Chapter 1: Introduction to managerial accounting and decision making
1.1: Distinguish between managerial and financial accounting
Although both functions are based on the principles of accounting they service two completely different audiences with different needs of information. Financial accounting is concerned with preparing reports that are decision-useful to external users (shareholders and creditors). Depending on your jurisdiction you followed a certain set of Generally Accepted Accounting Principles (G.A.A.P.) to prepare a certain set of financial statements for these external users (Statement of Income, Statement of Changes in Equity, Statement of Financial Position, and Statement of Cash Flows).
Managerial accounting is concerned with disseminating information to internal users for decision-making purposes. Internal users include employees of any type of company in a decision-making position. The scope of employee responsibility will dictate the information and report required to help with the decision-making process. Because of this the scope of reports and information is much wider within the managerial accounting function than the financial accounting function of a company.
Managerial accounting is an essential component of any type of business (manufacturer, merchandiser, or service provider) as well as any organizational form of business (sole proprietorship, partnership, or corporation). At its core, managerial accounting enables managers and other employees to make the best decision possible based on providing the best information possible.
1.2: Decision-Making and the Managerial Accountant’s Role
To understand what the managerial accountant does we need to evaluate the decision-making process. Below are the 7-steps to effective decision-making:
1. Identify the decision
2. Gather information
3. Identify alternatives
4. Weight the evidence
5. Choose among alternatives
6. Take action
7. Review your decision
The managerial accounting information plays a major role in steps 2, 3, 4, 5, and 7. Without our information, decision-makers would have a hard time evaluating alternatives as objectively as they possibly can.
Managerial accounting has the ability to turn qualitative information into quantitative reports. For most people it is much easier to evaluate numbers as opposed to the qualitative. By being able to see how much a project is going to cost, how much revenues will be generated from different alternatives, what effect on the bottom line a scenario will have, our decision becomes easier to make. That is what the managerial accountant tries to do: make the decision-making process as easy as it can possibly be. However this is much easier said than done, as you will see throughout this course.
Another way to put how a managerial accountant can add value is by evaluating the different roles manager’s function in a company, specifically the planning and controlling function.
Planning is the function of management where they set company objectives. Now these objectives can be short or long-term objectives. Usually they are somewhat broad in scope. Company objectives will differ from company to company because of the age, financial health, industry, economic conditions etc. Managers hope that carrying through and achieving their objectives will lead to value added to the company, which can be seen through an increase in stock price (if publically traded) or appreciation in selling price of the company if sold.
The objectives are mostly qualitative in nature. It is the duty of the managerial accountant to turn these objectives into quantitative plans (we will discuss this further in Chapter 8: The Budgeting Process).
It is one thing to set goals (company objectives). For companies to do well they must have a vision to follow. To see if a company is doing well they need to be able to assess are they on the path to achieving their company objectives. The managerial accountant is extremely involved in this role. Controlling is the monitoring of company financial performance to see if we are on track to achieving our objectives. It is the duty of the managerial accountant to prepare a report tailored to assessing this. That way it is easy for the decision-maker to see if we will achieve our objective or need to take corrective action. This can be done by comparing budgeted to actual information through variance analysis (discussed in Chapter 9: Standard Costs & Variance Analysis).
Illustration 1-1: Examples of planning and controlling activities
Younger company: turn a profit in the next 5 years
Established company: break through to a new geographical location
Budgeted versus actual results reports
1.3: How Managerial Accounting Can Help Ensure Ethical Behaviour
The Institute of Management Accountants (IMA) has a code of conduct for management accountants. The IMA Statement of Ethical Professional Practice contains 4 basic standards of ethical conduct for practitioners of management accounting and financial management:
Competence means the professional has the responsibility to:
1. Maintain an appropriate level of professionally applicable knowledge.
2. Perform duties in accordance with laws, regulations, and technical standards.
3. Provide information that helps with decision-making and recommendations that are accurate, clear, concise, and timely..
