The role and purpose of management accounting
Financial versus management accounting
Management accounting supplies information to internal managers for planning, control and decision making. It is not governed by company law or accounting standards, has no prescribed format, and is produced as often as managers need it - monthly, weekly or daily. Financial accounting reports to external stakeholders, follows statute and standards, is largely historical and is usually annual or half-yearly.
Concepts to know
- The decision cycle: plan, do, review.
- Cost classification by nature (direct/indirect), by behaviour (fixed, variable, semi-variable, stepped fixed) and by function (production, administration, selling, distribution).
- Cost objects, cost units and cost centres.
- Relevant costing, sunk costs and opportunity costs.
- Responsibility accounting and controllable versus non-controllable costs.
Traps in questions
- Assuming every cost is either purely fixed or purely variable - semi-variable costs need a fixed and a variable element, often split using the high-low method.
- Confusing direct with variable: a cost is direct if it can be traced to the cost object without arbitrary apportionment, and it may still be fixed, such as a supervisor dedicated to one product line.
- Treating sunk costs or apportioned head-office overhead as relevant to a decision.
- Forgetting that management information values timeliness and relevance above precision.
Worked example
A factory reports: line materials £40,000 (direct, variable); production supervisor salary £3,000 (indirect, fixed, production overhead); sales commission £2,000 (indirect, variable, selling overhead); factory rent £5,000 (indirect, fixed, production overhead).
Rule of thumb: first ask whether the cost can be traced to the unit without arbitrary apportionment - if yes, it is direct. Then ask whether it changes with activity - that decides fixed or variable.