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Essential Checklist Management Accountants Should Know

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This post offers an essential checklist for accountants in fulfilling their functions for managers. Accountants are saddled with the several functions listed below, and under the pressures of time they may end up giving short shrift to their duties to managers — which is understandable. However, the very continuance of the business depends on accountants providing managers information they need to know for making decisions and maintaining control. If managers don’t get what they need from their accountants, the business could fail or spin out of control. In this sense, management accounting functions are the most central — if the business fails, the other accounting functions are beside the point.

In a business, accounting has several functions. The responsibilities of the chief accountant and the accounting department include the following:

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  1. Complying with the manifold requirements of income taxes, sales taxes, property taxes, and payroll taxes.
  2. Designing and operating a system to capture, record, process, and store all relevant documents and information about the financial activities of the business.
  3. Ensuring the integrity and reliability of the information system, and preventing fraud from inside and outside the business (the latter being directed at the business).
  4. Preparing financial statements that are reported outside the business to its lenders and shareowners (If the business is a public company, the accountants are also responsible for preparing filings with the Security and Exchange Commission).
  5. Preparing financial statements and accounting reports for distribution to the business’s managers for their planning, control, and decision-making needs.

 

The last functions listed below are referred to as “management OR managerial accounting“. It concerns accounting’s role in helping business managers carry out their functions.

 

Designing Internal Accounting Reports

In designing internal accounting reports for managers, the accountant should ask, “Who’s entitled to know what?” Generally speaking, the board of directors, the chief executive officer, the president, and the chief operating officer are entitled to know anything and everything. This sweeping comment is subject to exceptions in business organizations that tightly control the flow of financial information. By virtue of their positions, the financial vice president and the controller have access to all financial information about the business.

Other managers in a business have a limited scope of responsibility and authority. The accountant should report to them the information they need to know, but no more. For example: the vice-president of production receives a wide range of manufacturing information but doesn’t receive sales and marketing information. The accountant should identify a particular manager’s specific area of authority and responsibility in deciding the information content of accounting reports to that manager. The reporting of information to individual managers should follow the organizational structure of the business; this practice is called “responsibility accounting”.

From the accounting point of view, the organizational structure of a business consists of profit centers and cost centers:

  1. A profit center could be a product line, or even a specific product model. For example, a profit center for Apple Computer is its iPod line of products; another profit center is its iTunes Music Center (where customers download audio and video files). Within each broad product line, Apple has sub-profit centers. For example, each type of iPod is a sub-profit center.
  2. A cost center is an organization unit that doesn’t directly generate sales revenue. For example, the accounting department of a company is a cost center.
  3. The accounting reports that go to the manager of a profit center should be oriented to the profit performance of that organization unit. The accounting reports that go to a manager of a cost center should be oriented to the cost performance of that organization unit.

 

Helping Managers Understand Their Accounting Reports

Most managers have limited accounting backgrounds; their backgrounds are usually in marketing, engineering, law, human resources, and other fields. Not to sound critical, but most business managers have their desires to learn accounting under control. Furthermore, they’re very busy people with little time to spare. Yet, accountants often act as if managers fully understand the accounting reports they receive and have all the time in the world to read and digest the detailed information they contain. Accountants are dead-wrong on this point.

One of the main functions of the management accountant is to serve as the translator of accounting jargon and reports to business managers — to take the technical terminology and methods of accounting and put it all into terms that non-accounting managers can clearly understand. Of course, being a controller for years (became more generalist rather than specialist as accounts are), I may be biased, but I believe that management accountants can perform a very valuable service by improving their communication skills with non-accounting managers.

 

Involving Managers in Choosing Accounting Methods

Some business managers take charge of every aspect of the business, including choosing accounting methods for their businesses. But many business managers are passive and defer to their chief accountants regarding the accounting methods their businesses should use. In my opinion, the hands-off approach is a mistake.

Ultimately, the chief executive officer (CEO) of the business is responsible for these decisions, as he or she is responsible for all fundamental decisions of the business. But such accounting decisions may not be on the radar screen of the chief executive.

