Accounting Systems for Managerial Decisions

This article provides a foundation for the basic accounting equation and how different types of accounting processes assist managers in making decisions. Financial accounting and managerial accounting are defined and compared and contrasted. There are nine different types of accounting transactions that can take place as a result of the basic accounting equation. However, only five of the nine transactions have a common effect on the accounting equation. The objective of financial accounting is to provide information to external decision makers, whereas, the objective of managerial accounting is to provide information to internal decision makers. There are two types of techniques utilized by decision makers in the planning process, and they are cost/value/profit (CVP) analysis and financial budgeting.

Keywords Accounting; Accounting Systems; Assets; Financial Accounting; Generally Accepted Accounting Principles (GAAP); Liabilities; Managerial Accounting; Owners' Equity; VisiCalc

Accounting > Accounting Systems for Managerial Decisions

Overview

Being familiar with financial transactions and their effects on financial reports can help accounting professionals with creating new reports that will assist decision makers, developing financial strategies in response to what may occur in the future, creating methods of filing and tracking financial information, automating financial records, and filing the required income taxes (Page & Hooper, 1985). If a business or individual is involved in any type of activity that requires money, there will be a need to keep detailed and accurate records on the financial operations of all activities that transpire. Businesses are accountable to entities such as boards of directors, creditors, and various governmental agencies. Individuals tend to report information to banks and other creditors. Both businesses and individuals must report to the Internal Revenue Service at least once a year. The reports prepared tend to give the reader an idea of the financial state of the businesses or individual's affairs. Basically, the reports tell a story of how the money is being managed. The process of collecting the financial information and preparing a report has been referred to as financial accounting.

Financial Accounting

Financial accounting focuses on preparing financial statements for external decision-makers such as banks and government agencies. The primary purpose of the field is to review and monitor an organization's financial performance and report the results of the evaluation to potential stakeholders. Financial accountants are expected to create financial statements based on Generally Accepted Accounting Principles (GAAP). Financial accounting exists in order to: Produce general purpose financial statements, provide information to decision makers in the accounting field, and meet regulatory requirements.

Acquiring & Creating Resources

Businesses are responsible for two tasks -- acquiring financial and productive resources and combing the two resources in order to create new resources. Acquired resources are called assets, and the different types of assets are called equities. Therefore, the foundation for the basic accounting equation is "Assets = Equities." However, since equities can be divided into two groups, the basic accounting equation can be revised to read as "Assets = Liabilities + Owners' Equity."

• Assets. Although assets consist of financial and productive resources, not all resources are considered to be assets. In order to determine if a resource is to be considered an asset, it must satisfy all three of the following criteria:
• The resource must possess future value for the business. The future value must take the form of exchange ability (i.e. cash) or usability (i.e. equipment).
• The resource must be under the effective control of the business. However, legal ownership is not mandatory. As long as the resource can be freely used in business activities, the resource will meet the asset criteria. An example would be a leased computer; although the organization may use the computer, legal rights still belongs to the leasing company.
• The resource must have a dollar value resulting from an identifiable event or events in the life of the organization. The value assigned to the asset must be tracked to an exchange between the organization and others (Page & Hooper, 1985).

If the resource does not meet all of the criteria, it cannot be reported as an asset.

• Liabilities. When someone other than the owner provides an organization with an asset, the claims against the business take the form of a debt. Sources of assets from someone other than the owner are referred to as liabilities. Liabilities are the debts and legal obligations that a business incurs as the result of acquiring the assets from non-owners.
• Owners' Equity. Some businesses may obtain assets via owner investment or sale of stock. When the owner supplies the organization with assets, the claim against those assets is called owners' equity (or stockholders' equity) in a financial report.

When a business accepts assets from a source other than the owner, it can be reported as a liability or owners' equity. However, there are some differences between these two sources.

Basic Accounting Equation Transactions

There are nine different types of accounting transactions that can take place as a result of the basic accounting equation. However, only five of the nine transactions have a common effect on the accounting equation. These transactions are:

• Increase in assets and decrease in assets (i.e. when an organization collects money that is owed to it, there is an increase in cash and a decrease in accounts receivable).
• Increase in assets and increase in liabilities (i.e. when an organization borrows money, there is an increase in cash and notes payable).
• Increase in assets and increase in owners' equity (i.e. when an owner invests money in the business, there is an increase in cash and owners' equity).
• Decrease in assets and decrease in liabilities (i.e. when a business pays off a loan, there is a decrease in cash and notes payable).
• Decrease in assets and decrease in owners' equity (i.e. when an owner decides to withdraw some assets from the business, there is a decrease in assets, usually cash, and a decrease in owners' equity since they tend to use the withdrawal for personal use).

Although organizations tend to focus a lot of time preparing financial reports for external stakeholders, the demands of an organization's management team are equally important. This group of individuals is responsible for providing direction to the organization. Therefore, it is crucial that they have access to the most up to date information regarding the organization's financial status. Therefore, the organization tends to select an accounting system that would provide the management team with information that will assist and validate why they make certain decisions. The process of providing the management team with financial information that will assist in decision making is referred to as managerial accounting.

