What is management accounting? What are the sources of data? How are the data used to make management decisions?
According to the official definition by CIMA (Chartered Institute of Management Accountants) management accounting “is the application of the principles of accounting and financial management to increase, protect, preserve and increase value for the stakeholders of for-profit and not-for-profit enterprises in the public and private sectors.” The main difference between financial and management accounting lies in the time frame and the level of details provided. Financial accounting reports information on the monthly and annual level, which may not be enough for some of the daily operations. In this case management accounting comes into place, providing a broader spectrum of information for a wider range of interested parties, however mostly for the internal use of the company. Unlike financial accounting, management accounting is not mandatory, thus no statutory regulations determine its use in the organization. Management accounting incorporates a larger amount and variety of data, including qualitative and non-monetary information. Moreover, it considers both historic and forecasted data equally relevant for the accounting procedures.
Management accounting fulfils six major functions: cost accounting, planning, auditing, control, financial management and decision making. Planning is subdivided into long-term (strategic) and short-term planning. Although, strategic planning is not entirely a part of management accounting, management accounting collects data and provides financial information, required for long-term planning. Short-term planning is usually referred to as “budgeting” and covers a time frame of not more than one calendar year.
Controlling function of the management accounting is exercised through comparing planned results over a certain period of time with the actual ones. The differences arising from this comparison are called variances. They are thoroughly examined by management accountants and the reasons for variation are reported to the senior management for further corrective actions. Disciplinary measures for causing variances are outside of the scope of management accounting.
Cost accounting (responsibility accounting) has always been in the core of management accounting, however at the moment its importance is being lost due to the rise of other functions. Its main role is to collect cost and revenue data, maintain it and “balance the books” by using double-entry system. It is also concerned with determining actual costs for controlling, stock valuation and further decision-making. Typical costing data comes from various sources such as timesheets, requisitions, notes upon goods receipt, and invoices. For the purpose of cost evaluation an entity is usually divided into segments (responsibility centres), which can be of three different types: cost centres, profit centres and investment centres. Cost centres are assigned clear responsibilities and the cost associated with the production or service cost centres is directly charged to them. Profit centres follow a similar idea, however revenues are being charged to them along with costs. Investment centre incorporates the responsibilities of all the investments, related to it. Such segmentation allows easier decision-making and control of the centres by the respective management, as well as simple responsibility assignment.
Financial management function of management accounting is gaining importance in the recent years. It is mostly concerned with financing planned activities and ensuring availability and efficient utilization of the funds.
The primary objective of auditing is to verify accounting information, and check accounting reports. It can be external and internal, with the former considered as a part of financial accounting, while the latter being in the responsibility of management accounting. Internal audit is usually conducted by the entity’s own employees and results are reported to the management. Its primary concern is evaluating management systems’ efficiency, rather than checking financial records.
Decision-making based on the information obtained from management accounting reports is becoming more and more important nowadays. This information usually has to provide not only the actual costs, but also the expected future revenues and expenditures, which would not usually be a part of a traditional accounting report. However, the decision-making power lies with the managers and not accountant, who merely provide them with the necessary information. As problems arising in an entity are often unique, solutions and respective decisions should be targeting the specific problem and cannot be generalized. Moreover, the data available from cost accounting is not sufficient for effective decision-making, therefore necessary information often has to be obtained separately. The scope of decision-making is usually limited to considering the cash flow, resulting only from a particular project. Revenues and costs, which are not influenced by the decision as well as fixed costs, are ignored for decision-making purposes. Moreover, decisions are made considering the opportunity costs, or the benefits foregone in favour of the chosen strategy. As decisions have to be carried out about the future, management accounting often involves probability testing, which helps to estimate the expected value of a specific project.
Decisions, which have to be taken by managers, can be classified into five categories. First and one of the most common decisions faced by the managers is the closure/shutdown one. The decision in this case is being taken, when an enterprise or a segment is considered “unprofitable”. While shutdown indicates a temporary problem, which is expected to be solved in the future, closure decisions imply permanent termination of operations, as no future is predicted for the segment. However, such decisions have to consider multiple factors, including product interconnection, staff involved and general contribution of the segment into the company.
Management accounting assists managers in making make or buy decisions. They concentrate on determining which products are more efficiently manufactured internally, while outsourcing all the activities, which are not core competencies of the company. In this case not only the cost aspect of manufacturing should be considered, but also various non-quantifiable factors, such as the loss of know-how, disturbances in the supply chain and delivery delays as well as difficulties to communicate product requirements to the suppliers.
Another type of decisions undertaken by managers is pricing. It refers to both external pricing (prices charged to external customers) and transfer pricing, which is the price charged internally, by one segment to another. External pricing can be cost based or market based. Transfer pricing can be based on market or adjusted market prices, total cost, variable cost, negotiated prices or opportunity cost.
Finally, management accounting helps managers to determine the strategy related to special orders. It supplies projected as well as historical information, evaluating the consequences of all the decision possibilities. The question usually arises in evaluating whether an entity is able to accept a special order and how much it can charge for it. In this case, excess capacity largely determines the pricing strategy. The lowest possible cost in this case is the variable cost of the order, while charging above that is associated with a higher risk of losing the customer.
Management accounting today is an important organizational function, which largely supports planning, controlling and decision-making. Despite the absence of statutory requirements for management accounting, it is considered to be an essential part of entity operation, which significantly contributes to the achievement of long-term objectives as well as to the day-to-day decision making.
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