Accounting is a common language within the business world. Over the years, new rules have been established and old rules have been modified to fulfill needs within specific industries. In this blog post, we review the three primary focus areas in accounting as well as provide useful applications of financial versus managerial accounting.
Within the world of accounting, the primary focus areas include tax, financial, and managerial accounting. Each is defined at a high level, below:
Tax – Focuses on complying with rules set forth by the Internal Revenue Code for individuals and organizations as tax returns are prepared.
Financial – Reports on an organization’s financial position and performance through financial statements by complying with Generally Accepted Accounting Principles (GAAP). Statements are intended to provide information to stakeholders outside of the organization.
Managerial – Used to assist organizational stakeholders make decisions that are in alignment with their goals. While financial in nature, managerial accounting often includes operational statistics and information in conjunction with financial data.
Each area of accounting has an important role. The principles of financial and managerial reporting are both widely accepted, but the application can be challenging, based on a business’s unique circumstances. The subtle differences are best explained through the application of the principles in common business scenarios.
Application: Managing Cost Structure in Manufacturing
Manufacturing has evolved over the years. Historically, it was simple to cost. In modern manufacturing systems, with the advent of flexible manufacturing cells and its reliance on cross-trained individuals, modeling cause and effect relationships at the product level has become increasingly more difficult. Today, managers have to learn how to manage the cost structure in order to manage the organization.
In its simplest form, a factory produces a product using raw materials and production expenses such as labor, utilities, and depreciation. Determining costs would be straightforward if the factory had one employee and one machine that produced a singular part. Unfortunately, this is rarely the case.
In a more typical scenario, a factory’s output level in any given year is rarely the same as its maximum capacity. Year-over-year, it would be unusual for capacity or production output to be the same between any given number of years. When you incorporate changing product mixes into the equation, calculating the cost to manufacture any part becomes more complex.
Rules have been developed over the years to determine how capacity-fluxuation issues impact the product cost structure and, therefore, inventory values. Both financial reporting and managerial accounting use this as a starting point for determining answers as outlined in Inventory Topic 330.
Management accountants, for internal evaluation purposes, have a lot more flexibility in how they evaluate a product’s economics for financial modeling. The objective is to sort and present information in a way that allows managers to make better-informed decisions about how to impact profitability.
By dynamically modeling sales volume, capacity utilization, product mix, raw material costs, and manufacturing costs, the management accountant can significantly impact an organization’s ability to make decisions.
Application: Calculating Brand Value
Businesses often desire to evaluate profitability or return on investment at the brand or product level. The question is, what tools make more sense to do the evaluation? Should you attempt to use the tools or the methodologies applicable for financial reporting and GAAP or should you use a different set of tools, such as marginal contribution, typically used by management accountants?
There is no singular way to do this, but in many cases, the tools used for management accounting purposes will provide solid directional information for decision making at far less cost and effort than the tools required to build GAAP compliant financial statements.
Tax, financial, and managerial accounting all play a vital role in managing a business. When executives are presented with conflicting, confusing, or inconsistent information, managerial accounting tools often prove helpful in finding the answers.
With over 60 years in industrial organizations, our managerial accounting team has the skills needed to solve these complex organizational challenges. Contact our team to learn more.