Confidentiality means the professional has the responsibility to:
1. Keep information confidential, with the exception of legally enforced disclosure or authorized to do so.
2. Inform all relevant parties regarding appropriate use of confidential information.
3. Refrain from using confidential information for unethical or illegal advantage.
Integrity means the professional has the responsibility to:
1. Mitigate conflicts of interest. Disclose any potential conflicts of interest.
2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically.
3. Abstain from engaging in or supporting any activity that might discredit the profession.
4. Contribute to a positive ethical culture and place integrity of the profession above personal interests.
Credibility means the professional has the responsibility to:
1. Communicate information fairly and objectively.
2. Provide all relevant information to help the user understand any report, analysis, or recommendation.
3. Report any delays or deficiencies in information.
4. Communicate any professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity.
In recent years there has been an enhanced focus on ethical behavior due to the several corporate scandals in the early 2000’s (Enron, Worldcom). These scandals lead to the Sarbanes-Oxley Act of 2002 (SOX) being passed and signed into law in the United States. Many features of the bill were to enhance the credibility of financial reports. This put greater importance on internal controls and record keeping by companies, or employees deemed complicit with fraudulent activity would be punished by fines and/or jail time.
This has affected financial reporting but also internal controls as well. Companies began monitoring for unethical behavior much more closely due to the increased scrutiny by the newly formed Public Company Accounting Oversight Board (PCAOB). Management accounting systems help with the monitoring and maintaining of ethical behavior.
Despite regulations deriving from SOX, corporate fraud is still prevalent. Specifically we are concerned with financial reporting fraud, which is the intentional misstatement of financial reports. This is the most costly of frauds committed by companies as it can lead to the bankruptcy of the company, thereby putting employees out of work and leaving shareholders with nothing to show for their investments. Adherence and enforcement to policies like the IMA reduce the risk of firms being victim to financial reporting fraud.
But beyond corporate fraud and the penalties that come with that if found guilty, how do we ensure managers are making the best decisions possible even if they have access to accurate information? The risk firms face here is that managers will make decisions that benefit themselves more than the company overall. This could be for several reasons, mostly financial well-being of the individual decision-maker.
Managerial accounting helps alleviate this issue by implementing monitoring systems and performance evaluations that motivate the manager or decision-maker to make decisions that are in the best interest of the company, which then benefits the individual. There are many issues to consider here including compensation, evaluation process, financial vs. nonfinancial metrics etc. These issues will be discussed throughout this textbook.
IMA’s CFO Explains the Key to Building an Ethics Program that Works:
1.4: What has caused the change in the managerial accountant’s job function
There are many reasons why the role of the managerial accountant has been enhanced from its initial function of tracking cost information. Some of these reasons include:
Change in technology. Due to the rapid change in technology, there has been a complementary change in business. New businesses that would have been unheard a short time ago have now emerged, and along with it, new business issues to consider. Expertise of the managerial accountant has helped in developing strategies to implement and monitor these emerging business practices to see how to best operate.
World is getting smaller leading to increased competition. With the advent of the internet and the ease with which we can connect globally, that means businesses don’t just have to worry about domestic competition but also international. Today it is almost as easy to buy locally as it is to buy from a different continent. This has forced companies to evaluate their entire business practice, which the managerial accountant has a key role in as you will see when we discuss value-chain activities.
Businesses getting smarter. As businesses face increased competition it has forced them to reevaluate every facet of their business. Because of this constant evaluation, old business myths are proving to not be true. Implementation of new philosophies and practices (ex. Inventory management, lean accounting etc.) has relied heavily on input from the managerial accountant as far as the identifying of inefficiencies, the cost of these inefficiencies, and how to remove them.
Managerial accounting is beneficial to anyone interested in business, whether or not you are pursuing an accounting career.By understanding managerial accounting’s role in business, it helps you become a better decision maker.We will see how we can use managerial accounting information to set goals, constantly monitoring the achievement of these goals, implement best practices to enhance data capturing, make operations more efficient, and ultimately just understand business better.