Introduction to Managerial Accounting

Welcome to AccountingForManagement.com. This website explains some of the most important concepts of managerial accounting (management accounting).

What is Managerial Accounting?

Managerial accounting is concerned with providing information to managers-that is, people inside an organization who direct and control its operation. In contrast, financial accounting is concerned with providing information to stockholders, creditors, and others who are outside an organization. Managerial accounting provides the essential data with which the organizations are actually run. Managerial accounting is also termed as management accounting. Financial accounting provides the scorecard by which a company's overall past performance is judged by outsiders. Managerial accountants prepare a variety of reports. Some reports focus on how well managers or business units have performed-comparing actual results to plans and to benchmarks. Some reports provide timely, frequent updates on key indicators such as orders received, order backlog, capacity utilization, and sales. Other analytical reports are prepared as needed to investigate specific problems such as a decline in the profitability of a product line. And yet other reports analyze a developing business situation or opportunity. In contrast, financial accounting is oriented toward producing a limited set of specific prescribed annual and quarterly financial statements in accordance with Generally Accepted Accounting Principles (GAAP). (Garrison, Noreen 1999)

Financial accounting vs. Managerial accounting:

Managerial accounting differs from financial accounting in a number of ways that are briefly discussed below.

Financial Accounting

Reports to those outside the organization owners, lenders, tax authorities and regulators.
Emphasis is on summaries of
financial consequences of past activities.
Objectivity and verifiability of data
are emphasized.
Precision of information is required.
Only summarized data for the entire organization is prepared.
Must follow generally accepted accounting principles (GAAP).
Mandatory for external reports.

Managerial Accounting

Reports to those inside the organization for planning, directing and motivating, controlling and performance evaluation.
Emphasis is on decisions affecting the future.
Relevance of items relating to decision making is emphasized.
Timeliness of information is required.
Detailed segment reports about departments, products, customers, and employees are prepared.
Need not follow generally accepted accounting principles (GAAP).
Not mandatory.

Managerial accounting is manager oriented therefore its study must be preceded by some understanding of what managers do, the information managers need, and the general business environment. Accordingly we shall briefly examine these subjects.

Need for Managerial Accounting Information:

Every organization-large and small-has managers. Someone must be responsible for making plans, organizing resources, directing personnel, and controlling operations. Every where mangers carry out three major activities-planning, directing and motivating, and controlling.

Planning:

Planning involves selecting a course of action and specifying how the action will be implemented. The first step in planning is to identify the alternatives and then to select from among the alternatives the one that does the best job of furthering the organization's objectives. While making choices management must balance the opportunity against the demands made on the companies resources.

The plans of management are often expressed formally in budgets, and the term budgeting is applied to generally describe the planning process. Budgets are usually prepared under the direction of controller, who is the manager in charge of the accounting department. Typically, budgets are prepared annually and represent management's plans in specific, quantitative terms.

Directing and Motivating:

In addition to planning for the future, managers must oversee day-to-day activities and keep the organization functioning smoothly. This requires the ability to motivate and affectively direct people. Managers assign tasks to employees, arbitrate disputes, answer questions, solve on-the-spot problems, and make many small decisions that affect customers and employees. In effect, directing is that part of the manager's work that deals with the routine and the here and now. Managerial accounting data, such as daily sales reports are often used in this type of day-to-day decision making.

Controlling:

In carrying out the control function, managers seek to ensure that the plan is being followed. Feedback, which signals operations are on track, is the key to effective control. In sophisticated organizations, this feedback is provided by detailed reports of various types. One of these reports, which compares budgeted to actual results, is called a performance report. Performance report suggest where operations are not proceeding as planned and where some parts of the organization may require additional attention.

The Planning and Control Cycle:

The work of management can be summarized in a model. The model, which depicts the planning and control cycle, illustrates the smooth flow of management activities from planning through directing and motivating, controlling, and then back to planning again. all of these activities involve decision making. So it is depicted as the hub around which the activities revolve.

History of Managerial Accounting:

Managerial accounting has its roots in the industrial revolution of the 19th century. During this early period, most firms were tightly controlled by a few owner-managers who borrowed based on personal relationships and their personal assets. Since there were no external shareholders and little unsecured debt, there was little need for elaborate financial reports. In contrast, managerial accounting was relatively sophisticated and provided the essential information needed to manage the early large scale production of textile, steel, and other products. After the turn of the century, financial accounting requirements burgeoned because of new pressures placed on companies by capital markets, creditors, regulatory bodies, and federal taxation of income. Johnson and Kaplan state that "many firms needed to raise funds from increasingly widespread and detached suppliers of capital. To tap these vast reservoirs of outside capital, firms' managers had to supply audited financial reports. And because outside suppliers of capital relied on audited financial statements, independent accountants had a keen interest in establishing well defined procedures for corporate financial reporting. The inventory costing procedure adopted by public accountants after the turn of the century had a profound effect on management accounting. As a consequence, for many decades, management accountants increasingly focused their efforts on ensuring that financial accounting requirements were met and financial reports were released on time. The practice of management accounting stagnated. In the early part of the century, as product line expanded operations became more complex, forward looking companies saw a renewed need for management-oriented reports that was separate from financial reports. But in most companies, management accounting practices up through the mid-1980s were largely indistinguishable from practices that were common prior to world war I. In recent years, however, new economic forces have led to many important innovations in management accounting. These new practices are discussed in other chapters.