In choosing accounting methods, the chief accountant shouldn’t allow managers to sit on the sidelines and be spectators. The chief accountant shouldn’t select an accounting method without the explicit approval and understanding of top-level managers. In particular, the head accountant should explain the differences in profit and asset and liability values between alternative accounting methods. The business’s accounting methods should reflect its philosophy and strategies, so if the business is conservative in its policies and strategies, it should use conservative accounting methods.

The chief accountant can find himself or herself between a rock and a hard place when top-level managers intervene in the normal accounting process. This interference may be referred to as massaging the numbers, managing earnings, smoothing earnings, or good old fashioned accounting manipulation. If the accountant accedes to management pressure, he or she should make clear to the manager what the consequences will be the following year.

Generally speaking, there’s a compensatory effect, or trade-off, between years; pumping up profit this year, for instance, causes profit deflation next year. Massaging the numbers produces a robbing Peter to pay Paul effect, and the accountant should make this very clear to the manager.

 

Designing Profit Performance Reports for Managers

The accountant needs to read the mind of the manager in designing the layout and content of reports to the manager. Ideally, the profit report should reflect the manager’s profit strategy and tactics. For example: a manager of a profit center focuses on two main things — margin and sales volume. Therefore, the profit report should emphasize those two key factors. It sounds simple enough, but one impediment exists in designing internal profit reports for managers based on management thinking.

In designing internal profit reports for managers, accountants too often follow the path of least resistance. They use the format and content of the income statement reported outside the business, but this won’t do. An external income statement conceals as much information as it reveals. External income statements don’t disclose information about margins and sales volumes for each profit center of the business.

The accountant has to break out of his or her external income statement mentality and think in terms of what managers need to know for analyzing profit performance and making profit decisions. My main advice on this point is straightforward: Listen to how the manager explains his or her profit strategy, which is called the “business model”. Get inside the manager’s head. Do your best to understand the mindset of the manager regarding how he or she sees the formula for making profit. Listen carefully to which particular factors the manager thinks are the most important drivers (determinants) of profit. Don’t try to remodel the manager’s thinking into the accountant’s way of thinking. Don’t forget that the manager is the boss — even though you might think the manager should go back and learn accounting.

In short, don’t try to educate the manager on accounting; let the manager educate you on what he or she needs to know in order to make profit.

 

Designing Cash Flow Reports for Managers

The conventional statement of cash flows is far too technical and intimidating for most managers to make sense of. What managers don’t understand, they don’t use. In my view, accountants are too bound by theirdebits and creditsthinking when it comes to the statement of cash flows. The statement of cash flows is designed to reconcile changes in the balance sheet during the period with the amounts reported in the statement. But, should this function also be the purpose of reporting this financial statement to managers? I don’t think so.

In mid-size and large businesses, the financial officers of the business manage cash flow. Other managers don’t have any direct responsibility over cash flow — although their decisions impact cash flow. Managers of profit and cost centers should have a basic understanding of the cash flow impacts of their decisions. They don’t necessarily need cash flow statements, but they need to know how their decisions impact cash flow.

The cash flow reports to managers of profit and cost centers should focus mainly on the key factors that affect cash flow from operating activities. These internal management reports should concentrate on changes in accounts receivable, inventory, and operating liabilities (accounts payable and accrued expenses payable). These are the main factors for the difference between cash flow and profit that the managers of profit and cost centers have control over and responsibility for.

 

Designing Management Control Reports

Management control is usually thought of as keeping a close watch on a thousand and one details, anyone of which can spin out of control and cause problems. First and foremost, however, management control means achieving objectives and keeping on course toward the goals of the business. Management control covers a lot of ground — motivating employees, working with suppliers, keeping customers satisfied, and so on. But there’s no doubt that managers need control reports that include a lot of detail.

The trick in management control reports is to separate the wheat from the chaff. Being very busy people, managers can’t afford to waste time on relatively insignificant problems. They have to prioritize problems and deal with the issues that have the greatest effect on the business. Therefore, the accountant should design management control reports that differentiate significant problems from less serious problems. In control reports, the accountant should use visual pointers to highlight serious problems. In other words, control reports shouldn’t be flat, with all lines of information appearing to be equally important.

