Managerial accounting, also known as cost accounting, is defined by the textbook as the phase of accounting that is related to providing information to managers for use within the organization (Noreen, Brewer, & Garrison, 2014, p. 19). Managerial accounting information is aimed at helping managers within the organization make sound business decisions. On the other hand, financial accounting is focused on providing information to individuals outside the organization. Managers rely on cost accounting to provide them with an idea of the actual expenses related to processes, departments, operations or products that are the basis of their budget procedures. This information allows them to analyze variations to determine the best method of improvement to generate profit. These analyses are used in management accounting, where managers can substantiate the need to cut expenses for a company in order to increase that company´s profit. Cost accounting is used as a tool for internal use, versus a tool for external users like financial accounting and is not required to adhere to GAAP standards (Generally Accepted Accounting Principles). Instead, cost accounting aims to provide reports and analyses that will assist internal users with improved performance measures (Noreen, Brewer, & Garrison, 2014, p. 19).
Role of managerial accounting and the management accountant in a business or organization
One of the most crucial elements of cost accounting is to determine product selling prices; however, it is one of the simplest. A second related cost accounting objective is cost control. Organizations want to be able to reduce costs on their inputs and increase the price for their outputs. Cost accounting is a mechanism to identify possible areas of inefficiencies to manage and control costs. Managerial accounting information is used by management to determine what products/services should be sold, how to sell them, and at what price (DeBenedetti, n.d.).
For managers to determine the best means of improving a company’s profitability, as well as saving the company money in the future, cost accounting is a necessary system in the management of a company’s budget, providing valuable data to analyze variations in company production expenses. Variance analysis is a vital part of cost accounting because it breaks down each variance into many different elements of standard versus actual costs. Some of these components include material expense variation, volume variation and labor expenses variation (Luft, 1997, p. 215). Understanding why these fluctuations occurred, when compared to what was planned, helps a manager to save their company money by taking actions that are appropriate to correct that variation and prevent it from happening in the future.
Managers are often faced with the difficult and daunting task of choosing between multiple products and deciding which one would be of most benefit to the overall profitability of the company. Once the product is determined, managers must then come to a consensus on the price that consumers will have to pay to purchase the item. Various factors come into consideration when this decision is being made; however, all costs associated with producing this product from start to finish play a key role in setting the appropriate price tag. This information regarding variable and fixed costs related to specific products comes by way of cost analysis reports that are usually the responsibility of the managerial accountant. Typically, managers must rely heavily on the accountant’s reports when deciding between two products. Also, managers may need to know what products should be produced now, but also want to know where they should focus their production efforts in the future. Managers take the information received to develop specific goals and strategies for the future production within the organization.
Ethical issues/concerns for the management accountant
Business owners and other decision makers require detailed and objective data when evaluating the operations of their company and making important decisions, regardless of whether or not the information is positive or negative. Therefore, it is critical that accountants are held to high ethical standards since they are usually privy to confidential business and sometimes personal information. It is important that these individuals are trustworthy since ethical standards require that information be reported in full, and without bias, regardless of the effects of the information. Accountants who reveal or use internal information for their personal benefit can break trust and set the business up for serious legal implications (Luft, 1997, p. 216).
Business owners may determine that unethical behavior does not translate to being illegal, a reasoning that creates a gray area within the organization. This perception could lead managerial accountants to potentially behave unethically when preparing and/or reporting financial information for the organization, thinking it isn’t doing any harm. However, it may raise a red flag to auditors who may begin to question the accounting practices of the company. An example of this could be a firm consisting of an owner-manager and two subordinates (divisional managers) who trade with each other and are rewarded based on divisional profit. One of the divisional managers with private information may conceal it from the other divisional manager to gain an advantage in bargaining if he or she expects the resulting increase in profits to exceed the time and effort costs of additional negotiation (Luft, 1997, p. 216). This type of behavior provides that manager with a potential edge when performance bonuses are calculated; whereas, the other manager’s division could appear unprofitable and could result in job loss or a shutdown of the entire unit.
