Functions in management accounting

A cost and management accounting system should generate information to meet the following requirements. It should:  

allocate costs between cost of goods sold and inventories for internal and external profit reporting .
provide relevant information to help managers make better decisions.

Financial accounting rules require that we match costs with revenues to calculate profit. Consequently any unsold finished goods stock or partly completed stock (work in progress) will not be included in the cost of goods sold, which is matched against sales revenue during a given period. In an organization that produces a wide range of different products it will be necessary, for stock (inventory) valuation purposes, to charge the costs to each individual product. The total value of the stocks of completed products and work in progress plus any unused raw materials forms the basis for determining the inventory valuation to be deducted from the current period’s costs when calculating profit. This total is also the basis for determining the stock valuation for inclusion in the balance sheet. Costs are therefore traced to each individual job or product for financial accounting requirements in order to allocate the costs incurred during a period between cost of goods sold and inventories. This information is required for meeting external financial accounting requirements, but most organizations also produce internal profit reports at monthly intervals. Thus product costs are also required for periodic internal profit reporting. Many service organizations, however, do not carry any stocks and product costs are therefore not required by these organizations for valuing inventories.

The second requirement of a cost and management accounting system is to provide relevant financial information to managers to help them make better decisions. This involves both routine and non-routine reporting. Routine information is required relating to the profitability of various segments of the business such as products, services, customers and distribution channels in order to ensure that only profitable activities are undertaken. Information is also required for making resource allocation and product mix and discontinuation decisions. In some situations cost information extracted from the costing system also plays a crucial role in determining selling prices, particularly in markets where customized products and services are provided that do not have readily available market prices. Non-routine information is required for strategic decisions. These decisions are made at infrequent intervals and include decisions relating to the develop­ment and introduction of new products and services, investment in new plant and equipment and the negotiation of long-term contracts with customers and suppliers. Accurate cost information is required in decision-making for distinguishing between profitable and unprofitable activities. If the cost system does not capture accurately enough the consumption of resources by products, the reported product (or service) costs will be distorted, and there is a danger that managers may drop profitable products or continue the production of unprofitable products.

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