Suite 1, 25 Westerton Road, Glasgow, G68 0FF

Blog

November 29, 2010

The Tension Between Financial Accounting and Management Accounting

I believe it is unhelpful, even dangerous, for accountants to use the same methods to compile their management accounts as they would their financial accounts.

 

Let me give one simple example – the matching (accruals) concept. The matching concept means that if we build inventory (stock) this month and sell it next month then the costs associated with that inventory (material, labour, overhead) should be capitalised this month and “realised” in the Profit and Loss account when the revenue is earned. That’s fair for external reporting because it ensures firms don’t play silly games with their costs and revenues to inflate (or deflate) profits to suit their own purposes.

 

However, is it helpful for the internal management accounts ?. I think not. The costs of building the inventory were actually incurred this month when we made it – not when we sold it (which, in fact, may be many months away). In management accounting we are interested in the actual behaviour of costs (and thus operational performance). The matching concept doesn’t help with this. Indeed, we cannot effectively manage the actual cost behaviour of the business at all under the matching concept.

 

Thus my assertion is that we shouldn’t compile internal management reports under the same approaches that we use for external reporting. In our management accounts we need to show the actual behaviour – as near to the cash impact as possible – of our business so that we can truly manage operational performance.

 

Views ?