1.2 Management Accounting and Financial Accounting

Click here to watch all videos for this section.

Alternatively, watch the videos one by one as you scroll through the text.

The DuPont story is an example of how management accounting evolves within organizations. This development pattern has been playing out across companies for a long time. Since the first days of the Industrial Revolution, business owners and managers have adopted the best accounting ideas available from other companies and then created their own new accounting system to provide a competitive edge. In fact, a company often regards a good management accounting system as a valuable company secret—and rarely discloses its details to the public.

In contrast, financial accounting has effectively developed in the United States to provide a common reporting platform to the public. The purpose of financial accounting, as defined by generally accepted accounting principles (GAAP), is to satisfy the needs of outside investors, creditors, and regulators for fair and consistent reports of financial position and operations. Accordingly, all companies are required to apply the same general financial accounting rules so that outsiders can compare financial reports coming from many different companies. These financial accounting rules are established by the Financial Accounting Standards Board (FASB) and are enforced by the Securities and Exchange Commission (SEC).

In contrast to the rules and regulations surrounding financial accounting, no government regulator or auditor is going to insist that a company implement a good management accounting system. The choice of how to collect and use information within a company is part of a company's competitive strategy. For example, no one forced the DuPont cousins to use the ROI formula to better manage their business; however, because the ROI evaluation framework worked well for DuPont, it was eventually adopted by many (but not all) of DuPonts competitors. Nevertheless, the only reason a company uses management accounting is to satisfy a competitive need, and competitive need often dictates that one organization's management accounting system will not look like another's. The differences between management accounting and financial accounting are summarized in Figure 1-1.

Managers are always making choices using the available management accounting information. What should be produced? What should be sold? How should the service be delivered? What does this client need? Which supplier should be used? Who should be promoted? How should financing be obtained? Figure 1-2 illustrates the central role that decision making, using management accounting data, plays in the general management process.

Figure 1-1: Differences Between Management Accounting and Financial Accounting

The three management functions of planning, controlling, and evaluating generally follow a natural order—at least in theory. In practice, managers are often expected to work with processes, customers, and employees requiring all three decision-making functions at once. For example, the manager of a campus copy center must simultaneously plan the week's work flow, control the production process by balancing the needs of student customers and faculty copy requests, and evaluate the performance of both the employees and the copy machines.

Planning

Management involves a process of recognizing problems or opportunities, identifying alternatives, analyzing alternatives, then choosing and implementing the best alternative(s). There are two basic types of planning:

  1. Long-run planning, which includes:

    1. Strategic planning

    2. Capital budgeting

  2. Short-run planning, which includes:

    1. Production and process prioritizing

    2. Operational budgeting (profit planning)

Figure 1-2: The Management Process

Long-run planning involves making decisions with effects that extend several years into the future—usually three to five years, but sometimes longer. This includes broad-based decisions about products, markets, productive facilities, and financial resources. Long-run planning is often called strategic planning. , likely the most critical decision-making process that takes place at the executive level in any organization today, usually involves identifying an organization's mission, the goals flowing from that mission, and strategies and action steps to accomplish those goals. Successful executives, such as William Weldon (Johnson & Johnson) or Warren Buffett (Berkshire Hathaway), have always displayed great skill in studying the market, identifying customer needs, analyzing competitors' strengths and weaknesses, and defining the right investments and processes their organization needs for success. Good management accounting supports good strategic planning by providing the internal information needed by executives to evaluate and adjust their strategic plans.

With strategic planning in place (or in process), the company can then plan for the purchase and use of major assets, like buildings or equipment, to help the company meet its long-range goals. For example, if a university's long-run strategic plan includes making its football team more competitive, the university should consider improving or replacing its existing football stadium and practice facility. This type of long-run planning of the acquisition of assets is called . We will cover capital budgeting in detail in a later topic.

Short-run planning is divided into two categories. Once the organization has made longterm resource commitments (e.g., land, buildings, equipment, management personnel, etc.), then managers need to determine how to best use those committed resources to maximize the return on their capital investments—a process often referred to as .1 Did you catch the phrase “return on capital investment” in the last sentence? Sound familiar? The DuPont ROI concept is one way to establish priorities on products, service processes, or divisions that make the largest contributions to the goals of the organization. For example, you can view your study of accounting as a production process; production prioritizing involves analysis to determine how you should best spend your time in preparing for the next exam—reading the topics, doing home-work problems, studying in a group, or catching up on your sleep.

Once the organization has determined what to provide to the marketplace in order to maximize its goals, then managers are ready to go on to the next phase of short-run planning—. Sometimes known as profit plans, operational budgets are used by managers to establish and communicate daily, weekly, and monthly goals (also known as “standards”) for the organization. Many individuals face severe personal financial problems because they fail to use even the most basic techniques of regular operational budgeting. We will discuss operational budgets in Topic 4.

Controlling

involves a process of tracking actual performance. These data are then used in the evaluating process to compare against the budgets and measure deviations from the original goals or standards. Deviations from standards are called “variances.” Controlling also involves the realtime, day-to-day management of all of a company's business processes. A good example of a control device is the radar gun used by major league baseball teams to measure the speed the pitcher is throwing his pitches. These measurements can be used at the end of the season in evaluating which pitchers are most valuable to the team. But they can also be used by the manager during the course of a game to indicate when a pitcher is getting tired and should be replaced. The radar gun measurements are useful for evaluating individual performance after the fact but are also useful in effectively managing the team during the game.

Evaluating

involves analyzing results, providing feedback to managers and other employees, rewarding performance, and identifying problems. Evaluating is typically a process of comparing actual performance against expected inputs of costs, outputs of quality, and timelines. This comparison typically results in variances that tell management how well the organization is achieving its plans. If performance is in accordance with the plan, the variances signal that operations are in control and no unusual management action is necessary. If performance is substantially different from the plan, management needs to decide how to alter operations in order to improve future performance. For example, most students in college classes are asked to evaluate their instructors near the end of the term. These evaluation results can be used by conscientious faculty members trying to improve their teaching and also by department heads in deciding which teachers should be retained or replaced. This third function in the management process, evaluating, brings us back to the point where we started, planning. The information gained through the evaluating function is used in planning for the following period. Remember that as managers evaluate performance in the last period, they may also be making planning decisions to improve operations for the next period while gathering and receiving results to control the current period.

Want to try our built-in assessments?


Use the Request Full Access button to gain access to this assessment.
Previous Next