Table of Contents
Managerial Accounting Definition……………4
The Aims of Managerial Accounting…………5
How Economic Theory is Practiced…………..7
“Accounting is the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information.” (Drury, 2008) Accounting provides financial and non-financial information to the company in order to make better decisions. Over the past few decades, the manufacturing and service industries have relied on a branch of accounting that leans towards helping organizations in their decision making process by evaluating the assets and liabilities in order to offset the future and present valuation of the organization. Management Accounting is viewed as one the essential tool for the success of an organization. The overall goal for management accounting is in the best interest of the shareholder and the organization. These goals are aligned with the economic theory that aims to maximize the wealth of the shareholders. The theory has proven controversial as it works against the ethics, corporate governance, and social responsibility of the organization. The purpose of this essay is to evaluate the role of management accounting in the decision making process that helps to determine if economic theory should be practiced to maximize the wealth of the organization’s shareholders.
Managerial Accounting Definition
According to Investopedia, management accounting is, “The process of identifying, measuring, analyzing, interpreting, and communicating information for the pursuit of an organization’s goals.”(Investopedia, n.d) Management accounting is viewed as the internal accounting fixture within organizations with the job of providing managers with helpful information for making the best decisions for the organization. Unlike financial accounting that focuses on providing the external parties with information, financial statements must be prepared to confirm with the generally accepted accounting principles, management accountants are not required to adhere to such requirements when providing managerial information for internal purposes. In financial accounting, the emphasis is placed on objectivity and verifiability of the consequences of past activities within the company that require mandatory reports. (Garrison, Noreen, Brewer, 2011) Additionally, management accounting provides information from different areas within the organization, with consistent updates and information as financial accounting focuses on the entire organization that uses financial statements posted quarterly, semi-annually, or annually for external users. It places emphasis on future decisions, relevancy of present activities and need to follow GAAP/IFRS. (Garrison, Noreen, Brewer 2011) The main aims of managerial accounting are to formulate strategies, plan and construct business activities, decision making process, resource allocation, financial report preparations, and the safeguard of assets. These aims help in different businesses environments, where managerial accounting is used in various organizations such as government entities, by individuals, enterprises, and not-for-profit organizations.
The Aims of Managerial Accounting
The three main concepts that are involved managerial accounting helps with budgetary control, investments, and other factors are Planning, Controlling, and Decision Making. Planning is the process of deciding which products to make. “Planning involves making choices between alternatives and is primarily a decision-making activity.” (Drury, 2008) Controlling, “involves gathering feedback to ensure that the plan is being properly executed or modified as circumstances change.”(Garrison, Noreen, Brewer, 2011) This method is used extensively in manufacturing businesses as, knowing the quantity of work being done within the organization, and the progress helps to give the managers on the floor any heads up on problems or situations that need to be addresses in order to maintain a steady flow of operations. This concept is especially essential in manufacturing industries, with assembly line supervisors, and floor managers. With budgetary controls, the purpose of the budget is to help managers manage and control the costs within the organization. Decision making is the last concept that involves helping to select the best course of action from other alternatives.
Within management accounting, there are several theories and concepts that accountants follow. Each is based on several assumptions that are largely faced in the manufacturing business as they deal greater with operations, costs, and control of products and product lines. Globalization of the economy and increase in the service sector has been a part of the key developments in managerial accounting, along with the emergence of just in time (JIT), Total Quality Management (TQM) programs, and the Theory of Constraint. “The basis of the theory is to identify bottlenecks in the production process and to focus all efforts on increasing the capacity of the bottleneck operations.”(Caplan, 2006) Each of these factors align with the purpose of helping managers with the decision making process.
The decision making process is the key principle in managerial accounting, with the aid of information collected from various departments for the benefit of identifying and evaluating financial importance to the company. The first step in the process is identifying the organization’s objective, the Economic theory is the basis at which many accountants operates. “Economic theory normally assumes that firms seek to maximize profits for the owners of the firm (the ordinary shareholders in a limited company) or, more precisely, the maximization of shareholder’s wealth.” (Drury, 2008) While many critics may disagree that this should be the sole goal, the other steps involve, deciding alternative course of action, gather information, implement decisions on alternatives, compare planned and actual outcomes, and respond to the plan. Profit Analysis and Profit Management. Profit making is the most common objective of all business undertakings. Economic theory guides organization in the management and measurement of potential profit, in order to make assessments for risk, in calculating the return on capital and profit for the future gains. Not only is an economic theory in companies prominent in managerial accounting, but as Drury relays, “profit maximization lead to the maximization of overall economic welfare.”(Drury, 2008) The counter argument is in the social responsibility of the organization as maximizing profit is not as indispensable as maintaining a clean environment, providing social benefits like employment, parks, and facilities. However stating the main objective when businesses is to maximize profit is simplistic of what organizations are aim towards presently. In some organizations, the managerial accountants are seeking future cash flows in maximizing the organizations profit, building an empire, being financially secure in this fluctuating economy, or subjecting to other objectives which include:
- “It is unlikely that any other objective is applicable in measuring the survivability of the organization in the future.