Managerial Accounting

Managerial Accounting is an internal function that focuses on using present financial information to anticipate and predict future events. All types of organizations can benefit from the use of managerial accounting information. The information obtained may assist organizations with their mission statement, vision, goals and objectives. Some of the major objectives of managerial accounting are:

• Provide information to decision makers so that they can plan for the future.
• Direct and control the daily operational activities of an organization so that they can produce a quality product or service. Managers need information on the cost of providing products and services so that the organization can set the appropriate prices. Also, managers can use the accounting information to compare the actual costs to the projected costs of a product or service.
• Guide managers to areas that may be problematic for the organization.

Financial Accounting versus Managerial Accounting

The objective of financial accounting is to provide information to external decision makers, whereas, the objective of managerial accounting is to provide information to internal decision makers. Although both areas need to use an organization's accounting records, there are differences between the two areas of accounting.

An organization's management team has the ability to create any type of internal accounting system. However, cost may be a key factor in deciding what type of system will be selected. The type and amount of information that needs to be stored is another factor in selecting the most appropriate information system.

Both financial and managerial accounting are bound by the Foreign Corrupt Practices Act. This act is a "U.S. law forbidding bribery and other corrupt practices, and requiring that accounting records be maintained in reasonable detail and accuracy, and that an appropriate system of internal accounting be maintained" (Horngreen, Stratton, & Sundem, 2002, p. 7). In summary, Drury (1996) stated that managerial accounting focuses on the provision of information to people within the organization so that they can make better decisions, whereas, financial accounting emphasizes the need of an organization to have the ability to provide financial information to stakeholders outside of the organization.

Application

Managerial Accounting

Techniques for the Planning Process

There are two types of techniques utilized by decision makers in the planning process, and they are cost/value/profit (CVP) analysis and financial budgeting. An organization's income and profit is based on the structure of its revenues and costs as well as the volume of activity that it achieves.

CVP Analysis

The CVP analysis is the decision making model that most managerial accountants utilize when predicting future actions. Decisions, such as pricing of products and services, selecting the appropriate advertising strategies, and deciding on which markets to enter, can be determined using this model. Page and Hooper (1985) determined that the steps in the cost/volume/profit analysis are as follows:

• Study cost behavior as volume changes and classify all costs as variable or fixed. Some costs may be classified if one understands the nature of the cost while other costs may need to the accountant to examine the organization's data on past activities in order to determine the amount of each cost at different volume levels and how each cost changed as volume changed.
• Determine total fixed costs (TFC) and variable cost per unit (VPU). Add up the total amounts of all costs classified as fixed to get the TFC. Divide the amounts for each variable cost by the level of volume at which that cost was incurred to get the per unit amount for each variable cost. Then add the individual variable costs per unit to get the VCU for the business.
• Calculate contribution margin per unit (CMU). The selling price per unit of product or service should be available from the organization's records and CMU=SPU-VCU. CMU provides the amount left over from the sale of each unit after the direct costs of the unit are covered.
• Determine before-tax target profit (BTP). This figure would be the after-tax desired profit of the business divided by the applicable income tax rate of the organization.
• Add TFC and BTP and divide the amount by CMU to get the number of units of product or service that must be sold to cover all costs and provide the desired profit for the business after taxes.

The CVP model is very versatile and can show the accountant the effect on the business given any change in one of the key variables in the equation.

The CVP model can be a powerful tool for managerial accountants because it allows one to evaluate different courses of action and see what their results would be before implementing a decision. Also, by looking at the relationship between the key variables, the accountant has the ability to analyze the total impact of a decision on the organization. However, it must be noted that the usefulness of the CVP model is dependent on the accountant's ability to properly classify the costs of the organization as variable or fixed. If one does not fully comprehend the organization's cost behavior patterns, errors can be made in the decision making process. On a positive note, an organization's information system can assist in documenting and storing the necessary information over a period of time.

Financial Budgeting

The second technique is financial budgeting. Financial budgeting is the function that connects a manager's ability to plan and control the process. The financial budget is a summary of the manager's decision making process for a particular project. It will show the overall impact of all of the possible alternative decision making ideas. The projected financial statements are referred to as the master budget of the organization. The master budget becomes the standard benchmark with which all future performance will be measured and evaluated.

The master budget has three components that may influence an organization's future.

• Profit Plan - An income statement projected over a future period.
• Cash Budget - A statement of budgeted cash flows could be in many forms and may cover any period of timed deemed important by the managers. Most organizations will budget cash on a monthly basis to make sure that there is ample funds available to meet short term needs such as payroll and accounts payable.
• Budgeted Balance Sheet - This statement summarizes everything by showing the final effects on the financial position of the organization based on the manager's decisions, assumptions and projections.
• The financial budgeting process can be accomplished by utilizing an information system to perform a spreadsheet analysis. This process will eliminate the need for paperwork. One popular software package is VisiCalc. VisiCalc was one of the first spreadsheet programs designed for microcomputers, and was created by Dave Bricklin and Bob Frankston.

