Management accounting principles
Management accounting principles were developed to serve the core needs of internal management to improve decision support objectives, internal business processes, resource application, customer value, and capacity utilization needed to achieve corporate goals in an optimal manner. Another term often used for management accounting principles for these purposes is managerial costing principles. The two management accounting principles are:
- Principle of Causality and,
- Principle of Analogy.
The framework of principles, concepts, and constraints will drive the classification of management accounting practices in the profession to "enable a better understanding both inside the profession and outside, of the compromises that result from inappropriate principles". Without foundational principles, managers and accounting professionals have no consistent footing on which to challenge or evaluate new theories of methods for managerial costing.
Some management accounting methods are designed primarily to serve and comply with financial accountancy guidelines. The importance of having distinct and separate principles exclusively for Management Accounting has received support and acknowledgement after almost a century of work on the topic. The idea that separate management accounting principles exist for managerial decision support distinct from financial reporting needs is now recognized by professional accounting bodies such as the International Federation of Accountants and the Institute of Management Accountants .
Brief History
Prior to 1929 no group – public or private – was issuing or responsible for any accounting standards. After the 1929 stock market crash, a call to regain the public's confidence and investor's trust was demanded and the Securities and Exchange Act of 1934 was passed resulting in public companies being supervised by the U.S. Securities and Exchange Commission . This set the groundwork for GAAP Generally Accepted Accounting Principles, outlining financial accounting principles for external reporting standards for users of financial statements' information such as capital markets and creditors.Over the next 47 years many individual committees, professional bodies and boards released various financial accounting procedural frameworks until 1976 when work began on a US framework that remains in place today, governed by the Financial Accounting Standards Board.
Note: Since April 1, 2001 the International Accounting Standards Board has been working on developing new international financial reporting standards. The new standards, referred to as International Financial Reporting Standards, aim to update and refine existing concepts and provide descriptive guidance that includes comparisons of reporting requirements between and U.S. GAAP. As a result of establishing International Financial Reporting Standards, the and Conceptual Frameworks and Standards are in the process of being updated and converged to reflect the changes in markets, business practices and the economic environment that have occurred in the two or more decades since the concepts were first developed. One of the foundations of a set of Financial Accounting Standards is the creation of a Conceptual Framework that defines the principles upon which the standards will be based. Most major national and international accounting standards have developed conceptual frameworks to support their work on setting standards.
In contrast, management accounting principles have been overlooked from both a conceptual and a standards point of view and, for the most part, overshadowed by financial accounting standards. Generally accepted accounting principles applies strictly to financial accounting because it was either the only guidance they had at the time, or did not know what else to do.
Until recently, no serious work has been done by the accounting profession on the conceptual differences between the use of management accounting techniques to support GAAP financial reporting and management accounting techniques used for internal decision support. This greatly compromises the management accounting practice and the ability of management accountants to provide managers with relevant decision support and optimization information. Yet, several innovative thinkers, shown in the Timeline below, saw value in management accounting having its own distinct set of principles. Over the last century it is more and more evident that management accounting principles be viewed as "indispensable to the evaluation and improvement of MA methods and practices".
Historical timeline
- the use of financial accounting criteria to judge the quality of management accounting systems,
- the assignment of management accountants to subordinate positions in organizational units whose primary purpose was financial accounting,
- the dominance of financial accounting in the market for educational materials,
- the judgment of the labor market that a financial accountant could replace a management accountant and,
- the need for a young profession to gain and retain the support of established interests in society.
Importance and objectives
The first principal part deals with the actual modeling of a company's operations, where the management accountant establishes and builds causal relationships based on the principle of causality and related management accounting concepts. Part two involves the principle of analogy and the manager's analytical needs for decision support information provided by part one. Part two requires analyzing the information in light of one or more decision alternatives so that the decision maker can reach the optimum decision. The cumulative application of both principles achieves management accounting's objectives and fulfills the managers' needs – the optimization of the company's operations, generally referred to as enterprise optimization.
First objective - managerial costing is:
- To provide a monetary reflection of the provision and utilization of business resources and,
- To provide cause and effect insights into past, present, or future enterprise economic activities.
- In their planning, analysis, and decision making and,
- Supports optimizing the achievement of an enterprise's strategic objectives.
- Provide managers and employees with an accurate, objective cost model of the organization and cost information that reflects the use of the organization's resources.
- Present decision support information in a flexible mold that caters to the timeline and insights needed for internal decision makers.
- Provide decision makers insight into the marginal/incremental aspects of the alternatives they are considering.
- Model quantitative cause and effect linkages between outputs and the inputs required to produce and deliver final outputs.
- Accurately values all operations of an entity in monetary terms.
- Provides information that aids in immediate and future economic decision making for optimization, growth, and/or attainment of enterprise strategic objectives.
- Provides information to evaluate performance and learn from results.
