managerial accounting

managerial accounting

Managerial Accounting in Decision Making

1. Introduction to Managerial Accounting

The information provided by managerial accounting is forward-looking. While historically the focus of financial accounting has been to summarize past performance, managerial accounting predominantly serves business managers’ needs for forward-looking information for decision-making activities. Managerial accounting meets this need by providing unique reports identifying changes, trends, and assigning responsibility for activities. As a result, the degree of accuracy in managerial accounting reports may be lower than in traditional financial accounting, and such reports are often prepared on an as-needed basis rather than for periodic distribution.

When discussing managerial accounting, the term “management accounting” is also used. In this report, the term managerial accounting refers to the concepts and techniques used in the decision-making process inside a business. Managerial accounting can provide valuable information that management can use to make decisions both in the short term and the long term. Information on managerial accounting can be found from many sources such as financial information of a company, company’s annual reports, etc. Managers in the company usually decide on major decisions which could potentially affect the company’s performance. This information can also be used by employees of the company in executing their daily job. In figure 1, managerial accounting is uniquely positioned to provide information for short-term and long-term decision making.

2. Cost Concepts and Analysis

c. Factory Cost: Factory (or works) costs refer to the total cost of production comprising prime or conversion cost plus indirect costs. Hence, it includes all costs which are incurred in the factory or production unit from the time of procuring and storing of materials, until the finished product is dispatched to the stores or warehouses, for selling, distribution or transfer. This term includes total manufacturing costs or inventoriable costs (i.e. Relevant costs of manufacturing).

b. Conversion Cost: Within prime cost, direct material and direct labor are regarded as material costs. Direct labor and direct expenses/inventory control (or other special) costs accruing as a result of transformation of materials into a finished product. As per the above definition, conversion cost is the sum of direct labor and direct expenses plus overhead charges such as supervision, materials handling, power for plant overheads and other indirect costs.

a. Prime Cost: ‘A prime cost is the sum of direct material cost, direct labor cost and direct expenses’ (i.e. Relevant Costs). The concept is sometimes also considered to be the sum of direct material cost, direct labor cost direct expenses and sundry direct special costs. In any case, prime costs are the basic costs associated with the products (or services). Realization of the prime cost is necessary to produce the outputs.

1. Introduction to Cost Concepts: The cost concepts in the business world involve the ascertainment of expenditures (actual or notional) for the purchase of material resources and services in a particular economic event (or object) for the past, future or current use of an organization. Managerial users of the accounting information are much concerned about defining the meaning and use of company’s costs of operations as compared to the outsiders who generally are also much concerned merely about the cost of final products during pricing. Accountants generally believe that costs are simply the ‘productive resources’ used in producing goods or services. The use of the term ‘cost’ is broader because it refers not only the outlay of cash or its equivalents, but also the forgone or sacrificed alternatives or benefits. But it is regret to say that accounting literature is yet to provide full consensus on the exact set of variables that give comprehensive, complete and applicable meaning to company’s operations depending upon the objectives of the users. Hence, different approaches have been employed in this regard so far.

3. Budgeting and Forecasting

Standardization is the breakdown of resources consumed by the enterprise, the volume of work performed in the production process, and manufactured products into standard costs and output rates. That is the definition of quantitative and value indices that are peculiar to the “average” unit of product and ingredient in the conditions of optimally organized production process for the application of methodological and economic calculations. The budget is a planned or target value for economic indicators (costs, revenues, production volumes, consumption and production volumes, and so on) for a certain period of time (month, quarter, year, including several years), which are related to the costs of the company’s operations or investments.

One of the main areas of managerial accounting is budgeting, preparing forecasts, and establishing standard costs, which is the basis for controlling the current activity of the enterprise. Preparing forecasts or budgets, it is necessary to remember that the process of forecasting or budgeting is based on the use of subjective methods, limited time frame, and the use of forecasting models, which were built using real data. It should also be borne in mind that as a result of external environment changes (inflation, price fluctuations, technological advances), forecasts may be incorrect. Therefore, the task of forecast consumers is to objectively assess the probabilities of various possible variations of economic development and to develop both nudging capabilities needed to implement decisions quickly, making changes to the decisions made by the established standards, and justifying the need for changes in tactical decisions.

4. Performance Measurement and Analysis

As the name indicates, performance measurement involves finding out the financial and operating results being achieved, whereas performance analysis is the process of invoking and evaluating different ratios to demonstrate trends and to identify areas of potential strengths and weaknesses. Analysis involves observing and checking how actual operational numbers differ from planned or budgeted numbers. It refers also to the process of evaluating the implications of trends in these figures on future returns, thereby ensuring that the firm performs effectively and efficiently. Should a manager find that the actual results differ from the projected or the budgeted results, he tries to identify the nature of such differences and the reasons which caused them. Also, he tries to investigate how these differences impact the overall profitability or efficiency of the firm. In the course of conducting the analysis, several tools are used, such as standard ratios and percentage analysis.

Performance Measurement and Analysis: Managers are responsible not only for immediate activities such as financial performance and product quality but also for future performance. In order to ensure good future performance, management must analyze the trends shown in financial statements. Therefore, performance measurement and analysis focus not only on the immediate past or present but also on future possibilities. This chapter is to discuss the various tools used for performance measurement and analysis.

5. Strategic Decision Making and Planning

The strategic plan describes only general goals and provides direction for an organization without including predetermined, immediate, and specific budgets for each organizational unit. In other words, the strategic plan provides a comprehensive direction in the context of growth, development, or new competences but does not contain as many specific, short-term, measurable scenarios as a typical budget affects. After the company has shaped its strategic plan, it can move on to structuring budgets and demonstrating specific plans for every part of the organization, as long as these plans sustain and encourage the general direction and are faithful to company-wide objectives and measurable results of the strategy.

Goals, strategic choices, and financial management policies should be the cornerstones of a company’s strategic plan. Companies need a strategic plan to create additional value for shareholders and cannot rely solely on traditional budgeting. Among other things, the strategic planning process involves studying the primary goals of the organization and determining the resources necessary to carry out those goals. The strategic planning process generally considers the factors that affect the organization’s operations, including management, human resources, business strategies, funding, vision, and restocking of resources.

Short-term operational decisions are generally hands-on and revolve around short budgeting for a specific purpose, while strategic decisions focus on how to fund capital, how to accelerate organizational growth, and the most important decisions that a management guard takes. The primary capital planning tool in an organization is the profit budget. The strategic plan is used by financial managers and boards of directors to design the capital structure of the organization, to plot the general growth and development direction, and to justify major capital expenditures.