What is Management Accounting

Management accounting is a management tool that meets the need for external and internal figures for managers to measure the organization's performance and to have data to help decision-making. Management accounting allows action on the behavior of the people who make up the organization, particularly their involvement and motivation. It uses cost accounting techniques by updating them (e.g., activity-based cost method) and widening the scope of analysis (e.g., cost of quality, hidden cost, value analysis, and target cost).

Management accounting is operating accounting internal to the company. Its purpose is to inform those responsible for the costs and profitability of a service or product.

Formerly known as cost accounting, management accounting is an optional but extremely useful analytical tool for the business. 

Indeed, management accounting is one of the two main categories of business accounting:

- general accounting: intended for external actors

- management accounting: intended for internal analysis

While keeping management accounting is not compulsory (unlike general accounting), it is very useful for the company to know its costs and analyze its profitability.

These two types of accounting are complementary: the information used in management accounting comes mainly from general accounting.

Definition of management accounting

Management accounting is a method that allows the managers to calculate costs. A cost is a set of charges that correspond to the costs incurred and consumed in the production of a product. The charges are recorded in the income statement. Expenses are classified in two possible ways: in general accounting and in management accounting.

Management accounting is used by those who manage to help position the business against the competition.

It is an instrument for internal use aimed at managing distinguished subsets in the company's activity. It is also very often a matter of a posteriori control of those responsible for this management.

Characteristics of management accounting

Management accounting makes it possible to analyze costs by product and/or by function. It details the different types of costs (direct costs and indirect costs or fixed costs and variable costs) involved in the production of a good or service:

- Direct costs: directly attributable to the production of a given good or service

- Indirect costs: involved in the production of several goods or services

- Fixed costs: independent of the level of activity of the company

- Variable costs: vary jointly or even proportionally to the level of activity

This accounting makes it possible to link the company's various resources to the products and purposes of the activity.

Through management accounting, we can determine the profitability of a product/service or a function, and identify the elements that perform and those that are not.

This cost analysis, profitability, performance, then facilitates decision making and forecasting. Future-oriented, management accounting is not an end in itself, but a means. It is used to manage the company's activity. Management accounting makes it possible to calculate production costs. By analyzing the costs and comparing them to the gains resulting from the activity, one can determine profitability and performance for the company's various products/services and functions.

Benefits of management accounting

Management accounting makes it possible to:

- Know the costs of the various functions and activities of the company

- Analyze results by calculating production costs and comparing them to selling prices

- Establish expense and income forecasts

- Compare forecasts to achievements

- Explain any differences between forecasts and actuals

- Control plans and budgets

It is a strategic tool for medium and large companies. For a very small structure, keeping management accounts is of less interest.

As it is not compulsory, it is not framed by precise standards. It proves to be flexible and adaptable according to the needs and wishes of the organization which implements it.

Main methods of management accounting

Management accounting brings together a set of methods, the most important of which are four: full cost methods, variable costs, direct costs, and standard costs. Here is an overview:

The full cost method

In the full cost method, this involves reconciling the products sold to their cost price.

This facilitates decision making when determining the selling price of a product.

The company is broken down into product production centers, and for each, we relate the total cost of production and the gain made following the sale of the product or service.

The variable cost method

Here we take into account only the costs which are directly induced by productive activity and not all the costs. That is to say; the costs decrease if the company's productive activity decreases and increases if the activity increases.

This method of variable costs, easy to put into practice, makes it possible to identify the breakeven point. The breakeven point is the degree of activity at which the company begins to profit and become profitable. The downside is that not all costs incurred are fully taken into account in the analysis.

The direct cost method

This direct cost method overcomes the drawback of the variable cost method and allows the breakeven point to be determined with greater precision.

Here, both variable costs and fixed costs are taken into account: costs that do not vary in conjunction with the level of activity. The calculation is a little more complicated than with the previous method.

The method of standard costs or pre-established costs

Here, the costs that will be incurred before production are determined. After production, the expected costs are compared with the charges that have actually been incurred. The deviations will then be analyzed. By this method of standard costs, we can calculate margins, forecasts, and budgets.

It is useful for companies that offer a wide range of products. On the other hand, data entry and processing are heavy.

The ABC method - Activity Based Costing, cost accounting by activity

By this ABC method, the cost price per product/service is taken into account by considering all the processes and activities necessary for the production of this one.

The various charges are distributed transversally between the various activities implemented by the company.

First, the resources committed are compared to the activities carried out; then, we compare them to the products.

This method gives realistic results but can be difficult to use.

The role and importance of management accounting

The financial accounting information system is the primary source of data for measuring and analyzing economic activity. But general accounting is not sufficient to break down costs and calculate returns. Management accounting is also called “cost accounting,” was therefore put in place to compensate for the shortcomings of general accounting. 

The objective of management accounting is:

- To reprocess information to calculate costs and margins;

- Help in making management decisions and steering the business.

A. What decisions?

The decisions that can be made through management accounting are: 

• At what price to sell a product? 

• At what price to establish an estimate? 

• Is the production of a product profitable? 

• Is an activity profitable?

• What corrective actions to take?

• What are the causes of the lack of profitability?

b. Using what information?

The information to be taken into account comes from knowing the costs.

The costs are of two kinds:

• Full costs, which include all charges. They make it possible to calculate the purchase cost, the production cost, the non-production cost, and the production cost.

• Partial costs, which only include a fraction of the charges. They allow the calculation of the variable purchase cost, the variable production cost, the variable non-production cost, and the variable cost price.

It is necessary to have precise knowledge of the company's production process to know the costs relating to purchases and those relating to production.

The essentials of Management accounting

Management accounting corresponds to cost accounting. Its objective is to restate the information given by the general accounts to calculate the costs. These costs will then allow the company to be able to make various decisions.

Author: Vicki Lezama