Management Accounting

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Management accounting encircles the process of identifying, analyzing, and capturing all the information that can aid the management decisions. It involves finding, organizing, interpreting and conveying information to the management for improving the business operations. Management Accounting is more focused on providing information about the insights of business operations and costs to achieve better results.

Definition:

Management accounting, also termed as managerial accounting is the process of gathering, analyzing, refining, and recording information about business costs and operations for internal managerial use.

Management accounting aims at improving the business processes by cutting unnecessary costs, targeting higher profits, and expanding the business operations. Information is gathered about the internal business projects, expenses, and plans and is then organized. This statistical information is then communicated to the higher management responsible for decision making.

A scrutiny of the past trends, analysis of the revenues, costs, and other expenses gives a better insight into the company’s performance. This insight helps the decision-makers to make better decisions about the future business actions. Also, it helps to spot the areas, departments, teams, and employees that are performing well and those who need to improve.

What is Management Accounting?

Every successful organization has a capable team of management accountants. These accountants, also known as managerial accountants, deeply analyze the events and operations taking place within and around a business. They gather all the data relevant to the progress of a company.

For instance, this data can include the past trends of a particular operation, project, or product line of a business. It should include all the costs incurred on that particular project, all the revenue earned from that project and the performance trends of that project i.e. whether it was successful or not. This data is then organized and translated to make it easy to analyze.

The top management of any company then analyzes this data. Based on this data, estimates for the future emerge. For example, if a company incurred $1 million on a project last year to earn a revenue of $3 million; then it can be estimated that a similar project this year can earn a revenue of $4 million by incurring a cost of $1.4 million (considering inflation and all other factors).

Together, the management accountants, cost accountants, and the management of any business use this data for bettering the business. The knowledge and insight gained from such information guides the company towards better decisions.

Examples:

Here are some examples to better understand the role of management accounting.

  1. TES Inc. deals in the construction industry. To win construction projects, the company submits tenders to its clients. A tender is a complete proposal that represents the plan of the company to establish the project, the estimated price of the project, the timeframe etc.

Recently, the government posted an advertisement for all the construction companies to submit their tenders for the upcoming construction project of National Highway 13. TES Inc. called upon the team of its management accountants to prepare the proposal.

The team, therefore, fetched the files for the past projects of National Highway 10, 11 & 12. Based on the area and costs of each of these projects, they proportionately estimated the cost to be incurred on NH13. Similarly, they made an estimate of their profit margin, to quote the price for their proposal. 

For the internal use of TES, they studied the report of all the previous highway projects to prepare an internal project feasibility report. Within this report, all the previous project failures were identified, and special plans were proposed in the tender to eradicate those problems. Also, considering the starting and ending dates of the previous Highway projects, TES made a reasonable estimate of the time required to construct NH13.

  1. Stephen is the CEO of a newly established company. For the quarter ended, he has the following pending tasks that must be completed in time;
    1. Preparation of financial statements
    2. Budgeting for the launch of a new product 
    3. Preparation of Tax Returns

Whom should he hire?

For the preparation of financial statements, Stephen should hire a financial accountant. Financial statements represent the annual performance of a company and thus only requires the presentation of data.

However, for the preparation of budget and tax returns, a management accountant should be hired. Both of these tasks require internal information and an analysis of the past trends for the estimation of future expenses.

Functions of management accounting:

Management accounting focuses on the collection, processing, and in-depth analysis of data. Accountants gather information and then quantify it into figures and statistical data to scrutinize past data. Also, this data is then used to make future estimates. 

The ultimate objective is, however, to record, interpret, analyze, and present this data to the higher management for better decision making. The following are the main functions of management accounting.

  • Collection and processing of information.
  • Quantifying information and presenting it in a statistical order to aid the management decisions.
  • Aiding realistic planning and future forecasting, based on data and statistical information.
  • Decision-making to the extent of grant of authority by the key management.
  • Preparation of business performance reports intended for internal use only.

Techniques and models used by management accounting:

Management accounting is a vast discipline with a wide variety of diverse topics, tools, and techniques that are used to understand the nature of a business, analyze its performance and then to plan for its future. Here are some of the common areas that are targeted by management accountants to fetch the desired results.

1. Costing:

The two main components that make the profit of any entity are revenue and costs. To maximize profits, a company has to either stretch their revenues or shrink their costs. Costing, therefore, is a superset of management accounting. Accountants analyze the variable, fixed, and other costs of each business operation and devise ways to cut these costs down. 

Example:

Sam was assigned the job to take note of all the costs incurred in the product manufacturing department of his company, and devise measures to minimize them. He visited the factory premises and scrutinized the manufacturing process.

He made the following observations,

  • The generators used to supply electricity to the manufacturing plant were run on diesel that costs $11,500 per month. Running the same generator on petrol could save the costs by $5000.
  • Product X is currently priced for $15 per piece in the market, whereas the cost for manufacturing it is $8. If the same product is sold after refining by incurring a further $3, it can yield a price of $25. Thus, increasing the profit by $7.
  • Product Y requires a separate factory space for manufacturing. Also, all the raw materials that go into the production process are imported. Ultimately, the profit margins on Product Y are too less to continue its production. It is advised to terminate the production of Product Y and start a new product line; Product Z.

