Management Accounting and its Roles and Principles
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Management accounting provides specialized data and reports for internal managers to help with decision making, while financial accounting provides standardized financial statements for external stakeholders like investors. Management accounting focuses on future trends and does not need to follow GAAP, whereas financial accounting focuses on past data and must follow GAAP. Effective management accounting implements four principles - influence through relevant and valuable communication that builds trust. It covers areas like cost accounting, inventory management, job costing, and price optimization to help managers with tasks like budgeting, analysis, forecasting, and costing.
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Management Accounting and its Roles and Principles
- 2. Management and Financial Accounting Financial Accounting • Standard Financial Statement: (e.g. Cash Flow, Balance Sheet, Income Statements) • For external users for assessing company’s health: (e.g. Stockholders, Investors) • Focus on past data. • Follows Generally Accepted Accounting Principles (GAAP). • Audited. Management Accounting • Specialized data products. • For internal users making smart decisions: (e.g. managers, general managers). • Focus on future trends. • Does not need to follow GAAP. • Not Audited. • May include more detailed info. • May include nonfinancial info.
- 3. Principles of Management Accounting ■ Effective management accounting implementation can develop decision-making in companies, it comprises of four basic principles. Influence: Communication provides insight that is influential. Relevance: Information that is relevant. Value: Impact on value is analyzed. Trust: Stewardship builds trust.
- 4. Definitions ■ Management accounting is the procedure of recognition, measurement, gathering, examination, preparation, explanation and communication of information that helps managers in particular decision making within the framework for organization’s growth and achieving its goals. ■ It is the process of preparing management reports and accounts that give correct and on-time statistical and financial information needed by managers to make day-to-day and short term decisions for the benefits of the company.
- 5. Role and Principles of Management accounting Managerial accounting covers all fields of accounting designed at informing management of business operation parameters, which include reports of budgeting, trend analysis, sales forecasting, product costing, constraint analysis and many more on daily, weekly or monthly basis. ■ Cost accounting: Cost accounting comprises of methods for evaluating the costs of products, processes and projects, in order to report the accurate costs and amounts on the financial statements, while supporting management in taking decisions.
- 6. Role and Principles of Management accounting ■ Inventory Management Systems: Inventory management system is the method of supervision and controlling of the orders, storage and use of parts that a company uses in the manufacturing of the products it sells. ■ Job Costing: Job costing is an order-specific estimation procedure, used in conditions where each job is different and is performed according to customer’s requirements. ■ Price Optimising: It is the utilization of mathematical procedure by a company to find out how buyers will react to different prices for its products and services through diverse channels
- 7. Costings ■ Absorption costing Absorption costing is a cost accounting process for valuing inventory. Absorption costing comprises or "absorbs" all the costs of manufacturing a product including both fixed and variable costs. ABC Corp. produces 100,000 sponges per month: 1) Labor charges per unit= $0.5 2) Material charges per unit= $0.25 3) Monthly rent = $30k => per unit => 30k/100k = $0.3 4) Monthly Insurance = $4 => per unit => 4k/100k => $0.04 Total Absorption Cost = $1.09 per sponge If ABC Corp. produces 200,000 sponges per month: 1) Labor charges per unit= $0.5 2) Material charges per unit= $0.25 3) Monthly rent = $30k => per unit => 30k/200k = $0.15 4) Monthly Insurance = $4 => per unit => 4k/100k => $0.02 Total Absorption Cost = $0.92 per sponge
- 8. Costings ■ Marginal costing The increase or decrease in the total cost of a production run for making one additional unit of an item. Marginal Cost of production = Change in total production costs / Change in total Quantity produced ABC Corp. produces 100,000 sponges at $1.5 each. The total cost of manufacturing 100,000 units is $150,000 If ABC Corp. decides to produce 100 extra units of sponges at $1.5 each. Then the total cost of producing 100,100 units is $150,150. Hence, the Marginal Cost is $150 ($150,150- $100,000)
- 9. How is Management Accounting integrated into an organisation ■ Cost centres ■ Price setting ■ Decision making ■ Departmental budget ■ Central budget
- 10. Benefits of Management Accounting ■ Determining the goals ■ Reduce Costs ■ Increase Efficiency ■ Maximizing the Profitability ■ Increase Financial Returns
- 11. Conclusion In this present multifaceted business world, management accounting has become an essential part of management, which is determine to guide and advise the decision makers of the company at every step. Management accounting not only increase efficiency of the management but it also increases the efficiency of the employees. As it is clear that management accounting is necessary in decision- making for those businesses which has the passion to continue being successful for generations. Based on the information given by these methods, the owner of the company can move forward, bring innovations and take risks without fear. Proper management accounting should be implemented in the organization which should has the ability to evolve according to the changing business strategies with respect to market.
- 12. Bibliography ■ www.investopedia.com ■ www.accountingcoach.com ■ www.businessdictionary.com ■ www.wikipedia.com
Editor's Notes
- Management and financial accountings are the major tools for any organization, but the function of both tools are different. Organization utilizes these tools to establish operational plans in the future, to examine the past performance and to monitor present business functions. Both tools have different audiences by means of externally and internally. Financial Accounting: Financial Accounting is performed by organization to show the financial condition of the business to its outer audience, such as Board of Directors, stakeholders, stockholders, other investors and financial institutions. It represents the specific time period performance of the company to show the audience that how the company has performed in the past. Financial accounting reports must be submitted on an annual basis and this annual report must be made public for publically traded companies. Management Accounting: Management or managerial accounting is used by managers to make decisions concerning the day-to-day operations of a business. It is based not on past performance, but on current and future trends, which does not allow for exact numbers. Because managers often have to make operation decisions in a short period of time in a fluctuating environment, management accounting relies heavily on forecasting of markets and trends.