Viewpoint

• Information Systems in Healthcare

According to Rogoski (2004), all expenditures and billings recorded will end up in the financial department. Unfortunately, most clinical applications and financial applications do not work together. They work independently, which causes duplication of efforts for the employees that have to process the information. As a result of this problem, some developers have created entirely integrated software; however, still others prefer to offer whatever is most effective at the time (best of the breed philosophy). Many chief financial officers are electing to do business with those organizations that create information systems that will satisfy their organization's needs. Top leaders such as Ron Bunnell, CFO of Banner Health, and Dan Deets, CFO of Hunterdone Healthcare, Inc., have found that as a result of integrated clinical and financial systems, they have increased access to the information necessary to reduce costs and improve efficiencies within the delivery of healthcare services. The integrated systems allow for improved tracking of both clinical and business initiative revenue. Having the ability to have access to all types of financial data has provided the CFOs mentioned above the opportunity to have more negotiating power when dealing with managed care contracts. There is an ability to monitor the relationships that these healthcare systems have with payers over a period of time. In addition, the integrated systems allow the healthcare organizations to identify weak areas that need to be improved so that they can increase their revenue.

Conclusion

Being familiar with financial transactions and their effects on financial reports can help accounting professionals with (Page & Hooper, 1985):

• Creating new reports that will assist decision makers
• Developing financial strategies in response to what may occur in the future
• Creating methods of filing and tracking financial information
• Automating financial records
• Filing the required income taxes.

Financial accounting focuses on preparing financial statements for external decision-makers such as banks and government agencies. The primary purpose of the field is to review and monitor an organization's financial performance and report the results of the evaluation to potential stakeholders. Managerial accounting is an internal function that focuses on using present financial information to anticipate and predict future events. All types of organizations can benefit from the use of managerial accounting information.

There are two types of techniques utilized by decision makers in the planning process, and they are cost/value/profit (CVP) analysis and financial budgeting. An organization's income and profit is based on the structure of its revenues and costs as well as the volume of activity that it achieves. The financial budgeting process can be accomplished by utilizing an information system to perform a spreadsheet analysis. This process will eliminate the need for paperwork.

Terms & Concepts

Accounting Systems: An organization's chronological list of debits and credits.

Assets: Those items owned by an individual or organization which hold economic value and have the potential to be converted to cash.

Financial Accounting: Purposed with alerting external stakeholders of a business’s performance through financial reports.

Generally Accepted Accounting Principles (GAAP): Established by the Financial Accounting Standards Board, is the body of regulatory parameters recognized in the reporting of financial information.

Liabilities: Total assets minus total owners' equity.

Managerial Accounting: Financial reporting that is aimed at helping managers to make decisions.

Owners' Equity: Total assets minus total liabilities.

VisiCalc: One of the first spreadsheet programs designed for microcomputers; was created by Dave Bricklin and Bob Frankston.

Bibliography

Alino, N. U., & Schneider, G. P. (2012). Conflict reduction in organization design: budgeting and accounting control systems. Academy of Strategic Management Journal, 11, 1-8. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=77929871&site=ehost-live

Drury, C. (1996). Management and cost accounting (4th ed.). London: International Thompson Business Press.

Fotache, G., Fotache, M., Bucsa, R., & Ocneanu, L. (2011). The changing role of managerial accounting in decision making process research on managing costs. Economy Transdisciplinarity Cognition, 14, 45-55. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90539750&site=ehost-live

Horngreen C. T., Stratton, W. O., & Sundem, G. L. (2002). Introduction to management accounting (12th ed.). New Jersey: Prentice Hall.

Page, J., & Hooper, P. (1985). Microcomputer accounting and business applications. Reston: Reston Publishing Company, Inc.

Rogoski, R. (2004). Investment pay off with financial information systems. Health Management Technology, 25, 14-17. Retrieved August 6, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=13924078&site=ehost-live

Thitiworada, S., & Phapruke, U. (2013). Best managerial accounting information system and firm performance: an empirical investigation of information technology and communication bussiness in Thailand. Review of Business Research, 13, 47-66. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=91830909&site=ehost-live

Suggested Reading

Brief, R., & Euske, K. (1988). Classifying and coding for accounting operations/decision support systems for management accountants. Accounting Review, 63, 721-723. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=4482727&site=ehost-live

Driver, M., & Mock, T. (1975). Human information processing, decision style theory, and accounting information systems. Accounting Review, 50, 490-508. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=4512328&site=ehost-live

Gordan, L., Larcker, D.; & Tuggle, F. (1978). Strategic decision processes and the design of accounting information systems: conceptual linkages. Accounting, Organizations & Society, 3(3/4), 203-213. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=12428951&site=ehost-live