Chapter 1 Introduction to Cost Accounting

Differences between Managerial and Financial Accounting

1. Internal focus of reports

Managerial accounting is concerned with providing information to managers-that is, people inside
an organization who direct and control its operation. In contrast, financial accounting is concerned
with providing information to stockholders, creditors, and others who are outside an organization.
Managerial accounting is managers oriented therefore its study must be preceded by some
understanding of what managers do, the information managers need, and the general business
environment.

2. Emphasis on the future

Since planning is such an important part of the manager's job, managerial accounting has a strong
future orientation. In contrast, financial accounting primarily provides summaries of past financial
transactions. These summaries may be useful in planning, but only to a point. The future is not
simply a reflection of what has happened in the past. Changes are constantly taking place in
economic conditions, and so on. All of these changes demand that the manager's planning be
based in large part on estimates of what will happen rather than on summaries of what has already
happened.

3. Emphasis on relevance of data

Financial accounting data are expected to be objective and verifiable. However, for internal use the
manager wants information that is relevant even if it is not completely objective or verifiable. By
relevant, we mean appropriate for the problem at hand. For example, it is difficult to verify
estimated sales volumes for a proposed new store, but this is exactly the type of information that is
most useful to managers in their decision making. The managerial accounting information system
should be flexible enough to provide whatever data are relevant for a particular decision.

4. Emphasis on timeliness
Timeliness is often more important than precision to managers. If a decision must be made, a
manager would rather have a good estimate now than wait a week for a more precise answer. A
decision involving tens of millions of pesos does not have to be based on estimates that are precise
down to the centavo, or even to the peso. In fact, one authoritative source recommends that, "as a
general rule, no one needs more than three significant digits, this means, for example, that if a
company's sales are in the hundreds of millions of pesos, than nothing on an income statement
needs to be more accurate than the nearest million pesos. Estimates that accurate to the nearest
million dollars may be precise enough to make a good decision. Since precision is costly in terms of
both time and resources, managerial accounting places less emphasis on precision than does
financial accounting. In addition, managerial accounting places considerable weight on non
monitory data, for example, information about customer satisfaction is tremendous importance
even though it would be difficult to express such data in monitory form.

5. Emphasis on segments of an organization

Financial accounting is primarily concerned with reporting for the company as a whole. By contrast,
managerial accounting focuses more on the parts, or segments, of a company. These segments
may be product lines, sales territories divisions, departments, or any other categorizations of the
company's activities that management finds useful. Financial accounting does require breakdowns
of revenues and cost by major segments in external reports, but this is secondary emphasis. In
managerial accounting segment reporting is the primary emphasis.

6. Not governed by Generally accepted accounting principles (GAAP)

Financial accounting statements prepared for external users must be prepared in accordance with
generally accepted accounting principles (GAAP). External users must have some assurance that
the reports have been prepared in accordance with some common set of ground rules. These
common ground rules enhance comparability and help reduce fraud and misrepresentations, but

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Chapter 1 Introduction to Cost Accounting

they do not necessarily lead to the type of reports that would be most useful in internal decision
making. For example, GAAP requires that land be stated at its historical cost on financial reports.
However if, management is considering moving a store to a new location and then selling the land
the store currently sits on, management would like to know the current market value of the land, a
vital piece of information that is ignored under generally accepted accounting principles (GAAP).

7. Managerial accounting is not mandatory

Financial accounting is mandatory; that is, it must be done. Various outside parties such as
Securities and Exchange Commission (SEC) and the tax authorities require periodic financial
statements. Managerial accounting, on the other hand, is not mandatory. A company is completely
free to do as much or as little as it wishes. No regulatory bodies or other outside agencies specify
what is to be done, for that matter, whether anything is to be done at all. Since managerial
accounting is completely optional, the important question is always, "Is the information useful?"
rather than, "Is the information required?"

Managerial versus Cost Accounting

Managerial accounting also called management accounting, is a field of accounting that provides
economic and financial information for managers and other internal users.

