Managerial accountants, who work with much of the information that a company routinely leaves out of its financial reports, could soon have a valuable supplement to generally accepted accounting principles (GAAP).
The Institute of Management Accountants (IMA) penned an exposure draft last week to create some guiding principles for managerial costing (the process of measuring and assigning value to a company’s operations) that are unrelated to the cost modeling commonly used for financial reporting today.
The framework is not meant to set actual standards for management accounting, notes Larry White, chair of the IMA’s Managerial Costing Conceptual Framework Task Force. It is a complement to GAAP, not an alternative. “Management accounting is about what goes on inside the organization and making the purely economic decisions that are necessary for sustainable long-term growth and profitability,” and the public information that’s presented in GAAP financial statements is in many ways woefully inadequate to achieve that objective, he says.
The IMA began drafting the framework two years ago. The organization routinely publishes statements on management accounting but has never written an exposure draft for managerial costing. The trade group consists of more than 65,000 accounting and finance professionals in 120 countries.
A key principle of the framework is that companies use a costing model that puts significant focus on cause-and-effect relationships, not just on financial reporting. It is especially important, White notes, to start with the resources available to a company, and figure out the costs involved and how the resources support each other as well as affect other areas of a firm.
When companies use a cost model for internal purposes simply because it satisfies external financial-reporting standards, they often make overly broad generalizations of cause and effect, which can create distortions that hamper internal decision making.
Manufacturing companies, in particular, often run into problems from the use of GAAP models for internal costing purposes, White notes. “We’ve seen factories where salesmen line up to get their orders run by the oldest production line in the factory, while there are brand-new production lines and machines sitting idle that would produce the order quicker and with better quality. The reason is that the factory was doing its costing based on a derivation of GAAP standards. Consequently, the fully depreciated machines didn’t have a depreciation charge associated with them, where the newer machinery did.”
Of course, companies have encountered assorted pressures to increase their focus on financial reporting in recent years. But White says they also need to be reminded that GAAP is “just one model of an organization.”
The International Federation of Accountants has also created practice guides on managerial costing, but they do not provide a conceptual framework in the way the IMA is aiming to do.
The IMA is looking for comments on its exposure draft by August 31. It expects to publish a final draft later this year.