Thus, the main purpose of both financial accounting and management accounting is the right allocation of the scarce resources. Financial accounting is the principle source of information for decisions on how to allocate resources among companies; management accounting is the principle source of information for decisions of how to allocate resources within a company. Management Accounting provides information that helps managers to control activities within the firm and to decide what products to sell, where to sell them, how to source those products and which managers to entrust with the company’s resources. Management accounting information is proprietary. This means that it is not mandatory for public companies to disclose management accounting data or many specifications about the systems that generate this information. Usually, companies disclose
168 Accounting for Managers very little management accounting information to investors and analysts beyond what is contained in the financial reporting requirements. A company discloses such kind of essential information like unit sales by major product category or product costs or product type only when the management is sure about the fact that the voluntary disclosure of this information will be viewed as “good news” by the marketplace.
Management accounting systems mostly work well. Therefore, it becomes difficult for a company to have an edge over its competitors by employing a better management accounting system. However, this observation does not imply that management accounting systems are not important to organisations. On the contrary, poor management accounting systems can significantly affect the investment community’s perception of a company’s prospects.
Study Notes
Assessment
1. Define "Management Accounting"
Discussion
Accounting for Managers 169
4.3 Definition and Scope of Management Accounting
Management accounting or managerial accounting is concerned with the provisions and use of accounting information to managers within organisations. It is meant to provide them with the basis to make informed business decisions that will permit them to be better equipped in their management and control functions. It is the process of measuring and reporting information about economic activity within organisations to be used by managers in planning, performance evaluation and operational control.
Planning: Planning is a process meant for the purpose of accomplishment. It is a blueprint of business growth and a road map of development. It helps in fixing objectives both in quantitative and qualitative terms. It is setting of goals based on aims, in keeping with the resources, for example, deciding what products to make and where and when to make them. It also determines the materials, labor and other resources that are required to achieve the desired output. In not-for-profit organisations, deciding which programmes to fund is also planning.
Performance evaluation: It refers to the evaluation of the profitability of individual products and product lines. It is a method by which the job performance of an employee is evaluated (generally in terms of quality, quantity, cost and time), typically by the corresponding manager or supervisor. The main objective of performance evaluation is to assess the extent to which an individual has added wealth to the firm and whether his performance is above or below the market or industry norms. It also determines the relative contribution of different managers and different parts of the organisation. In not-for-profit organisations, it is the evaluation of the effectiveness of managers, departments and programmes.
Operational control: It is the authority vested in the management to lead the activities of an organisation. It is to ensure that day-to-day actions are consistent with established plans and objectives. Corrective action is taken where performance does not meet standards. It also involves assigning tasks, designating objectives and giving authoritative direction necessary to accomplish the goals of an organisation. Examples include (a) knowing how much work-in-process is on the factory floor and at what stages of completion (b) to assist the line manager in identifying bottlenecks and maintaining a smooth flow of production.
In addition, the management accounting system usually feeds into the financial accounting system. In particular, the product costing system is generally used to determine inventory Balance Sheet amounts and the cost of sales for the income statement.
170 Accounting for Managers Management accounting information is usually financial in nature and Rupee- denominated, although increasingly, management accounting systems collect and report nonfinancial information as well.
Businesses can be categorised by the sector of the economy in which they operate. For example, the chief function of a manufacturing firm is to convert raw materials into finished goods. Agricultural and natural resource companies are also included in manufacturing firms. On the other hand, merchandising firms buy finished goods for resale. Legal advice, hairstyling and cable television are included in the category of service sector companies as they sell service and carry limited inventories, if any. Businesses can also be categorised by their legal structure: corporation, partnership, proprietorship. Finally, businesses can also be categorised by their size.
All of these organisations use management accounting extensively. Management accounting is also used by individuals in taking economic decisions in their personal lives, like home and automobile purchases, retirement planning and splitting the cost of a vacation rental with friends.
Study Notes
Assessment
1. Explain the concept of Management Accounting 2. What is the purpose of Management accounting.
Discussion
Accounting for Managers 171
4.4 Comparison of Management Accounting and Financial
Accounting
The field of accounting consists of three broad subfields: financial accounting, management accounting and auditing. This classification is user-oriented. Financial accounting is concerned with the preparation of financial statements for decision makers such as stockholders, suppliers, banks, employees, government agencies, owners and other stakeholders. Management accounting is concerned with the provisions and use of accounting information to managers within organisations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions. Auditing refers to examining the authenticity and usefulness of all types of accounting information. Other subfields of accounting include tax and accounting information systems.
These differences are generalisations and are not universally true. For example, GAAP allows choosing any methods for inventory flow, such as the FIFO or LIFO. In addition, GAAP uses predictions of future events and transactions to value assets and liabilities under certain circumstances. Nevertheless, the differences between financial accounting and management accounting shown above reveal important attributes of financial accounting that are driven by the goal of providing reliable and understandable information to investors and regulators. These investors are located quite far from the companies in which they have invested and are interested in the results regarding the profits/losses earned by the organisation. Therefore, a regulatory and self-regulatory institutional structure exists to ensure the quality of the information provided to these external parties.
For example, financial accounting makes use of historical information, not because investors are interested in the past, but rather because it is easier for accountants and auditors to concur on what happened in the past than to agree on management’s predictions about the future. The past can be “audited.” Investors then use this information about the past to make their own predictions about the company’s future.
As another example, financial accounting follows a set of rules (GAAP in the U.S.) that investors can study. Once investors obtain an understanding of GAAP, the fact that all U.S. companies comply with the same rules greatly facilitates investors’ ability to follow multiple companies. In addition, the fact that financial reporting is mandatory for all public companies ensures that the information will be obtainable.
Management accounting, on the other hand, serves an entirely different audience, with different needs. Management Accounting provides detailed information that is meant
172 Accounting for Managers for specific users. For example, managers require detailed information about their part of the organisation. Managers must also make decisions, sometimes on a daily basis, that affect the future of the business. So, Management Accounting provides necessary information central to future course of action. This information serves as input in those decisions, no matter how subjective those estimates are.
Table 4.1: Comparison between Financial Accounting and Management Accounting Financial Accounting Management Accounting
Backward looking: Focuses mostly on reporting past performance
Forward looking: Includes estimates and predictions of future events and transactions
Emphasis on reliability of the information
Can include many subjective estimates
Provides general purpose information used by investors, stock analysts and regulators (one size fits all)
Provides many reports tailored to specific users
Provides a high-level summary of the business
Can provide a great deal of detail
Reports, almost exclusively, in Rupee-denominated amounts, a recent exception being the increasing (but still infrequent) use of the Triple Bottom Line
Communicates many nonfinancial measures of performance, particularly operational data such as units produced and sold by product type
Accounting for Managers 173
Assessment
1. What is Financial Accounting.
2. State the difference between Management and Financial Accounting.
Discussion
1. Discuss how management accounting got its momentum.