For most of us, be it management accounting, financial accounting or cost accounting – well there isn’t really a lot of difference. Because it is still accounting – right?
Well, no. And a big one at that!
So how are the three different?
Accounting in its traditional sense is limited merely to recording transactions for the sake of keeping records. These records are dug up as and when necessary – and are what we call Financial Accounting.
Cost Accounting comparatively, has a broader scope. It uses Financial Accounting as a base, to first compute the costs of various functions in a production unit, and (then) more importantly, control them.
The scope of Management Accounting is the broadest, wherein by using Financial and Cost Accounting as a base; it gives the management necessary information while it is in process of planning, controlling, performing and evaluating a process – or simply put; when taking any decision. This includes preparing reports for taxation, budgeting, planning, & forecasting, analysis, etc.
Hmmm. Okay. So what is it that a Management Accountant does?
Well let us answer this in the light of things that happen around us all the time.
#1 attempt explaining the scope of management accounting: The Weaning Smile
If you know anyone who earns a salary each month, you would get this in a snap. Surely you have seen how ‘rich’ they are at the start of each month. Then, all that smug faced happiness weans away – literally. This because they spend way too much, way too early into the week. So neither do they save anything in the week and nor at the end of the month. By the end of the year, they turn into ‘scavengers,’ desperately trying to find ‘morsels’ of funds that do not exist.
In a firm, the scope of Management Accounting would have the accountant assess the current cash flows, project estimated inflows and outflows in a manner that allows to spend just that much, but still save a decent sum. Thus helping achieve both the short and the long-term objectives.
#2 Indecent Proposals In Life!
In 1993 came a rather controversial movie – Indecent Proposal.
The story – rich man offers an economically struggling couple a million dollars to spend a night with the wife. The interesting part – they agreed to the deal and got rich. The sad part – they end up losing each other!
A lot of decisions in our life our just like this. While seemingly oh so tempting and ‘safe’; they are fraught with risks. The scope of Management Accounting includes rigorous calculations to identify all possible risks in a decision, its alternatives, and the costs associated with each one. Thus saving us from falling for that indecent proposal.
#3 House Parties and management accounting
So it’s your birthday, and you decide to throw a party. You innocently call 80 hungry friends over.
Knowing completely well that they like eating (a lot), you call for pizza to be delivered. The pizza arrives warm & cheesy; all 80 of them – at one go.
Your friends however – well they aren’t as organised. While some show up early, some drop in late.
The problem – the pizzas have gone cold. With just one microwave oven at home, how do you heat so many pizzas for ‘friends’ who aren’t patient at all?
Similar situations arise in a manufacturing unit wherein a single bottleneck slows down the entire line. To the rescue comes management accounting. The scope of management accounting involves working with and around ‘constraints’ (microwave machine). Since resources are limited in business, the objective is to use them (microwave) in the most optimum and efficient manner, leading to the highest possible profits (or happy friends in this case).
#4 What’s Really Profitable?
You are in a coffee shop with your friend – a management accountant. It has two other tables that are vacant. All of a sudden, a group of five college going friends walk in. They sit down at one corner of the coffee shop and look to want to spend time at the coffee shop. Just a minute later walks in a man in his fifties, who seems in a hurry.
Your friend asks you, “Who out of the two do you think makes for a more profitable customer, the friends as a group or the lone man?”
Easy one you think – it has to be the lone man!
Well not necessarily.
While the lone man might place his order quickly, have his coffee and leave; the group of friends shall take their own time to settle down, talk about a zillion things before placing their order. This along with wanting to use the rest room, sipping away on complimentary water, accessing the free Wi-Fi, and using a lot of tissue paper. The point here is that people often ignore indirect and rather invisible overhead costs.
The scope of management accounting asks accountants to compute every single fixed and variable cost that is associated with an action, before defining what is profitable. Thus, it would take into consideration the direct as well as indirect costs; to ultimately compute sales price and profitability.
Along with all the consumables, the group of friends might be too noisy for the comfort of prospective guests to the coffee shop too!
Who do you think really was the profitable customer now?
#5 Another way to explain the scope of management accounting: Supermarkets Stock Almost Everything
A decent supermarket has anywhere between 35,000 to 50,000 stock keeping units (SKUs). That is a lot of money locked into maintaining inventory. Now imagine the numerous breakfast cereals that they stock.
A lot right?
The question that the manager needs to ask is: should the supermarket stock all brands; almost all, or just the top 3 selling ones?
Well just 3 is fine, but what about the potential loss in sales if a customer wanted to buy a brand they decided not to keep? Alternatively, what if they ran out of stock of a popular brand and customers ended up buying no cereals at all?
Nightmares like these are suitably addressed under the scope of management accounting by using inventory control tools to optimize inventory planning. Firms therefore can escape under stocking and overinvesting too; thus maximizing profitability.
That was all about management accounting…
So well, if you always thought that Management Accounting was just one for the books, surely you’re rethinking now! The scope of Management Accounting is all pervasive; be it in a growing business or in mundane activities of life.