Financial Accounting, Management Accounting, and Cost Accounting

Learning Objective 1 Distinguish financial accounting from management accounting

• reporting on past performance to external users
• helping managers make decisions

As many of you have already learned in your financial accounting class, accounting systems are used to record economic events and transactions, such as sales and materials purchases, and process the data into information helpful to managers, sales representatives, production supervisors, and others. Processing any economic transaction means collecting, categorizing, summarizing, and analyzing. For example, costs are collected by category, such as materials, labor, and shipping. These costs are then summarized to determine a firm’s total costs by month, quarter, or year. Accountants analyze the results and together with managers evaluate, say, how costs have changed relative to revenues from one period to the next. Accounting systems also provide the information found in a firm’s income statement, balance sheet, statement of cash flow, and performance reports, such as the cost of serving customers or running an advertising campaign. Managers use this information to make decisions about the activities, businesses, or functional areas they oversee. For example, a report that shows an increase in sales of laptops and iPads at an Apple store may prompt Apple to hire more salespeople at that location. Understanding accounting information is essential for managers to do their jobs.

Individual managers often require the information in an accounting system to be presented or reported differently. Consider, for example, sales order information. A sales manager at Porsche may be interested in the total dollar amount of sales to determine the commissions paid to salespeople. A distribution manager at Porsche may be interested in the sales order quantities by geographic region and by customer-requested delivery dates to ensure vehicles get delivered to customers on time. A manufacturing manager at Porsche may be interested in the quantities of various products and their desired delivery dates so that he or she can develop an effective production schedule.

To simultaneously serve the needs of all three managers, Porsche creates a database, sometimes called a data warehouse or infobarn, consisting of small, detailed bits of information that can be used for multiple purposes. For instance, the sales order database will contain detailed information about a product, its selling price, quantity ordered, and delivery details (place and date) for each sales order. The database stores information in a way that allows different managers to access the information they need. Many companies are building their own enterprise resource planning (ERP) systems. An ERP system is a single database that collects data and feeds them into applications that support a company’s business activities, such as purchasing, production, distribution, and sales.

In recent years, managers have begun to use data analytic techniques to gain insights into the data they collect. This is popularly referred to as big data, machine learning, and artificial intelligence. The most common application of machine learning and artificial intelligence is in making predictions. For example, using historical purchase data and other characteristics of a customer, a company like Netflix predicts which movie a particular customer might like and recommends that movie to the customer. Netflix then obtains feedback on whether the customer liked the movie or not and incorporates this feedback into the model, improving and refining it. In this sense the machine learns from its correct and incorrect predictions and is seen as acting intelligently. The vast quantities and variety of data have led to the development of many new prediction techniques. We introduce one such popular technique in Chapter 11 and discuss the role of the management accountant in a data-rich world.

Financial accounting and management accounting have different goals. As you know, financial accounting focuses on reporting financial information to external parties such as investors, government agencies, banks, and suppliers based on Generally Accepted Accounting Principles (GAAP). The most important way financial accounting information affects managers’ decisions and actions is through compensation, which is often, in part, based on numbers in financial statements.

Management accounting is the process of measuring, analyzing, and reporting financial and nonfinancial information that helps managers make decisions to fulfill the goals of an organization. Managers use management accounting information to

1. develop, communicate, and implement strategies;
2. coordinate design, operations, and marketing decisions and evaluate a company’s performance.

Management accounting information and reports do not have to follow set principles or rules. The key questions are always (1) how will this information help managers do their jobs better, and (2) do the benefits of producing this information exceed the costs?

Exhibit 1-1 summarizes the major differences between management accounting and financial accounting. Note, however, that reports such as balance sheets, income statements, and statements of cash flows are common to both management accounting and financial accounting.

Cost accounting provides information for both management accounting and financial accounting professionals. Cost accounting is the process of measuring, analyzing, and reporting financial and nonfinancial information related to the costs of acquiring or using resources in an organization. For example, calculating the cost of a product is a cost accounting function that meets both the financial accountant’s inventory-valuation needs and the management accountant’s decision-making needs (such as deciding how to price products and choosing which products to promote). However, today most accounting professionals take the perspective that cost information is part of the management accounting information collected to make management decisions. Thus, the distinction between management accounting and cost accounting is not so clear-cut, and we often use these terms interchangeably in the text.

Businesspeople frequently use the term cost management. Unfortunately, the term does not have an exact definition. In this text, we use cost management to describe the activities managers undertake to use resources in a way that increases a product’s value to customers and achieves an organization’s goals. Throughout the text, other than in a manufacturing context, we use the term product broadly to also include services. In other words, cost management is not only about reducing costs. Cost management also includes making decisions to incur additional costs—for example, to improve customer satisfaction and quality and to develop new products—with the goal of enhancing revenues and profits. Whether or not to enter new markets, implement new organizational processes, and change product designs are also cost-management decisions. Information from accounting systems helps managers to manage costs, but the information and the accounting systems themselves are not cost management.