Accountants have the option of joining the IMA (Institute of Management Accountants) to not only enhance their knowledge but also to follow the ethical guidelines set forth by the organization when performing accounting tasks for either their employer or the general public. Honesty, fairness, objectivity, and responsibility are the foundation of the standards put in place by the IMA (Noreen, Brewer, & Garrison, 2014, p. 14). This organization is not limited to CPAs as both licensed and non-licensed accountants can benefit from these ethical standards in their professional accounting career.
General description of at least three managerial accounting techniques available and their application within a business or organization
A breakeven analysis can be computed to give managers an idea of how much product or service needs to be sold so the company can recoup operating costs and generate a profit. Although the calculation is simple in nature, determining the variable and fixed costs required to obtain the breakeven result takes careful analysis, in addition to accurately determining sales volume. Such costs like administrative, rent and insurance are among the expenses that are included in the equation. Once the breakeven analysis is completed, then managers can determine the organization’s margin of safety. The margin of safety allows management to know the amount revenues can drop and still be above the break-even point. When management accurately calculates the breakeven analysis, their organization is more likely to achieve greater profits (Reilly, 2009, p. 29).
Inventory management is a vital tool managers must use to ensure adequate levels are maintained. Maintaining too much inventory, imprecise inventory tracking systems and a lack of priorities have the ability to disturb operations and lower profit margins. Just-in-time inventory management, part of Lean Production, and related calculations help managers keep stocking and reordering costs to a minimal level. As a result, the business can sustain or improve profit margins. Other inventory management methods also help reduce costs and maintain adequate inventory turnover times. By utilizing such techniques, inventory levels are kept at sufficient levels to meet consumer demand and inventory turnover is rapid; thus, resulting in a reduction in operations budgets being tied up in inventory sitting on a shelf not being sold. JIT inventory is a popular strategy a company can utilize to increase efficiency and decrease waste by purchasing supplies only when they are needed in the production process, thus reducing overall inventory costs. A negative aspect to this technique is that it requires manufacturers to be able to accurately predict inventory demand (“Just In Time (JIT) Definition | Investopedia,” n.d.).
Third, budgeting is an important tool used in both professional and personal settings. Although all budgets are valuable, one of the essential budgets in the business environment is the expense budget. This budget allows management to set preferred spending limits and control cash accordingly. Although budgets are usually created for the organization’s calendar years, they can easily be adjusted throughout the year in agreement with fluctuations in sales or operational activity. One of the most ideal features of an expense budget is that it can be created for each department, as well as the entire organization, which makes it easier for departmental managers to monitor better and manage their spending as needed (DeBenedetti, n.d.). Budgets may not be well received in all areas of the organization; however, they are a necessary part of any business to adequately control spending. Without budgets, managers have the potential to overspend or misapply resources and reduce bottom-line profit.
Part II
Cost management can be defined as the process of collecting, analyzing, evaluating and reporting of cost information that is used for budgeting, forecasting, pricing, profitability analysis and performance reporting (Berger, 2004, p. 79). Accurate cost information affects both financial and non-financial decision making. Inaccurate decisions often result in unprofitable service offerings, incorrect pricing, inefficient distribution of personnel and low return on investment for equipment purchases.
Profitability and cost management in today’s’ competitive industries are strategic and have caught management’s attention. Today‘s profitability and cost management solutions are driving a fundamental performance metric, which is the overall profitability of the business. With the financial pressures that health care organizations are now facing, many hospitals are using traditional cost cutting methods to save money by resorting to layoffs and staff reductions. Some hospitals, however, are finding ways to cut costs through lean management methods that don’t require layoffs and can improve quality for patients (Deschenes, 2012).
In the healthcare organization in which I am employed, leadership implemented the use of Six Sigma LEAN metrics to monitor and reduce inefficiencies within the workplace. These inefficiencies have a dramatic impact on the overall costs incurred by the company; therefore, using LEAN metrics allow us to identify issues in the early stages and formulate an action plan to reduce or eliminate the problems before they become a much larger problem. For instance, we wanted to lessen the amount of overtime wages within our particular department so more funds would be available in the budget to support departmental improvements and other expenses. However, overtime was unavoidable due to deadline requirements and the number of queries that had to be run to complete assignments by the deadlines. In our daily fifteen minute LEAN huddles, we have brainstorming sessions on how to reduce the lengthy query processes in order to have a faster turnaround time for our duties. The use of LEAN metrics allowed us to work together to combine methods to shorten our workload; thus, reducing the amount of hours required for us to work on our research projects. The use of LEAN has been a cost-saving tool that has significantly reduced overtime and saved the department thousands of dollars each month. Before implementing the cost management process of LEAN, the department was spending upwards of $1,000 per month in overtime for each employee, and there are 30 employees in the department. After streamlining our accounting processes to be more efficient, the department is now saving approximately $30,000 per month in overtime wages. The organization is in the process of implementing LEAN in every department; therefore, we do expect to see a drastic drop in unnecessary expenditures over the next several months.
