting is concerned with measuring performance in businesses. There are two types of performance that are typically measured. The first is employee performance. This can mean assessing whether an employee has been an efficient producer or it can mean using accounting methods to determine if a manager has attained certain goals in order to receive a bonus. The second performance measurement is the measurement of efficiency. This is concerned with how efficiently resources, such as capital, worker hrs or materials, have been used. Both types can be used to make corrections in order to improve performance.
Assessing risks – risks are an integral part of business. Taking risks can result in major losses, but being constantly risk-averse can result in missed opportunities. An objective of management accounting is to assess risks in order to maximize profits. An example of this would be determining the percentage of high-risk loans that a bank should make. A management accountant can identify a safe range in which the bank can expect to make profits without running the risk of collapse if the loans are defaulted. It can also be used for assessing the amount of money that should go into certain projects based on their expected return.
Allocating resources – resource allocation is important to any organization. Decisions need to be made about which projects to pursue, products should be produced and how portfolios should be designed. An objective of management accounting is to provide a method for allocating resources. Management accountants will determine the most efficient way to divide resources and maximize profits. For example, a management accountant should be able to tell you the most efficient product portfolio for a manufacturer based on resource availability, selling price, manufacturing time and consumer demand. This information is vital to efficient production within an organization.
- Accasyi “Cost Ascertainment” Retrieved, 20 February, 2011
- Accounting for Management “Financial Accounting versus Managerial Accounting” Retrieved, 19 February, 2011
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- EHow.com “Management Accounting Objectives” Retrieved, 22 February, 2011, from http://www.ehow.com/list_6755319_management-accounting-objectives.html
- Kapka, R. S. & Bruns, W. (1987). Accounting and Management: A Filed Study Perspective. Boston, MA: Harvard Business School
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- Rajput Brotherhood “Cost Accounting” Retrieved, 22 February, 2011
Here is a link to the study notes for ACCA F1 Accountant in Business. These study notes are designed by keeping the ACCA F1 syllabus in mind and thus cover the whole course. Please share these study notes with your colleagues as well so that everyone can benefit from them.