Management Accountingis concerned with providing managers in organisations with accounting information that serves to make informed business decisions. It also allows management to be better equipped in their management and control functions.
According to the Chartered Institute of Management Accounting (CIMA), management accountingcombines accounting, finance and management with the leading edge techniques needed to drive successful businesses. It is a field that is distinct from the preparation of monthly accounting statements (which is referred to as financial accounting) and is as critical for business performance as financial accounting. There are various occasions in which the usability and meaningfulness of management accounting for top management can be demonstrated. These would include new product pricing, business driver metrics such as key performance indicators, sales management, operations management and research, client profitability, as well as risk analyses and assessments.
Management accounting, unlike historical cost accounting, does not follow rigid rules, or standards, but instead makes use of principles, some of which are competing and mutually exclusive (i.e. adopting one means that the other cannot be adopted at one and the same time).
Activity Based Costing (ABC) is one among a number of possible costing methodologies utilised in organisations. It identifies activity centres in an organisation, and assigns costs to product or service units based on the number of activities or some form of utilisation metric used by each product or service unit. ABC ascertains the purpose of each activity or service and assigns the cost of such activity or service to the product or service unit that has made use of such activity. ABC may be considered to be a more precise costing tool in comparison to absorption costing, which is based on the principle of absorbing the cost of a finished unit in inventory or of a service as the sum of the cost of direct materials, wages of direct labour, and both variable and fixed overheads.More information about Activity Based Costing may be found here.
GPK is a comprehensive marginal costing system, with a highly accurate operational modelling. The accounting information it provides is of greater useful and practical use for management occupying different functions. The marginal-based approach of GPK is based on the principle of causality, which posits that the direct and indirect costs are linked to individual outputs (whether in the form of a final product or a support service) on a causal basis. Both direct and indirect costs that vary according to product output are proportional costs. Once the proportional cost of a particular product is calculated, it is deducted from the sales value that provides the first contribution margin that is the profit deriving from a product, prior to the deduction of fixed costs. This is of particular use to managers as, at this stage, this technique determines whether the product is viable to produce, that is whether it is profitable or not.
Although innately, at least over a certain range of output, fixed costs do not vary with output, with GPK there is a tendency for calculating a standard fixed product/service cost and the proportional cost per product mentioned earlier.
In essence, GPK’s composition consists of four important building blocks, namely:
This element separates the fixed and the proportional costs and allocates them to cost centres.
Cost Centre Accounting
The cost centre is the fundamental concept within GPK. These centres are areas of responsibility assigned to individual managers. They are responsible and accountable for the performance of their cost centre. There are two types of cost centres. The first is called a primary cost centre. This includes those costs directly related to output, such as service provision or manufacturing of product. The second is a secondary cost centre that incurs costs but its functions exist to support the primary cost centre. Typically, one would find HR, IT and other general administrative functions classified as secondary cost centres.
Product / Service Cost Accounting
This is where all product-related costs are collected in the GPK costing model. Generally, this would involve the allocation of proportional costs, but as indicated earlier, some product-related fixed costs are also inserted.
Contribution Margin Accounting For Profitability Analysis
This is the final component step of GPK. It adds in the revenues, the proportional and the fixed costs. This allows for a more detailed analysis because of the multi-dimensional contribution margin view. It also supports short-term decision making such as pricing decisions or internal pricing transfers, while also providing costing information for long-term decisions.
When utilising this technique, only the variable costs are considered in calculating the cost of a product, while the fixed costs are charged against the revenue of the period. This costing method has edified the concept of contribution. This is the sales revenue of the products less the variable cost, which means that contribution is profit made from a product before deducting the fixed costs. When the contribution equals the fixed cost we reach break-even point. Marginal costing is beneficial as it demonstrates how many units of a product one must sell before costs are recovered at a set price. It should also govern whether a firm will offer its services in a particular instance or not. If variable cost is not being covered and contribution is therefore negative, it makes no business sense whatsoever to operate.