- Effective management accounting practices can improve decision-making in organizations through, among other things, future-focused insight and analysis. 1- Influence: Conversation is the integral part of management accounting which is present at beginning and ending of the process. It improves decision-making by corresponding insightful information. By the discussion about the needs of decision-makers, the most pertinent information can be achieved and analyzed, which is useful for decision makers in achieving influence. 2- Relevance: Management accounting scrutinizes the finest obtainable resources for information that is relevant to the decision-makers to take decision. It requires achieving an appropriate balance between: Past, present, and future-related information Internal and external information Financial and nonfinancial information, including environmental and social issues 3- Value: Management accounting connects the organization’s strategy to its business model and requires a thorough understanding of the wider macroeconomic environment. It involves analyzing information along the value-generation path, evaluating opportunities, and focusing on the risks, costs, and value-generation potential of opportunities. 4- Trust: Accountability and scrutiny make the decision-making process more objective. Balancing short-term commercial interests against long-run value for stakeholders enhances credibility and trust. Management accounting professionals are trusted to be ethical, accountable, and mindful of the organization’s values, governance requirements, and social responsibilities.
- Inventory management is also the activity of supervision and controlling of quantities of finished products for sale. A business's inventory is one of its major assets and represents an investment that is tied up until the item sells. Businesses incur costs to store, track and insure inventory. Inventories that are mismanaged can create significant financial problems for a business, whether the mismanagement results in an inventory glut or an inventory shortage. Job costing involves keeping an account of direct and indirect costs. Since both types of costs are usually closely related (a job requiring high input of labor and material is likely to consume more power, machine time, supervision time, inspection time, etc.) indirect costs may be applied as an estimated fraction of direct costs. Job costing methods are similar to contract costing and batch costing methods, and are used in construction, motion picture, and shipping industries, in fabrication, repair, and maintenance works, and in services such as auditing. Price Optimization is also used to determine the prices that the company determines will best meet its objectives such as maximizing operating profit.
- Absorption costing means that all expenses including direct, like material costs, and indirect, like overhead costs, are comprised in the price of inventory. Absorption costing provides a much more detailed and correct view on how much it really costs to produce your inventory then the marginal costing method, hence it is also known as full costing or full absorption method.
- Marginal costs are variable costs consisting of labor and material costs, plus an estimated portion of fixed costs (such as administration overheads and selling expenses). In companies where average costs are fairly constant, marginal cost is usually equal to average cost. However, in industries that require heavy capital investment (automobile plants, airlines, mines) and have high average costs, it is comparatively very low.
- Cost Centers: In a Cost Center, inputs or expenditures are calculated in financial terms, but output is not. Managers of these units are classically evaluated by means of productivity measures that relate the quantities of inputs used to generate the required outputs. They are evaluated on the cost efficiency with which they use a mix of inputs (labor, materials, and outside services). Purpose of cost centers is to add the cost of the organization, but only indirectly add to the profit of the organization. Price Setting: Pricing tactics can be used to achieve various types of objectives, such as expanding market share, increasing profit margin, or driving a competitor from the marketplace. It may be essential for a business to modify its pricing strategy over time as its market changes. Decision Making: Management accounting continuously performs relevant tasks such as Cost Analysis, Make or buy analysis, sales forecasting etc, on daily, weekly or monthly basis to come up with short term decisions for the flourishment of the organization. Managerial accounting information gives a data-driven aspect at how to nurture business. Financial statement projections, budgeting and balanced scorecards are just a few examples of how managerial accounting information is used to provide information to help management guide the future of a company. By focusing on this data, managers can make decisions that aim for continuous improvement and are justifiable based on intelligent analysis of the company data, as opposed to gut feelings. Budgeting: Management accounting implements budgeting strategies to think for the future planning rather than taking decisions on short-term or day-to-day basis. Even if management fails to achieve the desired targets as mentioned in the budget, but at least it is thinking about the organization’s competitive and financial position and how to improve it.
- Determining the goals: Management accounting on the basis of available information, design its aim and tries to find out the route by which it can be achievable. Through proper management accounting, the company can set its target and moves in the correct direction for growth. Reduce Costs: Management accounting helps the business owners to review the cost of financial resources and other business operations which allows them to better understand how much money is required to run the business operation efficiently. Management accounting can also provide owners the idea of economic resources quality analysis, if the final product’s quality would not suffer by utilizing cheaper raw material, then owners will reduce the production cost to increase profitability. Increase Efficiency : Management accounting rises the efficiency of operation of company. Everything is done in management accounting with a scientific system for evaluating and comparing the performance. With this, we find deviations. We will take promotional decisions on this basis. Other employees will also be motivated with this because if their performance will be favourable, they get reward of this. Thus management accounting increases efficiency. Maximizing the Profitability : Using of management accounting’s budgetary control and capital budgeting tool, company can easily succeed to reduce both operating and capital expenditures. After this, company can reduce its price and then company will receive super profits. Increase Financial Returns: Business owners can also use management accounting to increase their company’s financial returns. Management accountants can prepare financial forecasts relating to consumer demand, potential sales or the effects of consumer price changes in the economic marketplace. Business owners will often use this information to ensure they can produce enough goods or services to meet consumer demand at current prices.