The Significance of Management Accounting to Manufacturing Firms
Many small-business owners would much rather have their hands dirty in their own business than be learning accounting techniques. However, management accounting is integral to the operation of manufacturing firms because it provides cost information necessary for decision making. Understanding some of the benefits of management accounting to your manufacturing company can help make completing your accounting records each month a little less painful.
Without product costing techniques, managers would not have a systematic way to determine how much cost is incurred when producing products. Costing information is used for inventory valuation and external reporting. In addition, product costs are also used to determine selling prices and to monitor manufacturing performance. The exact method used for product costing differs depending on the type of product manufactured. However, managers typically choose from job-order costing and process costing. Job-order costing is used when a company produces items in batches. This technique allows companies to assign costs to products based on the batch in which the product is manufactured. Process costing is used at companies where manufacturing occurs constantly. At companies that use process costing, costs are assigned to products in each part of the production process.
Generally accepted accounting principles, or GAAP, require that all costs of production are assigned to products. When the number of products produced differs from the number sold, this requirement causes a distortion in the reported net income of the company. The effect of this distortion causes net income to be inflated when more products are produced than sold. Variable costing, a management accounting technique, allows small-business owners to adjust typical net income figures to remove this distortion. This adjusted figure, known as variable costing net income, provides a better measure of performance when inventory balances are fluctuating significantly.
When manufacturing companies produce goods, the costs of production can be higher than expected for two reasons. First, the company could have used more inputs than expected. For example, if your company makes coffee tables, you may have used more lumber than expected. In addition, the inputs to your product may cost more than planned. For example, if one of your employees calls in sick, you might end up paying overtime to cover the shift. The number of hours used in production is the same, but the wage is higher. When only one of these scenarios happens, it is easy to figure out how much of an effect the change had on profitability; when they happen simultaneously, it isn't as simple. Variance analysis, a management accounting technique, provides a systematic framework for splitting differences from the expected cost of production into price and quantity variances, allowing managers to better manage differences from expected costs.
Management accounting helps small-business owners determine which products they should be in the habit of manufacturing in the first place. Manufacturing firms often have discretion in determining whether to build a product from scratch or to buy certain components of the product preassembled. Management accountants use a technique called differential cost analysis to perform an analysis of these decisions. By only examining costs that differ between the choices, managers can objectively evaluate make or buy decisions. Without this managerial accounting technique, small-business owners could get caught up in costs that are irrelevant to the decision.