Introduction to Managerial Accounting

In this video, we're going to talk about managerial accounting. Now, most of you probably heard of financial accounting. You know, things like income statements and balance sheets, but managerial accounting is different because it's basically for managers. Okay, so when we talk about managers, what we're talking about is that we're going to create some information, some info within the firm, and then we're going to give that info to managers to help them. So you might be thinking, okay, well, what kind of information do managers need? Why do they need this information? What are we doing here? So let's just think about an example here. So let's say this example that you start a business that you're going to manufacture furniture. So you start your own business, you're going to manufacture furniture, and it becomes a pretty large furniture making organization. You have a lot of different divisions and you're trying to run this company. And now we're going to figure out how does managerial accounting, how is that useful to you and your organization? So the first way we can think about managerial accounting being useful, we can think about it in terms of helping with planning. Now, you might think, okay, well, I can plan for my organization without managerial accounting. Well, what does this have to do with it? Well, a big part of managerial accounting is coming up with budgets. So we're going to have a marketing budget. We'll have budgets for all the different divisions based on what we expect that they're going to end up spending. We can budget out all different types of costs, what we think this is going to cost, what we think that is going to cost. Ultimately, we're coming up with a plan. That's what a budget is. We're just saying, okay, this is a plan for what these costs are anticipated or expected to be. And more specifically, we can start thinking about things like, okay, if we produce X number of units, what is that going to cost? How much marketing, how many marketing dollars should we throw at that? What is going to be the cost in terms of we think about like overhead, raw materials? What are all the costs? We're going to do some planning and just kind of look into the future and say, if we can plan out our costs and put together these budgets and so forth. But managerial accounting isn't just helpful with planning. It also helps when we think about decision making. So now we say, okay, well, we looked at the cost to produce a number of units, but should we go ahead and sell those same units to a customer who maybe offers a certain amount? Let's say somebody says, we'll give you $1,000 per couch. You manufacture furniture, so you got couches, $1,000 per couch. A customer offers you and they say that they'll buy 500 couches. Now you might think, okay, well, how do I go about determining whether I should sell for $1,000 a couch? Now we can talk about things like supply and demand. We can talk about what the market, what we think we can charge. We can talk about all those things. But at the end of the day, at a minimum, we should be able to get back our cost. We should not be selling that couch for less than what it costs us to produce it, unless we had a really compelling reason to do so, like market penetration or something like that. But typically, you want to, at a minimum, have this benchmark and say, okay, does this $1,000 a couch, does that match what it costs us to basically produce a couch? It's not so easy to figure out how much it costs to produce a couch, because there's all kinds of costs that maybe can't be directly traced to this couch. Maybe there's marketing expenses, there's headquarters expenses, there's all kinds of things. We don't just think of the material cost of that couch. We have some decisions to make in terms of what we'll actually include here, in terms of cost X, cost Y, cost Z, which ones are going to go in. But ultimately, we're going to plan and we're going to come up with some kind of idea about the cost to produce those couches, and then we're going to make a decision about whether it's a good idea to accept this customer's offer. We're going to use managerial accounting to help us make that decision. Now, managerial accounting is also very useful when we talk about directing and motivating. And again, this kind of gets into this idea that we can allocate costs through this process called cost allocation. And this is where it's really going to get into the motivating. You might think, well, how do I motivate my employees? Or how does cost allocation or managerial accounting, how does any of this have to do with motivating my employees to do their job? Well, let's think about this for a minute. Let's say that you allow your employees to take paper. Okay, they can take paper from work and they can use it at home or whatever. Just take all the paper you want. Well, if you don't charge them for that paper and just say, okay, this is free. Well, what are they going to do? They're going to take a lot more paper than they would if they were being charged for it. So now you can think about, okay, well, if I charge them for this paper, if I say, okay, now there's going to be a cost to it, they'll behave differently because then they'll start saying, well, wait a minute, I don't want to just take all this paper because it's actually going to come out of my salary. And it's the same way with cost allocation, right? We can think about, for example, if you have multiple divisions, you have, so you have your firm, sorry about that. You have your firm and you have, let's say, you've got three different divisions and you go ahead and you say, okay, well, we've got utility expense, we've got a light bill, we've got all these utilities and we just get a bill at the organization level, right? I just get some bill, I'm the CEO. But these different divisions, they all contribute in some way toward that utility. Now, am I going to allocate, am I going to split up this utility cost among these different divisions here? Or am I just going to say, you know what, just ignore that. That's not your responsibility. Well, if I ignore it, if I don't allocate this cost, then those division managers and so forth, they're going to behave a lot differently because they're not being evaluated on that cost. So maybe they leave the lights on, maybe they don't care about reducing the utility expenditures. But if I allocated these costs, now, all of a sudden, they have a reason to pay attention and try and make sure that these utility costs are as low as possible. So we're kind of motivating them and changing the way people behave based on what costs we allocate. And this is all part, this is a subset of managerial accounting is cost accounting. So we can also think about controlling costs. When we think about controlling, well, what do we mean? Do we just mean controlling spending? Well, to an extent, we do. So what we're talking about here is we can look and do things called variance analysis. Now, variance analysis is a whole topic in and of itself. But in a nutshell, basically, what we're doing with variance analysis is we're saying, OK, what was our planned spending? OK, what was our planned cost here? What did we expect that we were going to spend on raw materials or whatever? And then what was the actual cost? What did we actually spend? So think about it this way. You say, OK, well, I think I'm going to buy 100 units or spend $1,000 on raw materials to build these couches, right? So I'm going to spend $1,000. That's the budget. That's the plan that we talked about in step one. But then we find out that actually, after the period is over, we look and we say, OK, well, we actually spent $1,200. So now what we have is we know that we overspent here by $200, more than what we actually set out at the beginning of the period. So now we can go about thinking, OK, let's analyze this. And let's think about, are we doing a good job controlling our costs? Now, maybe there's a legitimate reason for this $1,200. And after we've analyzed it, we go ahead and say, you know what, that makes sense. But it's basically giving us a way to highlight this and analyze and say, OK, here's something that we should be looking at. We've got this difference here. And it might be an area where we're doing a poor job controlling costs. So we're basically using managerial accounting and this variance analysis tool to help us control our costs. So lastly, we can think about managerial accounting in terms of performance evaluation. Now, remember I said we can look at the firm potentially as different divisions, right? If you have different divisions at the firm and you have Division A, and you have Division B, and then you have Division C, right? Maybe one makes couches, one makes love seats, and so forth. However, you split the firm up and you look at these different divisions. And you say, OK, how do I evaluate the manager of Division A versus the manager of Division B and C? How can I go ahead and measure that? Because if we just look at like the income statement or something like that, that's for the entire firm, OK? That's for the whole firm. And maybe, you know, we're the CEO and maybe we don't, you know, not that we don't care about what's going on at the firm level, but we want to dig deeper and say, let's go ahead and let's see if we can compare these managers to one another and see if they're doing a good job. And what metrics do we compare them on? Well, that's up to us, right? If they have some kind of responsibility for generating sales and then they also have responsibility for some costs, we might come up with like kind of a divisional profit. We might say, what's the profit of Division A, the profit of Division B, and the profit of Division C? But if they don't really have any responsibility for sales and all they're really doing is basically manufacturing something or whatever and they're just kind of responsible for costs, then we might just look at costs. And we can come up with whatever kind of metrics we want because this is managerial accounting. It's just done for internal purposes to help us run this furniture manufacturing company. And so we can create whatever metrics that we think are useful and none of it has the follow gap.