Management accounting as defined by the Institute of Management Accountants (IMA) is a profession

that involves partnering in management decision-making, devising planning and performance
management systems, and providing expertise in financial reporting and control to assist management in
the formulation and implementation of an organization’s strategy.

Managerial accounting applies to all types of businesses – service, merchandising, and manufacturing. It
also applies to all forms of business organizations – proprietorships, partnerships, and corporations.
Managerial accounting is needed in not-for-profit entities as well as in profit-oriented enterprises.

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Chapter 1 Introduction to Cost Accounting

Cost accounting is the process of accounting for cost from the point at which expenditure is incurred or
committed to the establishment of its ultimate relationship with cost centers and cost units. In its widest,
usage, it embraces the preparation of statistical data; the application of cost control methods and the
ascertainment of the profitability of activities carried out or planned (ICMA London).

Basis for Comparison Cost Accounting Management Accounting

Deals with recording, classifying, Provides economic and financial

Meaning accumulation, allocation and control information for managers and other
of the cost of production. internal users.

Scope Scope is much narrow. Scope is much broader.

Data used Quantitative. Both quantitative and qualitative.

Cost accounting is one of the many Management accounting itself is pretty

Subset
sub-sets of management accounting. vast.

Cost accounting isn’t dependent on Management accounting is dependent

Dependence management accounting to be on both cost & financial accounting for
successfully implemented. successful implementation.

Management, shareholder, and

Used for Only for management.
vendors.

Cost vs. Managerial vs. Financial Accounting

Cost Accounting Management Accounting Financial Accounting

It also records and presents the

estimated /budgeted data. It Deals with projection of data for
It records Historical data.
makes use of both the historical the future (futuristic in nature)
costs and pre-determined costs.

Certain principles followed for

Not constrained by GAAP Governed by GAAP
recording costs.

Relationship of Financial, Management and Cost Accounting

Financial accounting uses cost accounting information for external reporting while management
accounting uses cost accounting information for internal purposes.

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Chapter 1 Introduction to Cost Accounting

Merchandising versus Manufacturing Operations

Figure 1. Flow of Costs in a Merchandising Firm

Figure 2. Flow of Costs in a Manufacturing Firm

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Chapter 1 Introduction to Cost Accounting

Uses of Cost Accounting Data

1. Determining Product Costs
Cost accounting procedures help management in gathering the data needed to determine product
costs and thus generate meaningful financial statements and other reports. Cost procedures must
designed to permit the computation of unit costs as well as total product costs.

Unit cost information is also useful in making a variety of important marketing decisions:
a) Determining the selling price of a product
b) Meeting competition
c) Bidding on contracts
d) Analyzing profitability

2. Planning and Control

One of the most important functions of cost accounting is the development of information which can
be used by management in planning and controlling operations. Cost accounting helps in the
development of plans by providing historical costs that serve as basis for projecting data for
planning. Management can analyze trends and relationships among such data as an aid in
estimating future costs and operating results and in making decisions regarding the acquisition of
additional facilities, changes in marketing strategies, and obtaining additional capital.

Planning can be divided into three components:

a) Strategic Planning
Strategic plans are designed with the entire organization in mind and begin with an
organization's mission. Top-level managers, such as CEOs or presidents, will design and
execute strategic plans to paint a picture of the desired future and long-term goals of the
organization. Essentially, strategic plans look ahead to where the organization wants to be
in three, five, even ten years. Strategic plans, provided by top-level managers, serve as the
framework for lower-level planning.

b) Tactical Planning
Tactical plans support strategic plans by translating them into specific plans relevant to a
distinct area of the organization. Tactical plans are concerned with the responsibility and
functionality of lower-level departments to fulfill their parts of the strategic plan.

c) Operational Planning
Operational plans are the plans that are made by frontline, or low-level, managers. All
operational plans are focused on the specific procedures and processes that occur within
the lowest levels of the organization. Managers must plan the routine tasks of the
department using a high level of detail.