Managerial Accounting Concepts and Decision Making Support

The Meaning and Purpose of Managerial Accounting

Managerial Accounting is the provision of accounting information for a company's internal users. This includes managers of all levels, executives (such as CEOs and CFOs), risk officers, board of directors, and members of the company's audit committee. Managerial accounting is used to generate information that helps managers and internal users take actions to create value for the organization. Managerial accounting has three broad objectives:

1. Provide information for planning company's actions - Information of action to achieve a particular end.
2. Provide information for controlling company's actions - Monitoring a plan's implementation and taking corrective action.
3. Provide information for making effective decisions - Choosing among competing alternatives.

Planning leads to controlling leads to evaluation and decisions. By following this flow, continuous improvements are the results. Continuous improvements then lead back to planning, to prepare for even more improvements.

Planning requires setting objectives and identifying methods to achieve these objectives. Once a plan is created, it must be implemented and monitored to ensure that it is being carried out as intended. Monitoring a plan's implementation and taking corrective action as needed is called controlling. Control is achieved by comparing actual performance with expected performance.

The information used for planning and controlling can be either financial or non-financial. Often financial and non-financial data is given to managers in the form of performance reports that compare the actual data with benchmarks or planned data. From this data, competing alternatives for moving forward are generated. The process of choosing between the alternatives is decision making. Decisions can be improved if information about the alternatives is gathered and made available to managers.

It should be noted that many companies are releasing their managerial accounting information, typically on their websites, to the public through optional reports. These optional reports are known as corporate sustainability reports, social responsibility reports, or citizenship reports. Companies often decide to release this information themselves rather than have Internet bloggers, newspapers or cable news networks publish their own estimates of such information.

Financial Accounting versus Managerial Accounting

The two basic types of accounting information systems are financial accounting and managerial accounting. There are basic differences between these types of accounting.

Financial accounting focuses on information and reports that are generated for external users, such as investors, creditors, customers, and other stakeholders. It must conform to rules and conventions that are defined by various agencies, such as the SEC, FASB and IASB. GAAP regulations are in effect. These rules govern the recognition of revenues, timing of expenses, and recording of assets, liabilities and stockholder equity. Financial accounting uses historical information to produce objective and verifiable financial information. Financial accounting focuses on the company's overall performance.

Managerial accounting focuses on information and reports that are generated for internal users. Unlike financial accounting, GAAP regulations do not cover managerial accounting. Managers are free to choose whatever information they want, as long as it can be justified on a cost basis. Managerial accounting uses historical information, but focuses on future events, for example, what it will cost to produce a specific product over the next year. Managerial accounting reports are much more subjective than financial accounting reports. Where financial accounting focuses on the company's overall performance, managerial accounting focuses on the performance of entities, product lines, departments, managers, etc.

Trends in Managerial Accounting and The Role of Managerial Accountants in Organizations

Developments in technology have created the need for better information. Several important uses of managerial accounting resulting from the advances in technology include new methods of estimating product and service profitability, understanding customer orientation, evaluating the business from a cross-functional perspective, and providing information useful in improving total quality.

As a result of the need for better information, Activity-Based Costing (ABC) was developed. Activity-based costing is a more detailed approach to determining the cost of goods and services. It emphasizes cost of the many activities or tasks that must be done to produce a product.

Customer Orientation

Customer value is the difference between what a customer receives and what the customer gives up when buying a product or service. Effective cost information can help the company identify strategies that increase customer value. There are two strategies for increasing customer value. Cost leadership provides the same or better value to the customer at a lower cost than competitors. Superior products through differentiation strives to increase customer value by providing something to customers not provided by competitors. Successful pursuit of increasing value requires an understanding of a firm's value chain. The value chain is the set of activities required to design, develop, produce, market and deliver products and services, as well as provide support services to customers.

Cross-Functional Perspective

Managerial accountants must understand the many functions of the business to manage the value chain. A decision affecting one function affects the others. This perspective allows management to see the big picture. This allows for an increase in quality, reduce time, and improve efficiency.

Total Quality Management

Total quality management is the idea of producing services and products with zero defects. Continuous improvement is fundamental in striving for total quality management. For this, management accounting must provide both financial and non-financial information about quality. One way this is done is through lean accounting. Lean accounting organizes costs according to the value chain, and collects both financial and non-financial information. This provides information to managers to support their waste reduction efforts and to provide financial statements that better reflect overall performance.

Meaning and Uses of Cost

Cost is the amount of cash or cash equivalent sacrificed for goods and/or services that are expected to bring a current or future benefit to the organization. Costs are incurred to produce future benefits. As costs are used up in the production of revenues, they are said to expire. Expired costs are also called expenses. Expenses are deducted from revenue to determine income. The revenue per unit is called price. It is important to note that price is not cost. Cost is what we pay for something. Price is what we charge customers of our products or services. Price must be greater than cost to earn income.

Accumulating costs is how costs are measured and recorded. For example, when a telephone bill comes in, the bookkeeper records an addition to the Telephone Expense account (and an addition to the liability account Accounts Payable). This is how costs are accumulated. At the end of the year, the company can see how much was spent in total for this expense.

Assigning costs is how a cost is linked to some cost object. A cost object is something that the company would want to know the cost of, for example, how much of the telephone bill was for the sales department, or manufacturing. A cost object is any item such as a product, customer, department, project, or other item for which costs are measured.

Direct costs are costs that can be easily and accurately traced to a cost object. The relationship between the cost and the object can be physically observed. Indirect costs cannot be easily traced to a cost object, and are not easily observed. These are generally assigned through allocation, or assigning the cost to a cost object.

