Management Accounting - Traditional Vs. Innovative Practices

Traditional Vs. Innovative Practices

Within the area of Management Accounting there are almost an infinite number of tools, methods, techniques and approaches floating around.

The distinction between traditional and innovative accounting practices is perhaps best illustrated with the visual timeline (see sidebar) of managerial costing approaches presented at the Institute of Management Accountants 2011 Annual Conference.

Traditional Standard Costing (TSC), used in Cost Accounting dates back to the 1920s and is a central method in management accounting practiced today because it is used for financial statement reporting for the valuation of Income Statement and Balance Sheet line items such as Cost of Goods Sold (COGS) and Inventory valuation. Traditional Standard Costing must comply with generally accepted accounting principles (GAAP US) and actually aligns itself more with answering Financial Accounting requirements rather than providing solutions for management accountants. Traditional approaches limit themselves by defining cost behavior only in terms of production or sales volume.

In the late 1980s, accounting practitioners and educators were heavily criticized on the grounds that management accounting practices (and, even more so, the curriculum taught to accounting students) had changed little over the preceding 60 years, despite radical changes in the business environment. In 1993, the Accounting Education Change Commission Statement Number 4 calls for faculty members to come down from their ivory towers and expand their knowledge about the actual practice of accounting in the workplace. Professional accounting institutes, perhaps fearing that management accountants would increasingly be seen as superfluous in business organizations, subsequently devoted considerable resources to the development of a more innovative skills set for management accountants.

Variance analysis is a systematic approach to the comparison of the actual and budgeted costs of the raw materials and labor used during a production period. While some form of variance analysis is still used by most manufacturing firms, it nowadays tends to be used in conjunction with innovative techniques such as life cycle cost analysis and activity-based costing, which are designed with specific aspects of the modern business environment in mind. Life-cycle costing recognizes that managers' ability to influence the cost of manufacturing a product is at its greatest when the product is still at the design stage of its product life-cycle (i.e., before the design has been finalized and production commenced), since small changes to the product design may lead to significant savings in the cost of manufacturing the products.

Activity-based costing (ABC) recognizes that, in modern factories, most manufacturing costs are determined by the amount of 'activities' (e.g., the number of production runs per month, and the amount of production equipment idle time) and that the key to effective cost control is therefore optimizing the efficiency of these activities. Both lifecycle costing and activity-based costing recognize that, in the typical modern factory, the avoidance of disruptive events (such as machine breakdowns and quality control failures) is of far greater importance than (for example) reducing the costs of raw materials. Activity-based costing also deemphasizes direct labor as a cost driver and concentrates instead on activities that drive costs, As the provision of a service or the production of a product component.

Other approach that can be viewed as innovative to the U.S. is the German approach, Grenzplankostenrechnung (GPK). Although it has been in practiced in Europe for more than 50 years, neither GPK nor the proper treatment of 'unused capacity' is widely practiced in the U.S. Thus GPK and the concept of unused capacity is slowly becoming more recognized in America, and "could easily be considered 'advanced' by U.S. standards".

One of the more innovative accounting practices available today is Resource consumption accounting (RCA). RCA has been recognized by the International Federation of Accountants (IFAC) as a "sophisticated approach at the upper levels of the continuum of costing techniques" because it provides the ability to derive costs directly from operational resource data or to isolate and measure unused capacity costs. RCA was derived by taking the best costing characteristics of the German management accounting approach Grenzplankostenrechnung (GPK), and combining the use of activity-based drivers when needed, such as those used in Activity-based costing. With the RCA approach, resources and their costs are considered as "foundational to robust cost modeling and managerial decision support, because an organization's costs and revenues are all a function of the resources and the individual capacities that produce them".