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Chapter 1 What Is Managerial Accounting? Dana Matthews is the president of Sportswear Company, a producer of hats and jerseys for fans of several professional sports teams. Imagine you are the accountant in charge of all accounting functions at Sportswear. Dana just reviewed the financial statements for the most recent fiscal year for the first time and has the following conversation with you: I just reviewed our most recent financial statements, and I noticed we did not do as well as we had planned. I would like to look more closely at the profitability of each of our products to determine exactly what happened, but I don’t have President- this information in the financial statements. Is there a reason we don’t include (Dana): this in the financial statements? Yes, the financial statements are prepared following U.S. Generally Accepted Accounting Principles (U.S. GAAP) and are intended for outside users, such as owners, banks, and suppliers. U.S. GAAP does not require us to disclose
profitability by product, and we prefer not to make this information public. Product profitability information stays in-house and is prepared by our Accountant: managerial accountant, Dave Hicks. That makes sense. Can you have Dave pull together product profitability information for the past year so we can take a close look at which products are President: doing well and which are not? Accountant: You bet. We’ll have the information for you early next week. Saylor URL: http://www.saylor.org/books Saylor.org
managerial accountants? Answer: Financial accounting focuses on providing historical financial information to external users. External users are those outside the company, including owners (e.g., shareholders) and creditors (e.g., banks or bondholders). Financial accountants reporting to external users are required to followU.S. Generally Accepted Accounting Principles (U.S. GAAP), a set of accounting rules that requires consistency in recording and reporting financial information. This information typically summarizes overall company results and does not provide detailed information. Managerial accounting focuses on internal users—executives, product managers, sales managers, and any other personnel within the organization who use accounting information to make
important decisions. Managerial accounting information need not conform with U.S. GAAP. In fact, conformance with U.S. GAAP may be a deterrent to getting useful information for internal decision-making purposes. For example, when establishing an inventory cost for one or more units of product (each jersey or hat produced at Sportswear Company), U.S. GAAP requires that production overhead costs, such as factory rent and factory utility costs, be included. However, for internal decision-making purposes, it might make more sense to include nonproduction costs that are directly linked to the product, such as sales commissions or administrative costs. Saylor URL: http://www.saylor.org/books Saylor.org
be a managerial accounting function. Another characteristic of managerial accounting data is its high level of detail. As noted in the opening dialogue between the president and accountant at Sportswear Company, the financial information in the annual report provides a general overview of the company’s financial results but does not provide any detailed information about each product. Information, such as product profitability, would come from the managerial accounting function. Finally, managerial accounting information often takes the form of nonfinancial measures. For example, Sportswear Company might measure the percentage of defective products produced or the percentage of on-time deliveries to customers. This kind of nonfinancial information comes from the managerial accounting function.
Table 1.1 "Comparison of Financial and Managerial Accounting" summarizes the characteristics of both managerial and financial accounting. Saylor URL: http://www.saylor.org/books Saylor.org 6 Table 1.1 Comparison of Financial and Managerial Accounting Managerial Accounting Financial Accounting
Often presents segments of an organization (e.g., Presents overall company information in Level of detail products, divisions, departments) accordance with U.S. GAAP Performance measures Financial and nonfinancial Primarily financial Follow-Up at Sportswear Company
Question: What did the president at Sportswear Company learn about product profitability from the information provided by the managerial accountant? Answer: The president at Sportswear, Dana Matthews, learned that the hats product line was much more profitable than expected, accounting for 55 percent of the company’s profits even though initial estimates were that the hat segment would account for 40 percent of company profits. Conversely, the jerseys product line was much less profitable than expected, accounting for 45 percent of the company’s profits. There are many issues associated with determining product profitability, including how to allocate costs that are not easily traced to each product and whether the product revenue and cost
information for decision making, planning, and control purposes. R E V I E W P R O B L E M 1. 1
- Suppose you are the co-owner and manager of a retail store that sells and repairs mountain bikes. Provide one example of a financial accounting report that would be useful to you and your co-owner. Provide two examples of managerial accounting reports that would be useful to you as the manager.
- Provide two examples of nonfinancial measures used by a pizza eatery that serves food in the restaurant and offers delivery services.
- For each report listed in the following, indicate whether it relates to financial or managerial accounting. Explain the reasoning behind your answer for each item.
- Projected net income for next quarter by division
- Defective goods produced as a percentage of all goods produced
- Income statement for the most current year, prepared in accordance with U.S. GAAP
- Monthly sales broken down by geographic region
- Production department budget for the next quarter
- Balance sheet at the end of the current year, prepared in accordance with U.S. GAAP Solution to Review Problem 1.
- Financial accounting reports provided to owners typically include the income statement, statement of owners’ equity, balance sheet, and statement of cash flows. All are prepared in accordance with U.S. GAAP. Managerial accounting
Saylor.org 8 customer’s table), and results of customer satisfaction surveys. (These are just a few examples. There are many correct answers to this problem.)
- The answers appear as follows. Be sure you explained your answers.
- Managerial accounting—information is for future projections and involves segments of the company
- Managerial accounting—nonfinancial detailed measure of defective products
- Financial accounting—historical information prepared in accordance with U.S. GAAP
- Managerial accounting—detailed information provided monthly
- Managerial accounting—information is for future projections and involves a segment of the company
- Financial accounting—historical information prepared in accordance with U.S. GAAP Saylor URL: http://www.saylor.org/books Saylor.org 9 1.2 Planning and Control Functions Performed by Managers L E A R N I N G O B J E C T I V E
Question: Continually planning for the future is an important quality of many successful organizations, such as Southwest Airlines (discussed in Note 1.11 "Business in Action 1.1"). How do organizations formalize their strategic plans? Answer: Organizations formalize their plans by creating a budget, which is a series of reports used to quantify an organization’s plans for the future. For example, Ernst & Young, an international accounting firm, plans for the future by establishing a budget indicating the labor hours required to perform specific services for each client. The process of creating a budget for each client enables the firm to plan for future staffing needs and communicate these needs to employees of the company. Rather than simply hoping it all works out in the end, Ernst & Young projects the labor hours required in the future, hires accounting staff based on these
projections, and schedules the staff required for each client. A budget can take a variety of forms. A budgeted income statement indicates a profit plan for the future. A capital budget shows the long-term investments planned for the future. A cash flow Saylor URL: http://www.saylor.org/books Saylor.org 10 budget outlines cash inflows and outflows for the future. We provide more information about how budgets can be used for planning purposes in later chapters. Business in Action 1.
