Managerial Accounting (Encyclopedia of Business)
Managerial accounting, or management accounting, is a set of practices and techniques aimed at providing managers with financial information to help them make decisions and maintain effective control over corporate resources. For example, managerial accounting answers such questions as:
- What is the company's average cost per unit of labor (enterprise wide or within specific departments)?
- How many dollars in sales does each marketing dollar bring in?
- What is the required rate of return to make a new investment worthwhile?
- Which activities require the greatest expenditures and which earn the greatest profits (and how can the organization maximize the former and minimize the latter)?
Managerial accounting procedures are intended primarily to supply knowledge to decision makers within an organization. Financial accounting, in contrast, is concerned with providing information to stockholders, government agencies, creditors, and others who are outside the organization. A corollary of that difference is that financial accounting procedures generally must conform to external standards, such as those developed by the Financial Accounting Standards Board (FASB), while management accounting methods are left almost completely to the discretion of individual organizations.
Cost accounting, the third major sphere of accounting, is the process of determining the cost of a specific output or activity. Although it is sometimes confused with the managerial accounting function, cost accounting information is used by decision makers both inside and outside an organization. Cost and managerial accounting differ in that the latter goes beyond the role of cost accounting by combining multiple management disciplines with financial information to facilitate internal decision making. Thus, cost accounting may be seen as a necessary component of managerial accounting, but its focus is much narrower.
The earliest recorded accounting records date back to about 3500 B.C., when ancient Egyptian and Sumerian businessmen recorded agricultural production, tax collection, and storehouse inventories. The first evidence of more advanced accounting practices, such as property depreciation, has been traced to ancient Greek and Roman record keepers. The earliest accounting records that expressed accounts in terms of common monetary units (currency) date back to 1340 and come from Genoa. In fact, it was during the Middle Ages that an emphasis on arithmetic and writing in commercial trade allowed accounting practices to advance significantly.
The popularization of property ownership and money lending during the Renaissance in Europe necessitated the creation of performance measurement methods to help bankers and investors rate the success or failure of business ventures. Thus, the first advanced accounting procedures evolved that accounted for interest, depreciation, fixed assets, inventory turnover, and other factors that still represent the core of managerial accounting practices. Luca Pacioli, a Venetian, was the first to document accounting practices in his 1494 book, Summa de Arithmetica, Geometria, Proportioni et Proportionalita.
Modern accounting practices emerged during the Industrial Revolution, when the very nature of business activity began to change. Complicated financing techniques and huge capital investment expenditures resulted in the formalized distinction between such factors as income and capital, and fixed assets and inventory. It also prompted the creation of advanced means of allocating overhead and accurately determining liabilities and net worth within companies.
After the Great Depression, and particularly following World War II, the delineation between financial and managerial accounting became more defined, as government regulations and professional groups began to mandate accuracy and standardization in financial reporting and accounting. The dominant trend in managerial accounting during the latter half of the 20th century has been the use of increasingly detailed, internally generated accounting data to help steer management decisions and improve profitability. An important reason for the rapid growth in the use of detailed internal accounting information since the 1970s has been the proliferation of computerized information systems that have allowed managers to quickly access and process vast amounts of data.
MANAGERIAL ACCOUNTING THEORY
Professionals within an organization who perform the managerial accounting function generally support two primary purposes. First of all, they generate routine reports containing information regarding cost control and the planning and controlling of operations. Second, managerial accountants produce special reports for managers that are used for strategic and tactical decisions on matters such as pricing products or services, choosing which products to emphasize or de-emphasize, investing in equipment, and formulating overall policies and long-range planning.
Managerial accounting activities include some or all of the following: recognizing and evaluating transactions and economic events; quantifying and estimating the value of those events; recording and classifying appropriate transactions and events; and analyzing the reasons for, and relationships between, the transactions and events. Managerial accountants also assist decision makers who use the information they generate, and evaluate the implications of past and future events on proposed plans or decisions. They also work to ensure the integrity of the information that they produce and strive to implement a system of reporting that contributes to the effective measurement of management's performance.
MANAGERIAL ACCOUNTING APPLICATION
The practical role of managerial accounting is to increase knowledge within an organization and therefore reduce the risk associated with making decisions. Accountants prepare reports on the cost of producing goods, expenditures related to employee training programs, and the cost of marketing programs, among other activities. These reports are used by managers to measure the difference, or "variance," between what they planned and what they actually accomplished, or to compare performance to other benchmarks.
For example, an assembly line supervisor might be interested in finding out how efficient his/her line is in comparison to those of fellow supervisors, or compared to productivity in a previous time period. An accounting report showing inventory waste, average hourly labor costs, and overall per-unit costs, among other statistics, might help the supervisor and superiors to identify and correct inefficiencies. A detailed report might evaluate the assembly line data and estimate trends and the long-term effects of those trends on the overall profitability of the organization.
As another example, a product manager for a line of hair care products at a corporation that manufactured beauty aids would probably want to know how much overhead each of the products is consuming. A report that breaks down the amount of overhead attributable to each product might help the manager better determine the profitability of each item in the line of goods and to find out if the sales and profit goals for each item are being met. For instance, a certain type of shampoo may be selling very well and generating large amounts of cash flow. However, a close accounting of that product's actual costs within the organization may reveal that its contribution to overall profits significantly lags that of other offerings in the hair care line. Armed with that information, the product manager might elect to adjust marketing expenditures to emphasize more profitable items, or to concentrate on reducing expenses related to the shampoo.