Lean accounting may be considered to be a ‘way of thinking’ and a strategic intent to move towards business practice excellence. In doing so, traditional accounting methods, controls, measurement, and managerial processes are changed to support lean thinking. The aims of lean accounting revolve on having accurate, timely and useful information that enables lean transformation throughout the organisation. It should also facilitate better decision-making that leads to increased customer value, cash flow, growth and profitability. Another key objective of lean accounting is that of waste elimination from the accounting process while ensuring adequate financial control. Waste reduction should not come at the expense of non- compliance with accounting regulations and internal reporting. Conversely, lean accounting should motivate and direct investment towards the adoption of a lean culture based on empowering individuals within the organisation to continuously take decisions that improve the organisation’s performance.
Resource Consumption Accounting (RCA) is an accounting approach based on the amalgamation of Grenzplankostenrechnung (GPK) and Activity-Based Costing (ABC)practices. The blending of the two concepts allows for focus on tracing the consumption of resources back to cost centres, as well as focus on assigning resource costs to activities. This provides a method of cost management that can deliver significant benefits, especially to manufacturing companies. RCA applies unit prices for cost calculations by identifying the resources that are used in time and quantity units of consumption. Accordingly, costs are allocated to products in accordance with the way resources are consumed. Implementing RCA requires a recognition that there are two objectives to financial management, one for manufacturing cost accounting and one for financial reporting. As in ABC and GPK, it requires the use of disciplined work practices when it comes to the company’s management, measurement and control systems. That said, once RCA is adopted as a financial management philosophy, it usually yields a sustainable long-term cost management solution.
Throughput Accounting is not a costing technique per se, but an important measurement and decision-making tool. It is based on Goldratt’s Theory of Constraints. Generally, every system has a bottleneck. A manufacturing concern producing four different products, for example, is limited by the amount of units it can produce of each of the four products. Therefore, when utilising throughput accounting, we focus on those product units (or the right mix of products) which generate(s) the highest return for the organisation. Throughput Accounting also informs decisions as to what investment should be undertaken and for which mix of products to maximise profits, as well as the operating expenses related to the production and sales of the product or product mix. When it comes to making decisions, throughput accounting calculates the ‘throughput’, which is the revenue expected from the sale of the product, less the variable costs which includes the cost of making and selling units. It also considers the investment made to setup the system and the operating expense which is the cost incurred (other than the variable cost) to turn the investment into revenue. Throughput accounting could be an important tool to have under circumstances of frequent investment spurts, as it calculates the throughput return per unit of bottleneck resource.
When a parent company and its subsidiaries or a group of inter-related companies, trade with one other, they generally establish a price for the transaction. This is called transfer pricing, and may include transfers of intellectual property, tangible goods, services, loans and other financial transactions.The unrelenting rise in multinational trade has increased and continues to increase the frequency of transfer pricing transactions. This has had a significant impact on corporate taxation especially if subsidiaries and the companies of the parent firm operate in different jurisdictions. Transfer pricing is not an illegal activity. However, it is highly regulated. Developing a tax-efficient structure that is compliant with legal requirements is essential in transfer pricing terms.
At Equinox Advisory we have been offering Management Accounting Services to leading international and local firms since 2008. We provide advice to senior management about the economic and financial implications of an investment or new business venture and help set up accounting systems that capture and store that data for later retrieval and analysis. We involve ourselves closely with senior management to help make informed decisions, devise planning and performance management systems, and provide expertise in financial reporting and control to assist management in the formulation and implementation of an organisation’s strategy.
Among other things, our management accounting services encompass:
- Business metrics development
- Price modelling
- Product profitability analytics
- Geographic, industry and client segment reporting
- Sales management scorecards
- Cost analysis
- Cost-volume-profit analysis
- Life cycle cost analysis
- Client profitability analysis
- Capital budgeting
- Buy vs. lease analysis
- Sales forecasting
- Financial forecasting
- Annual budgeting
- Cost allocation
- Risk analysis and management
Our accounting and economics capabilities and expertise underlie our management accounting services.