 

Developing Models for Management Decision-Making Analysis

For decision-making purposes, business managers need a model of operating profit that, theoretically, fits on the back of an envelope. Here’s an example of such a compact profit model, which I adapted from the Contribution—Margin—Minus—Fixed Costs Analysis method with the following formula:

(Unit Margin × Sales Volume) – Fixed Expenses = Operating Profit

 

Suppose the sales price is $100 and variable costs equal $65 per unit. Therefore, unit margin is $35. Assume the business sells 100,000 units, so its total contribution margin for the period is $3,500,000 ($35 unit margin × 100,000 units = $3,500,000 total contribution margin).

Last, assume its fixed expenses for the period equal $2,500,000. So its operating profit is $1,000,000 for the period.

The accountant should develop a condensed profit model, which is limited to the critical factors that tip profit one way or the other. This profit model helps the manager focus on the key variables that drive profit behavior. For example: continuing with the example just mentioned, suppose the manager is contemplating cutting sales price 10 percent to boost sales volume 20 percent. Using the profit model the manager can quickly do a before and after comparison of the proposed sales price cut:

Before: ($35 unit margin × 100,000 units) – $2,500,000 fixed expenses = $1,000,000 operating profit

After: ($25 unit margin × 120,000 units) – $2,500,000 = $500,000 operating profit

Giving up 10 percent of sales price for a 20 percent gain in sales volume may have intuitive appeal, but this decision would cripple profit. Operating profit would drop from $1,000,000 to only $500,000; the manager would give up $10, or 29 percent of the $35 margin per unit. The sacrifice is too great in exchange for only 20 percent gain in sales volume.

 

Working Closely With Managers in Planning

One of the most important managerial functions has two parts: forecasting changes that will affect the business and planning the future of the business. This task includes plotting the sales trajectory of the business, the need for additional capital, and shifts in size and makeup of its workforce and other factors. The accountant should be involved in the planning process from the get-go. Otherwise, the accountant is at a disadvantage in preparing budgets and financial projections. The better the accountant understands the planning process, and the closer the accountant works with managers in developing plans, the more useful the financial forecasts and budgets will be.

 

Establishing and Enforcing Internal Controls

Internal controls are the forms and procedures established in a business to deter and detect errors and dishonesty. Internal control certainly isn’t the most glamorous accounting function in a business organization. Even if everyone in the business and everyone the business deals with are as honest as the day is long every day of the year, errors are bound to happen.

Here’s a nice real example: One of my personal client recently started receiving retirement income from the organization that manages his retirement investment account. He completed a rather lengthy form giving the organization all the information it asked for, and being an accountant, I appreciated that it needed all this information. He has no problem with that, anyway. But the organization made a data input error, entering his wife’s year of birth as 1965 instead of 1945. This is called atransposition error“, and it’s a common error in accounting systems.

Every business should have internal control procedures in place to prevent, or at least to quickly catch, this type of error. Fortunately, I caught the error when he shown his document during our last meeting (he wanted me to check about why he received such low amount). I called the error to the company’s attention, and it took 15 telephone calls and over two months to get the error corrected! What bothered me is that the company didn’t have internal control procedures in place to prevent or to quickly catch the error.

Back to the main topic…. Well, a business is the natural target of all sorts of dishonest schemes and scams by its employees and managers, its customers, its vendors, and others. To minimize its exposure to losses from embezzlement, pilfering, shoplifting, fraud, and burglary, the accountant should establish and enforce effective internal controls in the business. As my uncle once said, “There’s a little bit of larceny in everyone’s heart.” Internal controls are an example of the principle that an ounce of prevention is worth a pound of cure.

 

Keeping Up-to-Date on Accounting, Financial Reporting, and Tax Changes

Accountants are very busy people because they carry out many functions in a business. Like business managers, they don’t have a lot of time to spare. One thing that gets short shrift in a crowded schedule is keeping up with changes in accounting and financial reporting standards. However, it’s absolutely essential that accountants stay informed of the latest changes. I personally recommand; Accountants simply have to set aside time to read professional journals, peruse Web sites, and keep alert regarding developments in accounting and financial reporting.




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