Precision in Management Accounting - Essay Example

Precision in Management Accounting Table of Contents Precision in Management Accounting Table of Contents 2 Introduction 3 Management Accounting Techniques 3 Activity Based Costing: Precision is less important 3 Precision is less significant: In the light of other Management Accounting Tools 6 Reference 11 Bibliography 12 Introduction Since the last few decades, with the changes in the business environment, management techniques have proliferated at an unprecedented rate. “The term management accounting refers to accounting the management i.e. accounting which provides necessary information to the management for discharging its function” (Anbuvelan, 2005). The functions of the management include planning, organising, controlling and monitoring. Management accounting provides the required information to the management to carry out the business operations in an arranged manner. The managers are supposed to apply appropriate management accounting concepts and technologies in processing historical and forecasted economic data to take necessary decisions for the betterment of the organisation and stakeholders. This paper offers an insight into the management accounting techniques and shows one significant difference between financial and managerial accounting is that the latter emphasises less on the precision of the accounting data. The focus of this report would be to investigate the importance of precision in management accounting techniques. A conclusion has been inferred from the whole analysis part. Management Accounting Techniques Activity Based Costing: Precision is less important Management accounting helps the management to carry out the managerial functions with more efficiency. This is done to enhance the profitability of the organisation by gathering the required information from various sources. The process includes gathering required information and analysing them systematically to make the relevant decisions. However, as decision-making becomes more comprehensive and complex, this requires management to re-evaluate all of their strategic options. For example, an organization may now have to decide whether to produce the parts internally or purchase parts produced by others. Using management accounting will provide valuable assistance to the organisations’ management to make decisions in each and every field of activity (Patankar, 2008). Many large companies use activity Activity Based Costing (ABC) today. In the traditional approach, the cost used to be calculated in three steps: accumulate the cost in the production and non production units, allocate the non production units costs to the production departments and allocating the total accumulated cost to the product, service or any other cost objects. In this process, products are also charged for idle capacity or unused resources. Such distortions have been removed in Activity Based Costing, which calculates cost based on cost pools or activity centres. The product or service cost includes the cost incurred in the activities associated with the respective cost driver (Akyol, Tuncel & Bayham, 2005). Furthermore, it has been shown by Geri and Ronen that the implementation of ABC requires a series of complex steps (Geri & Ronen, 2005). To simplify things, Robert Kaplan and Steven Anderson have introduced Time Driven Activity Based Costing. In this revised model, the corporate managers are supposed to estimate the demand of resources in each of the transactions, rather than relying on time consuming and expensive employee surveys and numbers. The key input used in this model is time or capacity required to carry out an activity that can be anything like processing an order, servicing the customer or performing a production run which is both easier to use and inexpensive than ABC (Kaplan & Anderson, 2007). For the strategic costing purposes of a Time Driven Activity Costing Technique, the organisations require accuracy higher than precision. For example, when reading numbers, it was acceptable to accurately know the first digit, estimate the second digit and then follow it with zeros and decimals. While estimating numbers and investing less expenses and effort, Time Drive Activity Costing shows that a high level of accuracy and precision can still be obtained. There are also other reasons why organizations emphasize less on precision of the required data and information. First, many organizations use direct observations and sometimes employee surveys as seen from ABC to take measurement that incurs less cost. Here management calculates the average time per transaction from a specific number of transactions (~50-100 transactions considered). Tools such as stopwatches are manually used to calculate the time, which shows how precision in these cases are not expected as stopping the watch is susceptible to the variability of when the watch is stopped by the user as it can take a few more or less seconds. In conventional ABC, the company usually does not expect the employees to precisely state the proportion of time spent in each activity when filling out employee surveys as it is both cumbersome and time consuming to keep track of the time spent on multiple activities; therefore the result would require less precision. Even Time Based Activity costing is based less on precision as the calculation of the standard time for the specific steps in a process such as the