First Things about Management Accounting

Management accounting is an internal function that operates within the boundaries of a business to help managers make sound decisions, develop plans and goals, and exercise control. The basic purpose of management accounting is to help managers be better managers. Management accounting, more than anything else, involves providing useful information to managers and helping them use this information in the most effective manner.

The design of accounting reports for managers is very dependent on the nature of the business and how the business is organized. If a business is divided into several sales territories, for example, accounting reports are organized by sales territories. Within each sales territory the business may be organized by major product lines. So, the accounting reports separate out each product line in each territory.

In short, management accounting follows the organizational structure of a business. This chapter focuses on the profit report to top-level managers of a business who have companywide responsibility. The chapter looks at the top of the organizational pyramid, and takes a summit point of view of the business.

The external financial statements of a business are not completely adequate for its top-level managers, despite the fact that these financials are for the company as a whole. This is not a knock on external financial statements, which are designed for the outside investors and lenders of the business and not for its managers. Managers should understand their company's external financial statements like the backs of their hands. But they need additional accounting reports that are much more detailed.

In particular, the external income statement is not a good explanation of profit behavior—especially for management analysis. All managers who have profit responsibility need a hands-on model that provides a clear pathway to profit. The next section introduces a management profit model. The profit model or schematic should make transparent the basic factors and variables that drive profit and how they all fit together to arrive at bottom-line profit (net income). A profit model should serve as a blueprint for constructing, maintaining, and improving the bottom line of the business.

One Word of Caution: Management accounting is an art, not a science. There are no authoritative standards, and no generally accepted management accounting principles that govern management accounting. Tax accounting must follow tax laws and regulations, and use prescribed tax forms. External financial statements have to be prepared in accordance with GAAP. Management accounting is a wide-open game with few ground rules.

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