- It is unlikely that maximizing the present value of the future cash flows can be realized in practice but by establishing principles.
- It enables shareholders as a group in the bargaining coalition to know how much the pursuit of other goals is costing them by indicating the amount of cash distributed among the members.” (Drury, 2008)
Economic theory is the basis that pricing decisions are made on as the cost of products helps to drive revenue, therefore it helps to drive profit for the organization. However, the questions of ethics play a vital role in the application of the economic theory to organizations. With the scandals of World Com, Enron, Computer Associates, and others, looking out for the best interests of the company and themselves. They ignored regulations and laws and turn a blind eye to fraudulent activity of cooking the books, in order to maximize profits. Ethics are essential in organizations, “Ethical behavior is the lubricant that keeps the economy running. Without that lubricant the economy would operate much less efficiently–less would be available to consumers, quality would be lower, and prices would be higher.” (Garrison, Noreen, Brewer 2011)
How Economic Theory is Practiced
Managerial accounting uses its three objectives in its overall goals for the company. Within mind the theories that apply to the organization’s focus budgeting is necessary in every organization, more importantly the role of managerial accounting deals with the concepts of planning, control, and decision making. “By setting standards of performance and providing feedback by means of variance reports, the accountant supplies much of the fundamental information required for overall planning and control.” (Emmanuel, Otley, Merchant, 1990)
Budgetary control is “A control technique whereby actual results are compared with budgets. Any differences (variances) are made the responsibility of key individuals who can either exercise control action or revise the original budgets.”(FAO, n.d) The way that this managed is by turning the master budget into a flexible budget and carefully evaluate the cost behaviors of fixed and variable costs. When assessed and calculated properly the total costs are configured with the actual level of operations in determining the actual costs of operations.
Capital budgeting and appraisal techniques are pivotal in an alternative method in maximizing profits. “The long-term success of any economic enterprise rests on its ability to take effective capital investment decisions.” (Emmanuel, Otley, Merchant, 1990) Capital budgeting allows for resource allocation for top management in making sound investment decisions in the acquisition of more assets. Capital budgeting requires long term planning, raising funds and searching for profitable investments. Company’s use capital budgeting in several appraisal methods such as, the payback period method, the discounted cash flow, and the internal rate of return method, the accounting rate method, which require the use of estimated cash flow amounts. Capital investments are meant to fund new projects, assets, meet demand of high capacity, diversity product portfolio, R&D, and other features that add to the growth of an organization.
In conclusion, managerial accounting is fundamentally essential in just about every organization as it is the consistent factor in updating the organization and management that controls the allocation of resources for the betterment of the company. In doing so, managerial accountant takes into account the factors of budgeting, budgetary controls, capital budgeting and investment appraisals that support the Economic theory that maximizes the wealth of its shareholders, with the methods of observation, planning, control, and evaluation. Although they are objection to the theory being the main focus and practice within organizations, managerial accountants are taking alternative methods in future net flows in making decisions that help to make the organization profitable.
Caplan, Dennis. Management Accounting Concepts and Techniques. (2006). University at Albany (State University of New York). Retrieved from http://denniscaplan.fatcow.com/Chapter02.htm
“Chapter 4- Budgetary control.” FAO. (N.d.). Retrieved from http://www.fao.org/docrep/W4343E/w4343e05.htm
Drury, Colin. Management and Cost Accounting. (2008). Cengage Lrng Business Press; 7 edition.
Emmanuel, Clive, Otley, David, Merchant, Dennis. Accounting for Management Control. (1990). Cengage Learning EMEA
Garrison, Ray, Noreen, Eric, Brewer, Peter. Managerial Accounting. (2011). Irwin/McGraw-Hill; 14th edition.
“Managerial Accounting.” Investopedia. (n.d). Retrieved from http://www.investopedia.com/terms/m/managerialaccounting.asp