time to perform a credit check or entering an item or placing an order is estimated as the results are different for different people. While the difference may not be drastic, expectation of precision is not desirable. It is clear that Time Driven Activity Costing is more prone to be approximately right instead of precisely wrong as the emphasis is less precision instead of making sure the time estimates line up perfectly with actual events (Kaplan & Anderson, 2003). Transaction characteristics also require less precision when estimating time. When asking about the time spent in a production order between a routine and an expedited order, the result would be the average of both estimations, which cannot be expected to be precise as the time to implement the order differs between the two methods. This same situation can also be applied when serving a customer as a standard or complex order would vary in time. In shipping, an employee may handle both the domestic and international shipping, but when asked on the time spent, the time would depend on the estimation of both varying factors. Usually, many companies estimate the time spent in a one-year period and if a major modification occurs in any of the processes, the time is re-estimated to reflect the modification in the costing approximation. Managers use information systems to capture the actual time consumption data for each transaction, which is reflects random variation in the type of task, individual variation among employees and some more non-recurring factors. As a result, this data would be less accurate as it would include the extreme cases, which occur in rare cases. Rather, it would be better to estimate the time from observation or interview instead of using the actual time consumption data. For example, if an employee starts an order in the afternoon and completes it in the following morning: the management’s information system would show about 17-18 hours of consumption when in reality the order may have taken only 30 minutes to complete: 15 minutes in the afternoon, and 15 minutes the next morning (Woodbury University, n.d.). Precision is less significant: In the light of other Management Accounting Tools One of the largest differences between management accounting and financial accounting in terms of decision-making is the emphasis on precision; in other words, precision for management accounting is less important than the quality and timeliness of the data. As management would require information quickly to make the right decisions, it can be assumed that the managers would value the speed of reporting higher than the immediate level of precision; therefore, the approximated numbers in management accounting are more significant and useful than the precise numbers. While this does not imply that financial accounting data is very precise, this shows that estimation in management accounting is used more broadly than that used in financial accounting. As management accounting is used for both short term and long-term decision-making, the reporting speed is also different that that in financial accounting. For short-term decisions, management would naturally require the data to be more frequent. In most of the large organisations, management accounting reports are generated monthly while information can also be obtained weekly or even daily (Khan & Jain, 2006). As the managers would like the information at a real time basis, it is inferable that precision would not be the ultimate goal nor would it be a significant factor in the decision making process. Rather an estimation of the information that is reported promptly would be more appropriate. Management accounting reports include information that is vital and essential to decision making that they would naturally be expected as soon as possible. It is shown how the time constraint and the speed of reporting can be more imperative than data precision. The following table shows the financial statement items and the related management accounting tools. To manage the cash there are cash budget and capital budgeting models. All these tools require a proper estimation of cash inflow and cash outflow. Even in these estimations, precision is not expected. For example, as cash inflow in an organisation could be around several millions it is common to precisely know the first three to four digits while approximating the subsequent numbers. Second, a lot of the data also estimates future data, which naturally cannot be expected to be precise. Forecasted or projected future data can’t be precisely correct instead they are rightly approximated. Table: Financial Statement Items and Management Accounting Tools (Source:Micro Business Publications, n.d., p.22) One significant management accounting tool is variance analysis. Variance is calculated as the difference between the estimated budget and the actual budget. While the actual budget includes precise values, the estimated budget includes approximation of all the required data. Therefore, even in this case, precision is less significant as estimated data would be used (Laney College, 2008). In addition to the differences in the types of uses between financial accounting and management accounting reports, they also differ on how they place importance on the use of past and future data. Planning is a significant task for management; as a consequence, management accounting has a very strong use for making future predictions. On