Users and purposes of management accounting information
Management accounting is a branch of accounting that produces for internal decision-makers the financial and non-financial information they need, when they need it to make the best possible use of available resources and achieve organizational or societal objectives.
Management accounting identifies, measures, accumulates, analyzes, prepares, interprets, and communicates information that helps managers within the organization make strategic and operational decisions. Such decisions are mostly about value chain management (e.g. internal allocation of resources between different activities, outsourcing, processing further), production management (e.g. investments in operating assets, priorities in production, investments in productivity) or sales management (pricing, advertising, or accepting orders).
For each kind of decision, management accounting helps managers on four occasions: (1) attention directing, i.e. the identification of challenges or opportunities on which managers should focus; (2) problem solving, i.e. the design of alternative courses of actions to address these challenges and seize these opportunities; (3) alternative evaluation, i.e. the assessment of the economic consequences of implementing each course of action; and finally (4) decision making, i.e. the choice of the best course of action to achieve organizational goals (effectiveness) without wasting resources (efficiency).
Since management accounting continuously assesses the relation between decisions and their consequences, it is also a very important tool supporting (5) organizational learning. The information it provides tells managers what works because it was well implemented, what does not work because it was poorly implemented and what does not work despite being well implemented. In other words, management accounting provides answers to the following questions: are we doing things right? Are we doing the right things? The first question relates to operations efficiency and proper implementation of a strategy (single-loop learning). The second question relates to strategy formulation (double-loop learning).
Finally, management accounting also serves the related purposes of (6) motivating, evaluating and rewarding or sanctioning performance (Atkinson, Kaplan, Matsumura, Young, & Mukherjee, 2012). Because it is used for both resource allocation and incentive contracts, management accounting information has important behavioral implications and shapes political struggles within organizations. It helps influence the decisions made by others and attempts to reduce conflicts of interest. However, we leave these behavioral implications out of the scope of this book because they will be addressed in greater detail in management control, the purpose of which is to shape behaviors in a desirable way (Merchant & van der Stede, 2007). This book focuses on the role of management accounting in supporting decision making, from the perspective of the manager making the decision, assuming she pursues the best interest of the organization as a whole.
Qualities of management accounting information
Since management accounting is fundamentally designed to complement financial accounting and overcome its core limitations, it takes an opposite stance on almost every characteristic. This is why they end up being so different - and attract very different mindsets.
Financial accounting favors comprehensiveness, objectivity, accuracy, verifiability and reliability. Instead, management accounting emphasizes the absolute primacy of relevance. This means that any information which does not help make a decision is seen as a distraction and thus purposefully and systematically ignored, even eliminated. It also means that any information which helps make a decision will be taken into account, even if it is highly subjective, approximate, unverifiable or unreliable. As you will soon discover, management accounting relies heavily on estimations, while financial accounting tries to reduce as much as possible the use of such estimations.
The reliance on estimations is crucial for management accounting to have its other two key qualities: being timely and prospective. Management accounting provides information when it is needed. Since relevant information is not always available when it is needed (especially information about the future), it often has to be estimated. Moreover, since information can be needed anytime, management accounting prepares reports on an ad-hoc basis and not only periodically or at a higher frequency.
Other key qualities of management accounting information which result from the primacy of relevance are its diversity and flexibility. Management accounting will use any piece of information which is deemed relevant to the decision at hand: financial and non-financial indicators, leading and lagging indicators, objective and subjective information, etc. In addition, managers set their own rules concerning the contents and form of internal reports so that they are adapted to the local situation and fit their own preferences.
Finally, where financial accounting is public and increases comparability and transparency, management accounting is fundamentally private and provides information which is highly strategic and sensitive and should therefore not get out of the organization.
Costs and benefits of management accounting information
Financial accounting is a legal requirement: it has to be done. But management accounting is not mandated: it is voluntary and implies additional costs for its design and maintenance. Moreover, maintaining two accounting systems is not only expensive, it may also generate some confusions as both accounting systems do not communicate the same numbers. So why would firms invest in management accounting?
This question has a straightforward theoretical answer (which is actually very difficult to implement in practice): additional information is produced if the expected benefits from such information outweigh the cost of collecting, analyzing and summarizing the data. In the design of management accounting systems, two questions are therefore systematically asked: what information is needed to make a specific decision in a specific context? And: do the benefits of making this information available on time exceed its cost?
The level of sophistication of a management accounting system must therefore always be justified by the benefits managers can extract from better information. This again has very concrete consequences in the choices management accountants make: even when it is theoretically possible to obtain a more accurate information, if the cost of increased accuracy exceeds its benefits, management accounting will keep producing a less accurate information.
Production of management accounting information
The next chapters introduce the various principles and methods on which management accounting relies to produce different kinds of information for different purposes.
Chapter 2 is about costing, a set of principles and methods useful to value the inventory and the cost of goods sold for financial reporting. By extension, these methods and techniques are also useful to assess whether a product or service is profitable in the long run.
Chapter 3 is about cost estimation, a set of techniques to model cost behavior and make predictions. These techniques rely on estimates to make forecasts which are highly useful for managers to assess the consequences of their decisions and actions.
Chapter 4 is about cost-volume-profit analysis. It builds on cost estimation techniques to model profit and assess the operating risk of a company which result from its cost structure. This analysis is important for managers to understand how sensitive the profit is to the volume of activity or other decisions they might make.
Chapter 5 addresses budgeting, a set of techniques to build pro-forma financial statements or to forecast cash flows related to investments. Operational budgeting is the backbone of the control cycle (plan-do-check-act) and capital budgeting allows managers to make informed long term investment decisions.
Chapter 6 deals with variance analysis, which consists in analyzing the causes for discrepancies between the budgeted profit and the actual profit. The systematic decomposition of a profit variance into well-identified sub-components allows managers to identify potential issues they need to address.
Chapter 7 is about differential analysis, which shares many features with variance analysis but is interested in future consequences of short term decisions rather than past discrepancies between expectations and performance.
Chapter 8 introduces scorecards which are useful to organize and make sense of a wide variety of information. It discusses the strength and weaknesses of different kinds of performance indicators and how they can complement each other to guide both operational and strategic decision making as well as organizational learning.
Finally, chapter 9 highlights some of the key takeaways of management accounting and opens towards other managerial disciplines which benefit from management accounting information: financial statements analysis, corporate finance, audit, risk management, and management control.
Atkinson, A. A., Kaplan, R. S., Matsumura, E. M., Young, S. M., & Mukherjee, A. (2012). Management Accounting (6th ed.). Harlow, UK: Pearson.
Merchant, K. A., & van der Stede, W. A. (2007). Management Control Systems –Performance, Measurement, Evaluation and Incentives. Essex: Prentice Hall.