Managerial accounting (cost accounting) - American businessManagerial accounting is sometimes called cost accounting. Unlike financial accounting, whose ultimate purpose is to report financial information about the firm to parties external to it, managerial accounting focuses on internal control and planning. While financial accounting is governed by generally accepted accounting principles (GAAP) to ensure accounting consistency among firms, managerial accounting need not conform to GAAP because it is used strictly internally.
Because of its emphasis on costs, managerial accounting is an excellent tool for internal decision making, budgeting, and planning. Drawing on microeconomics, managerial accounting makes use of budgets and costvolume-profit analysis to fully explore not only breakeven relationships but those volumes or activity levels necessary to generate target levels of profit.
In financial accounting, GAAP requires that the income statement use the report format, in which the firm’s expenses are organized by function, e.g., administrative expenses and selling expenses. In managerial accounting, the expenses are grouped according to cost behavior (fixed or variable), a type of income statement known as the contribution format. Income statements using this format are not generally accepted can be used only internally.
Following are examples of financial accounting’s report format and managerial accounting’s contribution format for the income statement.
In the contribution format, contribution margin is the revenue remaining after the variable expenses have been covered. The contribution margin must serve two purposes: to cover the fixed expenses and ultimately to contribute to net income. Once the fixed expenses are covered (that is, when the contribution margin is equal to the fixed expenses), all of any additional contribution margin goes directly to net income. In financial accounting, break-even occurs when the bottom line, net income, is zero. In managerial accounting, break-even occurs when the contribution margin is equal to the fixed expenses.
The following four formulas arise from the contribution format for the income statement and constitute the core of managerial accounting’s cost-volume-profit analysis.
Break-even point in units = FC/CM per unit
Break-even point in sales dollars (revenue) = FC/CM ratio
Units to be sold to earn a desired amount of net income
(DNI) = [FC + DNI]/CM per unit
Sales dollars (revenue) required to earn a desired amount
of net income = [FC + DNI]/CM ratio, where FC is the
firm’s total fixed costs, CM is the firm’s contribution margin
expressed in dollars, CM ratio is the firm’s contribution
margin expressed as a percentage of sales, and DNI is the
targeted or desired amount of net income.
These formulas give immediate answers to complex questions regarding break-even and other levels of volume or activity. This is why managerial accounting lends itself well to internal planning, control, and decision making.
See also break-even analysis.