Objectives: At the end of this tutorial students should be able to do the following:
Introduction to Cost and Management Accounting
Definition of Cost Accounting and Management Accounting
Cost Accounting is the systematic recording and analysis of all the costs incurred in a business. The information collected under cost accounting is mainly used by managers to make decisions and to improve management of the business. Under the cost accounting method all the costs incurred in carrying out an activity are collected, classified, recorded and analyzed. This information is in turn used by management to make economic decisions such as setting price levels, cutting spending, expanding or curtailing its operations and so on.
Management Accounting is concerned with how an organization is run and involves the provision of reports and accounts that provide accurate and timely financial information to management so that they can make short-term and long-term decisions. Management accounting reports typically provides information such as available cash, accounts receivable/payable balances, sales revenue, and inventory balances and so on. Management accountants also go a step further to analyze these reports and based on their findings provides relevant advice to management.
Financial Accounting is the process of recording the financial transactions of a company over a specified period of time. Using standard guidelines the recorded transactions are then summarized and presented in financial statements like the Balance Sheet, Income Statement and Cash flow Statement.
Cost and Management Accounting Vs. Financial Accounting
Financial accounting focuses on the production of a set of financial statements which are distributed to shareholders, financial institutions and others outside of the company. When preparing the Financial Statements which comprises of the balance sheet, income statement, statement of cash flows, and statement of changes in stockholders' equity,
generally accepted accounting principles and statutory laws and regulations must be followed. Cost and Management accounting on the other hand focuses on providing information to internal users; that is persons within the company, so management can operate the company more effectively.
Below is a comparison between Cost and Management Accounting and Financial Accounting:
The Importance of Management Accounting.
Management accounting refers to the process of tracking the internal costs for any business process that helps an organization, firm or an individual in making decisions related to production, operation and investment. Management accounting allows businesses to know the cost of their operations and to then allocate funds accordingly. The role of the management accountant includes identifying, recording, analyzing, interpreting financial and statistical information from several units of an organization, observing and analyzing the budget and suggesting how to obtain and allocate funds. All of the information produced by a management accountant is in turn reported to senior management or the Board of Directors to facilitate decision making and achievement of the organization’s objectives.
The Role of Management Accounting in an Organization
1. Aids in Forecasting: Through forecasting, management accounting assists managers when they need to make decisions like whether or not to invest in more equipment diversify into different markets, buy another company, etc. Management accounting helps in answering these critical questions and forecasting future trends for businesses.
2. Make-or-buy Decisions: Companies are often faced with operational and strategic decisions such as: whether to make a product or to source it from a third party and management accounting can provide the information needed for these types of decisions.
3. Forecasting Cash Flows: Predicting cash flows and its impact on the business is essential to a business’ survival. Information provided by management accounting helps management estimate how much money would be needed for the company to cover its short-term costs and expenses in the foreseeable future, to ensure that there is sufficient revenue available to cover these expenses.
4. Understanding Variances: Management accounting uses analytical techniques to help explain any variance between what was predicted and what was actually achieved by the business. This is a powerful tool as it allows management to build on positive variances and to manage or even eliminate the negative ones.
5. Selecting viable investment opportunities: Before embarking on a project that requires significant levels of investments, a company needs to be able to forecast the expected rate of return. This is particularly important if the company is faced with multiple investment opportunities as most companies would elect to invest in the most profitable option. Estimating the number of years it would take for the company to break even on an investment and predicting the levels of cash flows that would be generated each year by the project are vital questions that can be answered through management accounting.
The role of Cost Accounting in Manufacturing and Service Industries.
The manufacturing industry refers to the sector of the industry that is engaged in the process of using manual labor and machinery to convert raw materials and components or parts into finished goods for consumption. The service industry is made up of all companies that provide goods, services and intangible products to consumers but do not engage in manufacturing. Cost accounting plays a crucial role in both industries and it provides management with the information required to determine the following:
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The author holds a Bsc (Hons) Degree in Applied Accounting from Oxford Brookes University, England and enjoys a successful career as an Accounting Supervisor and a private tutor.