the other hand, financial accounting mostly concentrates on the past historical data to predict for trend and patterns from the financial statements; however, only examining and analyzing past financial data makes financial accounting limited it its use. Factors such as a changing economy and business conditions and an increase and decrease in market demands, on top of the financial statements, also play a significant role in future prediction. Future prediction would not only reflect past data but also the changing economic and business conditions. As financial accounting is appropriate for being objective and analytical with past financial data its inability to evaluate economic and market conditions places it as a disadvantage to management accounting. These changes in economy and business environment urge the manager’s future planning be based on a large part of estimation of future events. It will be more important to a manager to have information with a relevant approximation of financial data and economic behaviour than just strictly analytical past data for decision making. For example, to predict whether the sales volume for a new store will be successful, a manager would not just use past financial data but also would find past and current market and economic data to approximate future performance to be valuable. Estimation instead of precise data may be more appropriate and helpful in decision-making. The management accounting information system is flexible enough to offer the relevant data for particular decisions (Chadwick, 1993). Prompt estimation would be more significant for managers than time-consuming precision of data and information. If a decision is to be made quickly, a manager would rather have a good estimation now than wait for a more precise answer that might take twice as long. In addition, as being precise is both more expensive and time consuming, management accounting will unsurprisingly place less emphasis on precision than other significant factors. For example, a decision, involving millions of dollars, can be made from logical approximations instead of having to be precise and correct to the last penny. As long as the estimations are done well and are relevant to the certain situation, it will allow the manager to make crucial decisions (Murthy, 2009). Finally, management accounting also emphasizes less precision as it also uses and analyzes non-monetary and non-quantitative data that are useful for managers. As financial accounting is limited in strictly analyzing numerical and monetary values, management accounting’s flexibility and capability in analyzing different forms of data through information systems would be more effective. For example, customer service levels are of tremendous significance to management; however it would be difficult to express the relevant data in monetary form. Therefore, the data used in this category is of qualitative nature, which cannot be expected to be precise. Even when analyzing non-monetary data, it shows that the importance of precision in management accounting is not always desirable (Atrill & McLaney, 1994). Conclusion Traditionally, cost accounting used to be known as the technique to accumulate cost of a specific product or service; however, with the changing business environment, the scope of cost accounting has now been extended further to the accumulate and analyze a variety of information that helps executives to fulfil organizational goals. With the advent of modern cost accounting, also called management cost accounting, the focus has shifted more towards relevance than on the precision and as approximate data and information has become more effective, less time consuming and inexpensive for managers. It was also discussed that management accounting reports would be suitable for decision makers as they can be generated quickly compared to financial accounting reports that wont be able to generate high precision data in a short time. Furthermore, when it comes to forward planning and using other non-quantitative data, it has been shown that the need for precision isn’t essential. So, it would not be wrong to say that for managers to make the best decisions for their company, having precise data is not always the best option. Reference Akyol, E. D., Tuncel, G. & Bayham, M. G. 2005. A comparative analysis of activity-based costing and traditional costing. [Pdf]. Available at: http://www.waset.org/journals/waset/v3/v3-11.pdf [Accessed on December 16, 2010]. Atrill, P. & McLaney, E. 1994. Management accounting: an active learning approach. Australia:Blackwell Publishing. Anbuvelan, K. 2005. Management Concepts for Civil Engineers. Laxmi Publication. Chadwick, L. 1993. Management Accounting. New York: Routledge. Giri, N. & Ronen, B. 2005. Relevance lost: the rise and fall of activity-based costing. [Pdf]. Available at: http://www.boazronen.org/PDF/Relevance%20Lost%20-%20The%20Rise%20an`d%20Fall%20of%20Activity%20Based%20Costing.pdf [Accessed on December 17, 2010]. Kaplan, S. R. & Anderson, R. S. November, 2003. Time-Driven Activity-Based Costing. [Pdf]. Available at: http://www.hbs.edu/research/facpubs/workingpapers/papers2/0304/04-045.pdf [Accessed on December 24, 2010]. Kaplan, S. R. & Anderson, R. S. 2007. Time-driven activity-based costing. Harvard Business School Publishing Corporation. Khan, Y. M & Jain. 2006. Management Accounting. 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