1.5 Managerial Accounting

The third basic flavor of accounting is managerial accounting. Recall that financial accounting involves communicating summary results to outsiders. Organizations also need to use information to make internal decisions. That internal information is the focus of managerial accounting.  Think of managerial accounting data as being the detailed, private information that is used internally to make daily decisions.

If you have ever been involved in any kind of organization, worked in a company, been involved with a charitable organization, you've used managerial accounting data. You might have provided input into managerial accounting reports. You have probably used managerial accounting reports. These data are not things that you're going to share with outsiders. See, financial accounting reports are intended to be shared with outsiders. Managerial accounting? No.

Let’s consider some examples of managerial accounting information. Let's say that I have got a wood furniture business. Somebody comes in and orders a custom-made oak table. Well, in order to make an intelligent decision about whether I should sell that table and at what price I should sell it, I need to know how much it costs me to make that table. So product costing is part of managerial accounting.

Another example of managerial accounting is breakeven analysis. Let's say I'm considering opening up a scuba shop at the local mall. Wow! That's a risky thing to do, but okay, go ahead, think about it, and one of the first things you should do is figure out how much you're going to have to pay your manager. Figure out how much you're going to have to pay for rent. And then figure out how many customers are going to have to come into the scuba shop each month for you to break even, to avoid losing money.

Budgeting is part of managerial accounting. Many start-up businesses have been killed because they just haven't made a budget, a numerical plan on paper. A cash budget, for example, allows you to see in advance, sometimes months in advance, when a cash shortage will occur. If the company prepares a cash budget, that cash shortage problem can be addressed, in advance. Without a budget, each day is a suspenseful, exciting, stress-filled adventure with no advance warning of approaching problems.

Performance evaluation is part of managerial accounting. Some employees are doing their jobs very well. Some employees are not doing so well. We want to reward the one and not reward the other. So we need a system in place to gather the data to evaluate different employees, products, and processes in our company.

Internal decision making also involves assembling data to make long-term decisions. This is called capital budgeting and is an important part of managerial accounting. Let's say I want to invest in a long-term project. I want to build a new factory facility in Rock Springs, Wyoming. It's going to last for 20 years. Well, that's a decision that's going to require the use of managerial accounting information. How much is it going to cost to buy the land? How much is it going to cost to buy the building and the machines? And what profits are we going to make and how long will the facility last? All those data would be brought to bear in making a decision to invest in a long-term project.

Managerial accounting also involves making special decisions such as whether to accept a special order, to drop a product line, or to outsource production. What about outsourcing production? Let’s say I've got a production facility right now in the central valley of California, but should I stop making my product here, in California, and outsource it? Maybe it can be made in Brazil. Maybe it can be made in Ethiopia. There are all kinds of possibilities.

Product costs. Breakeven analysis. Budgets. Performance evaluation measures. Long-term capital budgeting. Outsourcing decisions. These are the kind of internal decisions that are made using managerial accounting data.