Management accounting is simply accounting for the management. While financial accounting serves many outsiders and non managers inside the organization apart from managers, management accounting is exclusively for the management. It is aimed at assisting the management by providing information.
Management can be described as a series of activities aimed at achieving a particular result. Among the activities of the management, planning and control are the most important. Now let us see how management accounting can help in these two activities.
Planning is setting a goal and choosing a plan of action on how to achieve the goal. Let us consider an example to understand planning better.
Let us say X Ltd., which produces pencils, wants to increase its profits by Rs 10 lakhs. Now, to increase the profits what should be done? Either selling price should be raised or sales should be increased. The management feels that raising selling price will result in a fall in sales and therefore wants to increase sales. For this the following information is required:
1. How many pencils should be sold and at what price to earn the desired profit.
2. What will be the cost of producing of each extra pencil?
3. Does the Company have the required production capacity?
4. If machinery has to be acquired to increase production capacity at the present costs, how is it going to affect the cost of producing each pencil?
The information for answering these questions excepting (3) consists of estimates of future costs or revenues. Planning, as already said, involves setting a goal for the future and deciding on the plans for achieving it.
Once a plan of action is decided on, managers need to check up:
1. Whether the plan is being implemented as laid down and
2. Whether the actions taken in accordance with the plan are giving the desired results.
If (1) is not taking place, managers need to ensure that actions are in accordance with plans.
If (2) is the problem, either the plan should be revised to achieve the desired goals or the goals themselves have to be revised to attainable levels. This in essence is called controlling.
To understand the nature of information required for controlling, let us take the previous example a little further:
The management of X Ltd wants to know after six months of implementing the plan:
1. Are we producing enough number of pencils to meet the required sales? If not, why?
2. Are we selling at the required selling price? If not, why?
3. Are we producing at the cost we targeted? If not, why?
The answers to these questions require comparing the actual performance with the desired performance. The information required for both planning and controlling cannot be provided by financial accounting which is why management accounting is required.