There is a saying in business that accounting reports frequently substitute for supervision. This is only half true. Essentially, management accounting reports
are worthwhile supplements to the supervisor’s own eyes and ears. This is the case at all echelons of management. Particularly at the vertex, comprehensive reporting plays a crucial role in terms of:
● Planning, and
● Control.
At the same time, however, it is no less true that financial accounting has its limi- tations, of which the reader must be aware. Managers cannot really be in charge unless they know where the limits are. The limits are the plan. Financial report- ing is part of the control activity. Four issues are brought into perspective in con- nection to management accounting and financial reporting:
● Budgets, which establish the financial plan for a term period (see Chapter 9)
● Valuing assets and liabilities, which is much more an art than a science (see Chapter 10)
● Subjective judgment entering into accounting policies and practices (see section 6)
● The need for forward-looking statements to drive the business in a dynamic market (see Chapter 12).
Let’s start with this last point. Theoretically, accounting is concerned with fac- tual measurement, in money terms, of operations undertaken by the enterprise.
Historically, accounting records and financial reports are considered largely as summaries of what has happened, without too much emphasis upon the inter- pretation of data they contain in terms of:
● Why things have happened, or
● How they may be expected to appear in the future.
In practical terms, parallel to this policy of reporting on past events, for which there exist accounting inputs and statistics, there has been the accountant’s tra- ditional and conventional emphasis upon historical costs. With the accruals method (see Chapter 1), historical cost has been the basis for:
● Stating assets
● Evaluating liabilities, and
● Measuring expense.
Both good governance of an entity and shareholder value require that manage- ment accounting reports and financial statements are forward-looking – which brings into consideration the second bullet point, on subjective judgment.
Contrary to historical figures, which essentially constitute hard data, or statistics (noun, singular), forward-looking statements talk about the likelihood, shape, and weight of future events. This is soft datainvolving opinions, with the entries into the management report characterized by different levels of dependability – each with ‘yes’ or ‘no’ probabilities attached to it.
An example of a forward-looking exercise is the valuation of assets and liabili- ties at current market value. In a dynamic market, this is necessary in order to get an appreciation of how solvent a company is. As far as the whole enterprise is concerned, a currently popular algorithm is:
⬎1 where:
A⫽assets at fair value using market capitalization as proxy
L⫽liabilities at book value, because these represent commitment the company must face, no matter what its market value may be.
This is, of course, an approximation, but it is useful because management deci- sions must always be forward-looking in the sense that history is irrelevant except in so far as it may be a basis for forecasting. The cost of the approxima- tion is that what is prognosticated may not materialize, therefore inducing man- agement error.
In a way, it makes no difference whatever what the historical cost of a transac- tion, and risk associated to it, may have been when the decision is made as to whether this transaction should be hedged. Similarly, in manufacturing, last year’s costs have no relevance to the selling prices of current and future periods, except as:
● They may provide a reasonable basis for current interpretation of profit margin(s), or their future adjustment, and
● They can be used in applying rigorous cost control procedures, because costs matter greatly (see section 6).
For management purposes, the financial data must be related to the use to be made of them. Therefore, while the origin of data for general accounting and man- agement accounting purposes is very similar, their massing, reporting, and timing requirements differ. For instance, along with the need for detailed information
ᎏAL
concerning certain aspects of operations, there is a difference between financial and managerial accounting in terms of timeframes.
● General accounting has a periodicity fixed by the law of the land, through prevailing rules, regulations, and even customs.
The basic figures for the preparation of conventional financial reports arise from general accounts, by summarizing major data classes concerning enterprise oper- ations. Revolving around the general ledger, accounting practice has built a com- plex set of procedures and records closely integrated with operations, but designed to accomplish a number of objectives not associated directly with enterprise management.
Classical general accounting includes the preparation of documents or business papers commonly referred to as vouchers. These are original documents and memoranda designed to accomplish various tasks, one of which is to keep the accounting department informed as to what has occurred in various parts of the firm’s activities; another, to provide documentation for general ledger entries.
Being the basis for all accounting records and tabulations, vouchers support the accounting data as classified and presented in various kinds of subsidiary ledgers, analyses, and reports. They also permit implementation of a system of internal checks and controls. By contrast, common tools of financial reports and of management accounting are balance sheets and income statements. This is not surprising because:
● Regulatory financial reporting responds to legal and supervisory require- ments targeting the governance and solvency of the entity, and
● Management accounting responds to the entity’s internal criteria for good governance as well as for management control.
To be truly helpful in this mission, management accounting must be ad hoc, polyvalent, and deliverable in real time (see Chapter 15 on real-time balance sheet). At the same time, it is important to recall the difference made in the Introduction regarding general accounting’s need for high precision, while good accuracy is enough to satisfy management accounting requirements.
Another principle to keep in mind is that, quite often, incomplete details of an operation obtained promptly and submitted to management may be more useful than complete information that is available only after a considerable lapse of time.
The requirement of current relevancein terms of risks, costs, prices, productivity,
and sales conditions has attracted management attention because in a dynamic market it is key to competitiveness and the survival of the firm.
Take costs as an example. The costs that are important and relevant to a decision are those that will be different when the choice is made in one way rather than in another. In terms of productivity, what management accounting is after is deviations from planned performance expressed in the form of:
● Variances from standard costs and other question-raising data.
● Budget estimates that are not matched by actual costs because productiv- ity is lagging.
From the intelligent raising of questions as to why deviations occur may be found better ways of accomplishing the tasks that are to be done in the firm.
From this viewpoint, management accounting should be the source of questions to answer in a factual way. In the broader sense, management accounting is the trigger for asking the questions senior executives are curious enough to want answered (see also section 7).