2. Budgeting:

Another important task of a management accountant is to channelize the budgets of a company. A company runs upon its budgets and forecasts. A budget is prepared in advance for the upcoming years of a company. It shows the estimated future sales of a company and accounts for the cost rises or falls, administrative and selling expenses, taxes, etc. in the future years

It makes sure that the company would be able to produce and sell reasonable inventory levels, maintain sufficient margins to make up for their costs, earn good profits and maintain solvency in the long run. Also, budgets are made to outline the anticipated capital expenses. For example, a plant is operational for the last 7 years and is expected to run for 3 more years. The cost to buy a new plant in the fourth year along with all the installation and other direct expenses, would be budgeted today.

3. Performance Measurement:

Once the budgeting is done, it is then checked regularly for accomplishment. If the business had anticipated to sell 1000 units in the first quarter and make a profit of $10,000, then during and after the quarter being ended, the estimates are compared with the actual results.

In case of any negative deviations from the estimates (lesser sales or lesser profits), the reason is tracked, and measures are taken to improve the business performance. Also, based upon the actual performance, new budgets are made. Businesses depend upon performance indicators to compare their actual performance with the projections made during their budgeting phases.

Such projections not only enhance the performance of a company but setting such performance benchmarks are crucial to compare the company’s performance over the years and also with other market competitors. Management accounting is used in setting such performance indicators for any business.

4. Cashflow management:

Businesses usually follow Accrual based accounting which is a true representative of the company’s financial position and affairs. Accrual based accounting requires the recording of any expense or income as soon as it is realized, even if the cash against it is not received. For instance, if you have made a sale of $500 on credit, it is recorded as income against an account receivable. The accounts thus show a revenue of $500, whereas, no cash has been received in reality.

This doesn’t represent the true cash impact of any transaction. With accrual-based recording of transactions, it is hard to judge the true liquidity state of a company at any time. A management accountant implements working capital optimization strategies to manage the cash flows of a company and make sure the company remains liquid to fulfill its short-term obligations (paying off creditors, overdrafts settlement, etc.).

Management Accounting v/s. Financial Accounting:

Accounting has many sub-disciplines – all deal a different set of users, different information and serve a unique purpose. Managerial Accounting differs from Financial accounting on various grounds. Let us understand a few areas that distinguish them both from each other.

1. Different Users:

One major difference between both management and financial accounting originates from different intended users of the information. Financial accounting aims to keep the external stakeholders in loop. The main users of financial reports are shareholders, owners, employees, lenders, government, and other stakeholders.

These people being connected with the business, in one way or another, are interested in the internal business affairs. Financial accounting records and represents the actual financial performance of a company, intended to be used by these external stakeholders.

Management accounting, however, is aimed at helping the internal management of a company. It gathers, processes and quantifies information to aid the decision-making process of a company.

2. Flexibility:

Both the accounting disciplines are subjected to the preparation of information. However, the flexibility of preparatory standards vary. Information derived from Management Accounting is used for internal purposes only and offers flexibility i.e. it can be altered to the need of intended users. 

For instance, the Finance manager may wish to see the next quarter budget in the form of graphs. Whereas, the director may want to analyze the same data in the form of percentages and ratios. It can, therefore, be presented in various forms, as no hard and fast rules apply.

On the contrary, financial accounting observes strict preparatory rules and guidelines by the accounting standards board i.e. IFRS and GAAP. Both the standards specify the number of financial statements/reports to be prepared along with comprehensive guidance about the recording and presentation of information. Financial accounting offers almost no flexibility when compared to management accounting.

3. Recording & Forecasting:

One major difference that distinguishes Management and Financial accounting is the nature of accounting. Management Accounting is all about gathering and organizing information from relevant sources. Based on this data, future estimates are built, and business performance is forecasted. 

Financial accounting is all about recording the events and transactions that took place in the past. It surrounds the standards to record the information and present it to the business outsiders. It doesn’t deal with the future ventures of the business.

Conclusion:

The following points must be kept in mind whenever referring to the discipline of Management accounting:

  • Management accounting refers to the collection, processing, refining, and quantifying of data for reporting to the key management of a business. It helps in analyzing business performance and making better decisions.
  • This information is intended for use by the internal management of a company and can be prepared varyingly depending upon the user preferences. For e.g. in the form of graphs, ratios, percentages or a summary etc.
  • It deals with the preparation of budgets and forecasting. Also, based on the estimates made by management accountants, key performance indicators (benchmarks) are set for the business’s future performance.
  • Some common areas of management accounting include cash flow analysis, budgeting and forecasting, job costing, Inventory turnover management etc.
  • Management Accounting is a far more different discipline from Financial accounting. It aims to aid the internal management’s decisions about the future of a business. Financial accounting whereas only records and represents the company’s past financial performance.