MAT 201 Module 5 Introduction to Managerial Accounting Example

Profitable Overall, Unknown by Product: Why a Creamery Needs Managerial Accounting

Student Name

Business Administration Program, Aspen University

MAT 201: Principles of Accounting II

Instructor Name

Month Day, Year

Profitable Overall, Unknown by Product: Why a Creamery Needs Managerial Accounting

Cedar Valley Creamery's audited income statement in Module 4 shows a corporation earning $622,500 from continuing operations. Its stockholders and bank are satisfied. Its managers are not. The plant now makes whole and low-fat milk in gallons and half gallons, plain yogurt in tubs, Greek yogurt in cups and cream for local bakeries, all on shared equipment with shared labor. The financial statements report one cost of goods sold for everything. The plant manager cannot tell which products earn money, and the sales director cannot judge whether to accept a grocery chain's demand for a 6% discount. This paper explains what managerial accounting adds and designs the creamery's first internal reports.

What Financial Statements Cannot Answer

Financial statements are designed for outside users. They follow generally accepted accounting principles, summarize the whole company and look back over a year or quarter. They answer whether the company as a whole earned a profit. They do not answer which products, customers or shifts earn it, what a decision would cost or what next quarter will look like.

Accounting Systems Change With Organizations

Hopwood (1987) traced the development of accounting systems inside a manufacturing company over many years and argued that they should not be seen as neutral techniques that simply record reality. Accounting systems change as organizations change, in response to internal pressures, such as new products and new managers, and external ones, such as competition. New accounting practices can in turn change what managers notice and how they act, by making some activities visible and others invisible.

Cedar Valley illustrates the first half of his argument: its accounting was designed for a family butter and milk business and is now inadequate for a multi-product corporation with outside owners, a bank covenant and a yogurt line that competes on price with national brands. The second half is a warning: whatever reports the creamery creates will shape what its managers pay attention to.

Accounting as Part of a Control Package

Malmi and Brown (2008) argued that management accounting is one element of a broader package of management controls. They described five groups: planning controls, such as long-range and action plans; cybernetic controls, such as budgets, financial and nonfinancial measures; reward and compensation controls; administrative controls, such as organizational structure, governance and policies; and cultural controls, such as values and symbols. Controls in the package interact, so a new report works only if the other parts support it.

At Cedar Valley, a product margin report will matter only if managers' goals and bonuses include product margins and if the culture values acting on the numbers.

Fitting Controls to the Company

Chenhall (2003) reviewed contingency-based research on management control systems. The evidence suggested that the best design depends on context: firms in uncertain environments, with complex technologies, decentralized structures, larger size or differentiation strategies tended to use broader, more flexible and more nonfinancial information. No single system is best for every firm.

Cedar Valley is mid-sized, faces volatile milk prices and competes on quality and freshness. That profile calls for timely, product-level information and nonfinancial measures such as freshness and waste, not only financial totals.

Product Costs and Period Costs

Managerial accounting also changes how costs are grouped. Product costs, such as milk, packaging and the labor and overhead of the plant, attach to the units made and become cost of goods sold only when the units are sold. Period costs, such as sales salaries and office expenses, are expensed in the period they occur. For product margins to mean anything, the creamery must decide how to assign shared plant costs, such as the pasteurizer that serves milk and yogurt alike, to each product. A simple rule, based on gallons of milk processed, will serve for now; Module 6 looks more closely at how those costs behave. The rule will be reviewed after six months, because a poor allocation can make a product look unprofitable when it is not, and managers may then drop products that actually cover their own costs.

Nonfinancial Measures

Not everything managers need is in dollars, and some of the most useful signals in a dairy plant are not financial at all. Freshness, measured as days between production and delivery, drives grocery buyers' orders. Waste, measured as product discarded per thousand units, is both a cost and a quality signal. Plant downtime shows whether equipment is limiting output. Chenhall's review suggests that firms like Cedar Valley, facing uncertain input prices and competing on quality, benefit from combining such measures with financial ones.

The First Internal Reports

Four reports will be built. A monthly product margin report shows revenue, direct costs and a share of plant costs for each product. A weekly plant cost report shows milk, labor, energy and waste per unit. A quarterly customer profitability report shows margins after discounts and delivery costs for the ten largest customers. A rolling thirteen-week cash forecast supports the warehouse project. Each report names the manager who owns it and the decision it supports. The plant manager owns the weekly cost report and uses it to schedule production and spot waste early; the sales director owns the customer report and uses it in contract negotiations, including the grocery chain's discount request taken up in Module 6. The controller will review the reports with the managers for the first three months to make sure the numbers are understood the same way by everyone who uses them.

Conclusion

Cedar Valley's financial statements show a profitable corporation but cannot guide its managers. Hopwood shows why the accounting system must change as the company has, Malmi and Brown show that new reports must fit within a wider control package and Chenhall shows that the design should fit the creamery's context.

References

Chenhall, R. H. (2003). Management control systems design within its organizational context: Findings from contingency-based research and directions for the future. Accounting, Organizations and Society, 28(2-3), 127-168. https://doi.org/10.1016/S0361-3682(01)00027-7

Hopwood, A. G. (1987). The archeology of accounting systems. Accounting, Organizations and Society, 12(3), 207-234. https://doi.org/10.1016/0361-3682(87)90038-9

Malmi, T., & Brown, D. A. (2008). Management control systems as a package: Opportunities, challenges and research directions. Management Accounting Research, 19(4), 287-300. https://doi.org/10.1016/j.mar.2008.09.003