Management Accounting

Management accounting involves collecting, analyzing, and presenting financial information used to help
company management make sound business decisions. This would include everything from providing
detailed financial statements for different divisions within a large company, to analyzing the financial impact
of a potential expansion or business acquisition. Management accounting is at the center of almost every
significant business decision made. Management accountants are called upon to assess whether a
company’s current products and processes are still viable. By comparing data on the projected profits
generated by a line of business against the cost of shutting it down, management accountants can
determine if operations should be discontinued. In this scenario, a comprehensive analysis would involve
consolidating human resource data to assess the costs of potential layoffs, and using data from engineering
and marketing to decide whether a new product needs to be added to the production line. A complete
analysis of this nature would also consider the potential profits that could come from using resources from a
discontinued line of business elsewhere.

Management accountants prepare detailed analyses of both business problems and opportunities. Their
reports are ultimately used to assist a company’s senior management in making the major decisions that
determine the company’s financial success.

How Management Accounting Differs from Other Accounting Practices

The accounting methods used by management accountants differ from those used by traditional
accountants, financial controllers, and internal auditors whose jobs are focused on providing reports to
external users. External parties privy to a company’s financial data generally include investors, or bankers
considering the issuance of a loan, or regulators concerned with regulatory compliance. The question of
whether the data is intended for external or internal users is the important factor that differentiates
management accounting from other forms of accounting.

Generally accepted accounting principles (GAAP) must be followed for external reporting to ensure these
reports are standardized, but GAAP serves only as a guide in management accounting. For internal decision-
making, management accountants often forgo the use of GAAP in order to develop the most accurate and
useful picture of the future. They apply best practices documented by leading management accountants in a
similar industry along with statistical processes to provide the most complete analysis possible. Internal
users are more focused on how a cost will benefit the company in the future, while financial accounting is
dedicated to presenting a picture of the past that allows for an easy and standardized comparison to other
companies.

Financial accounting for external parties follows strictly defined rules, but may not always present
management with the information required to make sound business decisions. As an example, GAAP rules
allowed Internet based companies to appear profitable even when they weren’t, which helped fuel the .com
bubble in 1999 and early 2000. At that time, GAAP rules allowed companies to recognize revenue based
upon service sharing agreements rather than cash transactions. If two companies sold banner ads to one
another under a barter agreement, it would lead to higher revenue for both companies under GAAP, even
through the reported revenue couldn’t actually be used to pay the bills. As a result of this, GAAP rules now
require cash sales to take place before any revenue is recognized. Management accountants would’ve
disregarded these barter transactions because they didn’t actually add to the company’s cash flow.
Learn more about financial accounting.

Cost Benefit Analysis

Cost-benefit analysis is the most common goal of management accounting. As an example, a company
could build up excess cash after a few profitable years. The business then must choose how best to use that
money. Company officers may consider acquiring a competing business or may return the money to
shareholders. Senior executives may also want to consider the possibility of investing in the current business
to expand output, or increase productivity by buying new equipment.

Management accountants would prepare a detailed analysis of each choice. This would involve reducing
each of these options to a single number representing its net present value, which is an estimate of how
much money the company will make from moving forward with each option. The decision to return cash to
investors would be the preferred option only if the company can’t earn at least as large a return on the
investment as individual investors would likely get investing the cash on their own. Generally, a company will
consider whether it can use cash to boost shareholder wealth, and management accountants will consider
this question carefully in their analysis. If the business is likely to see lower returns than a safe bond
investment would yield, or if it will generate returns that are less than those of the average company, it is
usually best to return the cash to shareholders.