In addition to reducing overtime wages as a cost management mechanism, there are a tremendous amount of delays in billing, including too many people involved in different parts of the process (Deschenes, 2012). If there’s a better flow, if people are handing off the work to the next person in the chain immediately, then bills are sent out in a couple of days instead of a couple of weeks. It’s also incredibly important to make sure invoicing is being done properly. If mistakes are made and proper preauthorizations aren’t followed, but procedures are done anyway, hospitals might be voluntarily giving away revenue. This is another area where the use of LEAN, or any other cost-saving metric, can be utilized for the benefit of the organization.
A second managerial accounting technique used is quality control. Quality control is essentially a set of quality standards enforced by management to ensure that products and/or services are at a specified level before being offered to consumers. These control metrics can include a wide array of protocols to ensure products meet safety, dependability, and satisfactory requirements, among others (“Quality Control Definition | Investopedia,” n.d.). A major element of quality control is implementing these standards in a way that all employees fully understand and adhere to follow. Room for error can be greatly reduced by specifying which production activities are to be completed by which personnel; thus, reducing the chance that employees will be involved in tasks for which they do not have proper training.
Although I am not employed in a manufacturing industry, the healthcare industry employs quality control standards unique to each department. For example, I work in Research Finance on the accounting team. The department also has a budget team and an invoicing team that has specific responsibilities for research projects and patients. One of our quality control measures is that the accounting team is not allowed to negotiate and/or prepare budgets; only the budget team is capable of this task due to the specialized training they have received. Conversely, the invoicing and budget teams are not authorized to perform any accounting duties for the same reason as only the accounting teammates have the knowledge to properly abide by strict accounting guidelines and standards. This system offers a “checks and balances” measure that ensures that only qualified individuals are performing specific job duties. This drastically reduces errors that can lead to frustration, re-work, audits, and most importantly- fines.
Lastly, a third managerial accounting technique is methods for capital investment decisions. Capital investment decisions can be some of the most expensive decisions managers must make; therefore, it is important they choose wisely and use their funding in the most effective way to ensure the best return possible. Usually, these decisions are reached subjectively and at times techniques are used to increase the likelihood that certain projects are chosen over others (Noreen, Brewer, & Garrison, 2014, p. 310). For instance, one project may be attractive based solely on revenue potential; however, it may result in a much higher investment of funds than others and the end result may not be as profitable as one first assumed. It can be tricky to distinguish which project would be best suited for the organization in the long-term, but managers should carefully consider all aspects of the project’s capital requirements before making unwise and costly choices.
Capital investments generally require high-dollar funding and are anticipated to realize long-term value for an organization, usually one year or longer. Such investments are quite common in the health care industry and commonly fall into three categories. First, strategic decisions are capital investment decisions designed to increase a healthcare organization’s strategic position. Second, expansion decisions are capital investment decisions designed to improve the operational capability of a health care organization. And lastly, replacement decisions are capital investment decisions designed to replace older assets with newer ones (DeBenedetti, n.d.).
Regardless of the type of capital investment decision facing managers, there are usually groups of individuals, or entire departments, which are interested in pursuing one particular project over another. Project ranking is not uncommon in today’s business environment and is dependent on the fact as to how much the specific projects would return, as well as which project has the ability to provide the business the greatest value in the shortest amount of time. The majority of capital investment decisions are reached with specified deadlines in mind which can result in more than one step in the decision-making process being ignored. This, coupled with rivalry within departments, can bring about poor outcomes.
After management narrows down the list of potential projects, they must then start the process of using capital budgeting decision tools to reach their final decision. Several tools can be used; however, the most common are the payback period, net present value method, and the internal rate of return method (Noreen, Brewer, & Garrison, 2014, p. 318).