- Provides the basis and baseline factors for exploratory and predictive managerial activities
Truth as the foundation
Philip Lawton, investment professional and co-author of The Top Ten Operational Risks: A Survival Guide for Investment Management Firms and Hedge Funds writes
The Correspondence theory of truth was originally defined by Aristotle; however, a simpler and more up-to-date definition is: "A statement or opinion is true if what it corresponds to is a fact." The correspondence definition of truth forms the foundational building blocks for management accounting's principles. In this regard, the foundation of MAP is grounded in the laws of logic and structured reasoning outlined and discussed at length in the Management Accounting Philosophy series published in Cost Management. The recognition of truth as the basis for management accounting goes back a long way.
This emphasis on truth should not be confused with precision; it should be clear that costing methods are disputable, while principles are not. Principles support managers who are required to make inferences about future outcomes of all the decision alternatives they are considering based on cause and effect insights. The use of principles enables managers to deal with causes and their effects in different time frames. This is not to say that management accounting is a science, it is not. But Decision science —that which management accounting supports, with the information it provides — is a science
The growth of management accounting and its practices as outlined in Management Accounting – Approaches, Techniques and Management Processes, mentions that management accountants remain dissatisfied with the quality of their management accounting information in the absence of guiding principles. This disconnect is clearly documented in research such as the 2003 Survey of Management Accounting by Ernst & Young LLP; co-sponsored by IMA and the follow up survey 2012 Alta Via, SAP, and IMA Management Accounting Survey: A Replication and Longitudinal Comparison. Confusion and frustration took hold of the MA profession partly because accountants were trying to satisfy two very different goals with one information system; the compliance needs of financial reporting alongside managerial costing decision analysis needs. In addition, controllers, accountants, and managers who were seeking to improve operations or resolve internal costing issues discovered that when selecting different costing methods, each one subscribes to assorted allocation techniques and produces very different results. And finally, the lack of a conceptual framework and foundational principles that previously did not exist in order to do costing for internal decision support.
Contradicting theories and practices do not instill trust or truth towards the optimization of an entity. Foundational principles are intended to drive the classification of approaches, tools, and processes, thereby providing a way for accountants and managers to evaluate the tools and approaches they may be considering for the decision or costing tasks at hand. The principles function as a way of better understanding the risks and compromises associated with a practice or method when it strays from the principles of causality and analogy.
Not GAAP
Companies need to identify the economic reality of their organization based on resources and operations, not reflect dollar values calculated using accrual-based accounting methods that conform to Generally Accepted Accounting Principles. Accountants may argue that financial accounting principles represent true values and are more than sufficient for management accounting purposes. Maximizing financial statement results is a primary objective; however, focusing only on accounting numbers or common financial ratios can lead to bad behavior versus focusing on operations and resource use for long term sustainable economic success.By examining two of the four financial accounting principles, it will reveal that financial accounting principles do not serve the objectives of management accounting. Let's examine the following two GAAP principles:
The two financial accounting principles noted above briefly describes the chasm that exists between financial accounting and managerial accounting objectives. Financial accounting's objective is to produce a coherent set of standards for consistency and comparability purposes; therefore, providing external parties in the capital markets, a level playing field for evaluating a company's individual performance as well as across other competing businesses. Where Management accounting's objectives exist is to inform internal managers of the correct choices for long term economic success.
As discussed with Larry R. White, task force member of the Managerial Costing Conceptual Framework, in ,
Concepts and Constraints
Principles
Management accountants can rely on causality and analogy as foundational principles as they are grounded in decision science – the laws of logic.Principle of Causality enables modeling the organization's costs based on the relationship between the inputs and outputs of the resources involved in the production of products and services it provides. Often this is straightforward when dealing with strong causal relationships. However, where weaker causal relationships exist, costs need to be attributed according to the concept of attributability, which maintains the integrity of causality.
Principle of Analogy governs the user of management accounting information's ability to apply the knowledge or insights gained from the causal relationships modeled using inductive and deductive reasoning about past and future outcomes for continuous optimization efforts.
Concepts
The following concepts serve as operational guidelines and modeling building blocks to the two main principles in developing a reflective cause & effect model and then using the information the model provides. These concepts are intended to cover a variety of assumptions that would make up a model, their characteristics, and relationships and to provide rational perspectives when modeling many managerial costing issues.The first ten concepts support the Principle of Causality the modeling of Cause&Effect-based modeling principles, while the remaining four concepts are applicable to the Principle of Analogy and informational in nature and supports managers with decision making guidelines.
- Attributability
- Capacity
- Cost
- Homogeneity
- Integrated data orientation
- Managerial objective
- Resource
- Responsiveness
- Traceability
- Work
- Avoidability
- Divisibility
- Interdependence
- Interchangeability
Constraints
- Materiality
- Measurability
- Objectivity
- Verifiability
- Congruence
- Impartiality