In addition to being a direct or indirect cost, there are other categories of cost. Variable cost increases in total as output increases, and decreases in total output decreases (for example, an electric bill). With fixed cost, however, the total does not increase nor decrease as output changes (for example, rent).

Opportunity cost is the benefit given up or sacrificed when one alternative is chosen over another. Opportunity costs are not included in the accounting records because it is the cost of something that did not occur. They are, however, important to calculate as they are used in decision making.

Product and Service Costs

Output represents one of the most important cost objects. There are two types of output. Tangible products are goods produced by converting raw materials through the use of labor and manufacturing resources. Services are tasks or activities performed for a customer, or by a customer using an organization's products or facilities. Organizations that produce products are manufacturing organizations, and ones that provide services are called service organizations.

Although managerial accounting does not generally follow a stated set of regulations, it must follow GAAP when their companies provide outside parties with cost information about the amount of ending inventory on the balance sheet and the cost of goods sold on the income statement. In order to calculate these two amounts, costs must be subdivided into two categories: production and period (nonproduction) costs.

Product costs are direct and indirect costs associated with the manufacture of goods or the provision of services. Only the costs in the production section of the value chain are included in product costs. They can be further classified as direct materials, direct labor, and manufacturing overhead. No cost can be omitted from classification, no matter how far removed you might think it is from the actual production of a product.

Direct materials are materials that are part of the final product, and can be directly traced to the goods and services being produced. The cost of the materials can be measured through physical observation the quantity used by each product.

Direct labor is labor that can be directly traced to the goods or services being produced. Physical observation can be used to measure the amount of labor used to produce a product.

Manufacturing overhead (also known as factory burden or indirect manufacturing costs) are the product costs other than direct materials or direct labor. This category includes supplies, utilities, indirect materials and indirect labor. Indirect materials are materials used in the production process, but the amount used by each unit cannot be easily determined. Indirect labor is labor where the workers do not actually make the product, however, their contribution is necessary to production.

The total product cost is the sum of the direct materials plus direct labor plus overhead. The total product cost divided by the number of units produced will yield the unit cost. Product costs are sometimes grouped into prime cost and conversion cost. Prime cost is the sum of direct materials cost plus direct labor cost. Conversion cost is the sum of direct labor cost and overhead cost.

Production costs are assets that are carried in inventory until the goods are sold. There are other costs of running a company that are not carried in inventory. These are called period costs, or nonproduction costs. These are the costs in all areas of the value chain other than production. Period costs are expensed in the period they occur. Fixed assets (capital expenditures) also fall in the category of period costs. Period costs are often subdivided into selling costs and administrative costs.

Selling costs are costs necessary to market, distribute and service a product or service. These are sometimes referred to as order-getting and order-filling costs. Administrative costs are costs associated with research, development and general administration of the organization that cannot reasonably be assigned to either selling or production costs.

Income Statements for Manufacturing and Service Organizations

Costs of Goods Manufactured

The cost of goods manufactured represents the total product cost of goods completed during the current period. When determining total product cost, only costs assigned to goods completed are the manufacturing costs of direct materials, labor and overhead. It is possible to have direct materials used, but the work not completed, during a period. These materials are said to be part of a work in process.

The basic formula for determining direct materials used in production is beginning inventory of materials, plus purchased inventory, minus ending inventory of materials, equals the materials used in production. Sometimes ending inventory won't be known, but direct material used will be. In that case, the equation is changed to beginning inventory, plus purchases, minus direct materials used, equals ending inventory of materials.

Once direct materials are calculated, direct labor and manufacturing overhead for the time period can be added to get the total manufacturing cost for the period.

As mentioned previously, there is a second type of inventory - work in process, or WIP. WIP is the cost of the partially completed goods that are still on the factory floor at the end of a time period. These are units that are started, but not completed. WIP costs include direct materials, direct labor and overhead costs. The total manufacturing cost for the time period must be adjusted for the inventories of WIP.

Cost of Goods Sold

Cost of goods sold represents the total cost of units sold during a period. When sold, these costs are transferred from finished goods inventory on the balance sheet to cost of goods sold as an inventory expense on the income statement. Ending inventories of materials, WIP, and finished goods are assets and appear on the balance sheet as current assets.

Income Statement: Manufacturing Firm

Income statements are for a period of time. Usually this is for a month, but may be a quarter of a year. All sales revenue and expenses attached to that period of time appear on the income statement. The income statement always begins with "sales revenue" (or "sales" or "revenue"). Sales revenue is the price multiplied by the units sold.

Expenses are separated into three categories. These are production, selling and administrative. Production is the cost of goods sold. This is subtracted from the sales revenue to determine the gross profit. Finally, selling and administrative expenses for the period are subtracted to arrive at operating income. When determining the percentage of the lines on the income statement, the line items are calculated as percentages of sales revenue.

Income Statement: Service organization

In a service organization, there is no product to purchase or manufacture, and therefore, no beginning or ending inventory. The result of this is there is no cost of goods sold or gross margin on the income statement. Instead, the cost of providing the services appears along with the other operating expenses of the company.

Managerial Accounting and Ethical Behavior

To promote ethical behavior by managers and employees, organizations commonly establish standards of conduct referred to as Company Codes of Conduct. Generally, There are ten core values for ethical conduct within a company:

10 Core Values
3.Promise keeping
6.Caring for others
7.Respect for others
8.Responsible citizenship
9.Pursuit of excellence