Managerial Accounting and Dynamic Business Environment:

The last two decades have been a period of tremendous upheaval and change in the business environment, including the explosive growth of the internet. Competition in many industries has become world wide in scope, and the space of innovation in products and services has accelerated. This has been good news for consumers, since intensified competition has generally led to lower prices, higher quality and more choices. However, the last two decades have been a period of wrenching change for many businesses and their employees Many managers have learned that cherished ways of doing business don't work any more and that major changes must be made in how organizations are managed and in how work gets done. These changes are so great that some observers view them as a second industrial revolution. This revolution is having a profound effect on the practice of managerial accounting-as we will see through the rest of the text. First, however. it is necessary to have an appreciation of the ways in which organizations are transforming themselves to become more competitive. Since the early 1980s, many companies have gone through several waves of improvement programs, starting with Just-In-Time (JIT) and passing onto Total Quality Management (TQM), Process reengineering, and various other management programs-including in some companies The Theory of Constrains (COT), When properly implemented, these improvement programs can enhance quality, reduce cost, increase output, eliminate delays in responding to customers, and ultimately increase profits. They have not, however, always been wisely implemented, and there is considerable controversy concerning the ultimate value of each of these programs. Nevertheless, the current business environment cannot be properly understood without some appreciation of what each of these approaches attempts to accomplish. Each is worthy of extended study, but we will discuss them only in the broadest terms the details are best handled in operations management courses.

Code of conduct for Management Accountants

Practitioners of management accounting and financial management have an obligation to the public, their profession, the organization they serve, and themselves, to maintain the highest standards of ethical conduct. In recognition of this obligation, the Institute of management Accountants has promulgated the following standards of ethical conduct for practitioners of management accounting and financial management. Adherence to these standards internationally is integral to achieving objective of management accounting.

Competence

Practitioners of management accounting and financial management have a responsibility to:

Maintain an appropriate level of professional competence by ongoing development of their knowledge and skills.
Perform their professional duties in accordance with relevant laws, regulations and technical standards.
Prepare complete and clear reports and recommendations after appropriate analysis of relevant and reliable information

Confidentiality:

Practitioners of management accounting and financial management have a responsibility to:

Refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally obligated to do so.
Inform subordinates as appropriate regarding the confidentiality of information acquired in the course of their work and monitor their activities to assure the maintenance of that confidentiality
Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage either personally or through third parties.

Integrity

Practitioners of management accounting and financial management have a responsibility to:

Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict.
Refrain from engaging in any activity that would prejudice their ability to carry out their duties ethically.
Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions.
Refrain from either activity or passively subverting the attainment of the organization's legitimate and ethical objectives.
Recognize and and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity.
Communicate unfavorable as well as favorable information and professional judgment or opinion.
Refrain from engaging or supporting any activity that would discredit the profession.

Objectivity:

Practitioners of management accounting and financial management have a responsibility to:

Communicate information fairly and objectively
Disclose fully all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, comments, and recommendations presented.

Resolution of Ethical Conflicts:

In applying the standards of ethical conduct, practitioners of management accounting and financial management may encounter problems in identifying unethical behavior or in resolving an ethical conflict. When faced with significant ethical issues practitioners of management accounting and financial management should follow the established policies of the organization bearing on the resolution of such conflict. If these policies do not resolve the ethical conflict, such practitioner should consider the following course of action.

Discuss such problems with immediate superior except when it appears that superior is involved, in which case the problem should be presented to the next higher managerial level. If a satisfactory resolution cannot be achieved when the problem is initially presented, submit the issue to the next higher managerial level.
If the immediate superior is the chief executive officer or equivalent, the acceptable reviewing authority may be a group such as the audit committee, executive committee, board of directors, board of trustees, or owners. Contact with a level above the immediate superior should be initiated only with the superior's knowledge. assuming the superior is not involved. Except where legally prescribed, communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate.
Clarify relevant ethical issues by confidential discussion with an objective adviser to obtain a better understanding of possible course of action
Consult your own attorney as to legal obligations and rights concerning the ethical conflict.
If the ethical conflict still exists after exhausting all levels of internal review, there may be no other recourse on significant matters than to resign from the organization and to submit an informative memorandum to an appropriate representative of the organization. After resignation, depending on the nature of the ethical conflict, it may also be appropriate to notify other parties.
Resources:
Managerial Accounting, Ray H. Garrison Eric W. Noreen
Cost Accounting, Adolph Matz Milton F. Usrey
Advanced Financial Accounting M. A. Ghani