Because of the need for detailed information about specific operations within a company, management accounting reports are typically much more in-depth than traditional financial accounting reports, such as balance sheet ratios and net income calculations. Most managerial reports also differ from financial reports in their frequency. Many internal reports, in fact, are generated monthly, weekly, or even daily in the case of information such as cash receipts and disbursements. Despite their emphasis on detail, a critical characteristic of most managerial accounting reports is that they are presented in summary format. Managers can read the summaries, efficiently identify possible problem areas, and then examine the details within those areas to determine a course of action.
PLANNING AND CONTROLLING
In the examples described previously, just as in most managerial accounting applications, information produced for managers is used to make decisions about the future and to judge the effectiveness of past decisions and actions. In managerial accounting, the process of setting goals, determining resource requirements, and devising a means of achieving goals is referred to as "planning." Monitoring financial results and measuring the outcome of planning processes within the enterprise is called "controlling." The person in charge of an entity's accounting department is usually called the "controller." The controller generally plays a key role in both planning and controlling endeavors throughout the organization.
The plans of management are formally communicated as budgets, and the term "budgeting" typically refers to management planning. The controller oversees the development of budgets by the accounting department, usually on annual basis. Budgets are commonly prepared not only for the overall organization, but also for divisions and departments within a company or institution. Budgets are important to the goal-setting function of an organization because they express the wishes and objectives of management in specific, tangible, quantitative terms.
Once a company's plans, or budgets, have been established, managerial accountants begin gathering information generated by the organization that indicates whether or not the company is achieving its goals. The accounting department presents its findings in the form of performance reports tailored for individual executives or departments. The detailed performance reports essentially compare budgets with actual results for a given time period, allowing managers to identify problem areas. For instance, a company's store managers may utilize data such as inventory levels and sales volumes to direct advertising and promotional programs.
Besides producing routine reports, management accountants also create special reports for other managers that help them to make decisions about proposed projects or problems that arise. Special reports are often created to analyze the relationship between costs and benefits related to different alternatives in the decision-making process. For instance, if a company's competitor drops its prices, management may ask the accounting department to produce a report comparing possible competitive responses, such as lowering prices, increasing advertising, or even changing its product or service. Such reports often involve forecasting as well as the collection of outside information.
Information gathered by cost accounting methods within an organization make up most of the detailed data used to create managerial accounting reports (and financial accounting reports). Understanding the costs associated with producing goods and services is vital to the decision-making process because that comprehension can help place a measurable value on the results of a company's individual decisions.
Four basic cost accounting activities that support the managerial accounting function are
- cost determination, which involves determining the actual cost of a product or an activity, such as marketing;
- cost recording, whereby costs are recorded in journals and ledgers;
- cost analyzing, which refers to accountants and managers analyzing the data to help solve problems and make plans; and
- cost reporting, which entails showing the costs in detail, including showing how the costs were measured, what characteristics the costs have, and what the costs actually mean and how they should be interpreted.
Significant advances in automating routine transaction-related accounting tasks, combined with a strong corporate emphasis on value creation, have signaled new directions for managerial accounting. This trend had been building since the 1980s and accelerated in the mid-1990s. The thrust of the changes have been to make management accountants strategic partners and analysts in management decision making, rather than simply suppliers of data. Many companies now expect their managerial accounting staff to assist in developing strategies to enhance shareholder wealth and to participate on cross-functional teams with managers from operating departments throughout the organization, among other things. If the old analogy was supplying endless data for management to sift through, the new analogy has been providing value-added information that is directly to the point and suggests options that management might not otherwise have considered. Indeed, at some companies the work of management accountants has increasingly been labeled "finance" rather than "accounting" to suggest a broader set of skills and expectations.
To facilitate this increasingly interactive role, some observers of the profession believe that management accountants will need broader business underpinnings in their academic and professional background. This means studying a wider array of management topics in school, but also gaining handson knowledge of their companies' operating units and competitive climate in order to tailor accounting information to narrowly defined needs.
A related trend has been redesigning finance and accounting departments themselves to reduce costs and make all of their operations more efficient and timely. Accountants are expected to take the lead in demonstrating the practices of lean management and continuous improvement.
PROFESSIONAL GROUPS AND DESIGNATIONS
Numerous professional groups and designations exist for accountants. Chief among the professional designations for management accounts is the Certified Management Accountant designation, offered by the Institute of Management Accountants (formerly the National Association of Accountants). The CMA is the management accounting equivalent of the Certified Public Accountant (CPA) designation. Accountants earn the certificate after passing a two-and-one-half-day, five-part examination, and by meeting certain accounting experience requirements. CM As early in their careers often hold staff and supervisory positions, while more experienced CMAs serve as controllers, chief financial officers, or in other executive financial positions.
One of former NAA's objectives in establishing the CMA designation was to increase the recognition of management accounting as a professional discipline with an identifiable, underlying body of knowledge, and to outline a course of study by which that knowledge could be attained. Among other goals, the designation helps employers, educators, and students by establishing objective measurements of an individual's knowledge and competence in the management accounting field. The NAA has also promulgated complementary ethical standards related to competence, confidentiality, integrity, and objectivity in the management accounting process.
Pay in management accounting and related fields varies considerably with education, experience, and even sex. For entry-level management candidates with a bachelor's degree and no professional certification, the average salary as of 1998 was around $39,850 for women and $45,550 for men, according to an annual survey by the Institute of Management Accountants. For middle managers holding the CMA credential and a master's degree, pay was significantly higher, averaging $72,640 for women and $78,140 for men. Top earners in senior/executive management, mostly men, took in $100,000 or more on average when they held a master's degree.
SEE ALSO: Accounting; Cost Accounting
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