Managerial Accounting: The Profit-Making Function of Business Managers - dummies

Managerial Accounting: The Profit-Making Function of Business Managers

The accounting function in a business should help managers in their decision-making, control, and planning. Internal accounting reports provide essential information for controlling current profit performance, and for planning future profit performance. This sub-field of accounting is generally called managerial or management accounting.

Designing and monitoring the accounting system, complying with tax laws, and preparing external financial reports all put heavy demands on the accounting department of a business. Managers’ needs for accounting information should not be given second-level priority. The chief accountant must ensure that the financial information needs of managers are served with maximum usefulness.

Managerial accounting: Following the organizational structure

The first rule of managerial accounting is to follow the organizational structure: to report relevant information for which each manager is responsible. If a manager is in charge of sales in a territory, the controller reports the sales activity for that territory during the period to the sales manager.

Two types of organizational units in a business are of primary interest to managerial accountants:

  • Profit centers: These are separate, identifiable sources of sales revenue that expenses can be matched with, so that a measure of profit can be determined for each. Rarely is the entire business managed as one conglomerate profit center, with no differentiation of its different sources of sales and profit. A profit center can be any of the following:

    • A particular product or a product line

    • A particular location or territory in which a wide range of products are sold

    • A channel of distribution

  • Cost centers: Some departments and other organizational units do not generate sales, but they have costs that can be identified to their operations. The managers responsible for these organizational units need accounting reports that keep them informed about the costs of running their departments. Examples of cost centers include:

    • The accounting department

    • The headquarters staff of a business

    • The legal department

    • The security department

Large businesses commonly create relatively autonomous units within the organization that, in addition to having responsibility for their profit and cost centers, also have broad authority and control over investing in assets and raising capital for their assets. These organization units are called investment centers. An investment center is a mini business within the larger conglomerate.

Managerial accounting: Centering on profit centers

One of the most important tasks of managerial accounting is to identify each source of profit within the business and to accumulate the sales revenue and the expenses for each of these sources of profit. Can you imagine an auto dealership, for example, not separating revenue and expenses between its new car sales and its service department? For that matter an auto dealer may earn more profit from its financing operations (originating loans) than from selling new and used cars.

There are no sweeping rules for defining the profit centers of a business. Every business has to sort this out on its own. The controller (chief accountant) can advise top management regarding how to organize the business into profit centers. But the main job of the controller is to identify the profit centers that are established by management and to make sure that the managers of these profit centers get the accounting information they need.