This page will make the most sense if you start with the:
Management Accounting Principles are not GAAP
When Accounting & Finance professionals hear the word “principles”, they have been trained to think ‘GAAP’ (Generally Accepted Accounting Principles). GAAP is not what we are talking about here. The conception of GAAP and its application to Financial Accounting and reporting to external stakeholders & investors has been in existence for over 80 years.
The principles we are talking about here applies to the practice of Management Accounting, for internal decision support and optimization.
Management Accounting professionals are concerned about and tasked with compiling, analyzing and presenting important company data for internal stakeholders. Who are these internal stakeholders? These stakeholders are every manager and team that analyze information to gain insight and who make decisions at all levels to grow and optimize their organization.
Are Management Accounting principles really different? After all, it is still accounting. Well, we’re about to tell you why. Your curiosity and understanding of Management Accounting Principles will be a worthwhile endeavor for both you and your firm. You probably already sensed that, which explains why you landed on this page!
Management Accounting and its principles consider historical, current, and forward-looking information. Unlike GAAP and Financial Accounting, which focuses only on historical information by recording what happened. Managerial accounting strives to:
- Foster learning by providing insight into past outcomes so that management can repeat good ones and avoid bad ones [the past]
- Enable optimization by giving decision makers real-time insight into the outcomes of today’s decision alternatives they are considering [the present]
- Support management’s simulation and estimation activities to evaluate the best or better strategic options for the future [the future]
The need for a specific set of principles in Management Accounting stem from the detailed insights required by decision makers today compared to the aggregate historical information compiled in Financial Accounting using GAAP.
Management Accounting’s cost model is a representation of an organization’s resources, processes, and products and services. This means the cost model must be a logical/rational reflection of the operational inputs and outputs to provide decision makers with cause and effect insights into the operations they seek to optimize.
Management Accounting’s principles, therefore, are fundamental laws expressing irrefutable truths related to the relations between causes and their effects. For this reason, the three articles (links provided below) that proposed the principles for management accounting did so from the perspective of the laws of logic.
The two principles for Management Accounting are:
- The Principle of Causality (the need for cause-and-effect insights), which governs how the management accounting model is constructed.
- The Principle of Analogy (the analogous use of cause and effect information), which governs how management accounting information must be used.
The beauty of what these Management Accounting Principles provide to the managerial costing community is… that these two principles do not represent yet another costing methodology (e.g., Lean Accounting or ABC), or tool, or costing formula/calculation. What these principles do provide, is a yardstick by which all past, current (and future) methodologies, tools, or calculations can be measured against.
A graphical representation of such a ‘yardstick’ is the Costing Continuum / Levels of Maturity, published by the International Federation of Accountants (IFAC) – Professional Accountants in Business Committee Accounting & finance professionals and other internal stakeholders can now apply this principles-based yardstick to evaluate what costing level of maturity they are at, and how reliable and/or comprehensive their costing information is. “Without foundational principles, managers and accounting professionals have no consistent footing on which to challenge or evaluate new theories of methods for managerial costing.”
Not so long ago it was unimaginable to think that an internal costing model could capture and mirror all the cause-and-effect relationships within an organization so that decision makers can analyze all of that relational data.
Technology is the key enabler that now allows businesses to model their cause-and-effect relationships. And then analyze these relationships, through the use of progressive visually-enhanced dashboard tools. Online Analytical Processing, referred to as OLAP, is the technology that stands behind many Business Intelligence applications. This technology allows for the deployment of management accounting’s principles in a cost-effective manner. Learn more about OLAP from our partner Jedox
We’re living in a world today where ‘the truth’, within the accounting & finance profession, is becoming more and more questionable. With alarming frequency, we see business headlines such as, “Company X’s Deceptive Accounting Games” and “Accounting Investigation [by S.E.C.] Adds to Challenges Facing Company Y”.
When dealing specifically with Management Accounting and the topic of truth, one may often read or hear conversations that suggests with managerial costing ‘anything goes’, or ‘who cares’, or ‘principles’ aren’t required to determine how ‘truthful’ the information is because it’s for internal purposes only. An individual cannot be sent to jail for internal accounting errors, whereas an individual can go to jail for external reporting errors, such as misrepresentation of financial statements and/or theft, if the company and its representatives misleads investors (external stakeholders). However, this should not be interpreted as management accounting or its principles as being ‘less important’ or inferior to financial accounting, because without truthful managerial costing information, needed to run an efficient enterprise, (and therefore profitable business), the business would fail and thus the whole argument ends.
As finance professionals, it is important to understand that the two Management Accounting Principles (principle of causality & principle of analogy), are grounded in ‘truth’ by way of inductive and deductive reasoning processes. This topic is discussed at length and published by the Institute of Management Accountants as outlined in the Task Force Report on the Conceptual Framework for Managerial Costing, classified as a SMA (Statement on Management Accounting) and presents the IMA’s position on best practices in management accounting (Appendix A: Truth as a Foundation for Managerial Costing pg. 93).
If ever there was a need for Management Accounting Principles and its laws of logic, it is now. “The foundation of truth for managerial costing is absolutely essential; truth must guide every aspect of managerial cost modeling. This is the premise upon which the managerial costing principles are based… to provide the structure and guidance to create information that will better support managers.” – The Foundation of Truth for Managerial Costing