Out of the three methods, the payback period is one of the most popular due to its basic and simple calculation, although it does not factor in the time value of money like some of the other methods. The payback period in essence allows one to calculate how long it would take for a project to recapture the cost of the initial investment (Noreen, Brewer, & Garrison, 2014, p. 327). The calculation is simple as it is the total cost of the project divided by the estimated cash inflows expected each year. The end result is the number of years to recover the initial cost, or the payback period. As an example, my employer used this method as a guideline when deciding which research projects should/should not be undertaken. Although the assumption is that most research projects will generate revenue for the organization, it isn’t known how long it will take before the healthcare organization recoups the investment they initially put into the project to get it off the ground. Based on the results of the payback method, leadership will decide whether or not to accept or reject the project if the payback period is too far out of their comfort zone.
There was a case recently in which one of our research sites proposed a new project that would study a new therapeutic drug used to potentially treat individuals affected by Parkinson’s disease. The example is just an approximation of costs as I do not know the exact dollar amounts proposed for the project. The proposal stated that the yearly revenues generated from this new research study would be approximately $100,000 and the initial investment required would be $1 million dollars. Therefore, the payback period would be 10 years: 1,000.000 (initial investment) / 100,000 (yearly inflows) = 10 years. This project was hotly debated because some members of upper leadership wanted the payback period to be no longer than 7 years. However, other leaders felt that although it would take slightly longer to recoup the investment, the project was actually going to last for 20 years instead of 10 years. After 10 years, the organization has recovered their initial cost and the remaining 10 years would be revenue of approximately $1 million. This doesn’t include the potential revenue if the new drug becomes FDA approved and can be used on a much larger population of patients within the entire healthcare industry. Even though the payback method has flaws because it does not take into account the time value of money, leadership did decide to accept this particular project simply based on the potential revenue growth and healthcare benefit this could provide if the new treatment improved the overall health of those patients affected by the disease.
Another useful tool when evaluating capital investments is the internal rate of return (IRR), which does consider time value of money. In terms of the project discussed above, the internal rate of return factor would be 1,000,000 / 100,000 = 10. This factor found in Exhibit 8B-2 of the textbook represents an 8% rate of return. If this method had been the only one used in deciding whether or not to accept the project, it would have been rejected because the organization requires a 15% internal rate of return. However, all else considered, the project was accepted and has provided a promising future for the treatment of Parkinson’s disease. I guess the organization will know in about 20 years if they made the right decision or not.
There are a variety of methods that organizations can use to measure profitability, cost control, budgetary success, work efficiency, and the best capital investment decision, among others. Managerial accountants and managers can improve the success of their organization if they fully understand and correctly implement the many tools available to them. No one method is fool-proof; however, if used in conjunction with other resources, managers will have a greater likelihood of making the most favorable decisions.
References
Berger, S. H. (2004). 10 ways to improve healthcare cost management. Hfm (Healthcare Financial Management), 58(8), 76-80.
DeBenedetti, J. (n.d.). The Impact of Management Accounting Techniques on Profitability | Chron.com. Retrieved from http://smallbusiness.chron.com/impact-management-accounting-techniques-profitability-77635.html
Deschenes, S. (2012, July 24). 7 ways lean healthcare management reduces cost | Healthcare Finance News. Retrieved from http://www.healthcarefinancenews.com/news/7-ways-lean-healthcare-management-reduces-cost
Luft, J. L. (1997). Fairness, Ethics and the Effect of Management Accounting on Transaction Costs. Journal Of Management Accounting Research, 9199-216.
Just In Time (JIT) Definition | Investopedia. (n.d.). Retrieved from http://www.investopedia.com/terms/j/jit.asp?layout=orig
Noreen, E. W., Brewer, P. C., & Garrison, R. H. (2014). Managerial accounting for managers (3rd ed.). New York, NY: McGraw-Hill/Irwin.
Quality Control Definition | Investopedia. (n.d.). Retrieved from http://www.investopedia.com/terms/q/quality-control.asp
Reilly, C. (2009). Break-Even Analysis–Making it Work for Your Franchise. Franchising World, 41(7), 29-30.