Practicing Traditional Managerial Accounting

Like anything, managerial accounting has changed over the years to keep up with the changing world. Companies work differently than they once did, and that means things like managerial accounting have had to adapt to stay alive. While financial accounting has been the dominant form of business accounting for decades, managerial accounting has always been sitting in the background, waiting for its time to shine. While waiting, it changed and evolved to become the accounting method that many companies are now employing these days.

We are going to address traditional managerial accounting to help form a solid basis to understand the newer forms of traditional managerial accounting.

Cost Accounting Systems in the Early Years

In the early days of managerial accounting, the cost of a product was based completely on the direct labor costs and direct material costs. As the years moved into the 20th century, overhead costs began to be calculated into the overall cost of the product in order to get an accurate measurement. During this time, most companies would determine the indirect costs of a product as a simple percentage of the direct labor costs. This means things like administration and sales would all be factored into the direct labor costs. The problem with this is that it can be inaccurate because you are not getting a true idea of the direct costs going into the manufacturing of the product. It was very common this time to just average out a large section of expenses and to then express it as a simple part, or percentage of wages or time. This created a misleading set or reports because the expenses of indirect costs had little to do with the wages or with the time to make the product.

As a result, a change was advocated in the early part of the 20th century where the factory would be divided into production centers. That way, using the production center method, the costs of each department or center could be determined. Therefore, the hourly rate of each department was expressed in the total cost of the production center per hour. Then, the production department cost is loaded into the work (cost flow) that passes through on an hourly rate in the production process.

Budgetary Control Systems

Budgets are a very important tool in managerial accounting because they are forward looking, determining the direction of the company based on the costs that have been allocated in the future. For example, a company may want to expand its warehouse to manufacture more toy trucks; therefore they have to budget for the building in their upcoming annual budget. While managerial accounting has existed since the early part of the Industrial Revolution, using budgets as a tool to forecast the future expenses of a company or organization dates back thousands of years to Ancient Egypt. In Egypt, there was a budget of corn supplies and the Egyptians could plan the Pharaoh's investment and consumption policy from it.

Even in Britain, the use of budgets dates back 250 years as a tool for the government to determine its expenses.

It was not until 1911 that overheads were budgeted as a form of managerial accounting to control costs and to help acquire accurate results when compared with the actual expenditure under each department. This early type of managerial accounting budget was not flexible since the overheads were fixed and not adjusted for changes in the number of products that were produced. However, a new method came about a few years later with the flexible budget. Henry Hess was able to compare the budgeted expenses with the actual expenses and for each group he plotted a straight line to represent the relationship that existed between the expenses and how much output there was. This meant that budgeted expenses were changed by the levels of output. This was a large step forward in traditional managerial accounting techniques and helped to make managerial techniques one of the major accounting practices in some companies that were forward thinking.

Scientific Management

Performance standards are an important part of traditional and current managerial accounting. Managerial accountants will look at the performance of employees as a way for managers to make day-to-day decisions and determine the direction of the company, and whether or not certain employees will be a part of that new direction.

Performance standards as they are seen in traditional managerial accounting dates back to 1842 at the Springfield Armory, which recorded the performance and deviations of performance by employees at the armory.

Years later, U.S. railroads took this approach by using an operating ratio of revenues over costs to measure the performance of the managers under their employment. By the 20th century, standards were developed for the use of materials and labor in the manufacturing tasks of the company. They were able to use time and motion studies, or scientific methods to help determine the performance standards of the company. These systems compared the actual labor and material with the performance standards created by the scientific methods to monitor the labor and material efficiency. By doing this, the railroads and subsequent companies made the employees accountable for their performance, which in turn made managers accountable. Hence, managers started looking to managerial accountants to analyze these reports and help them make decisions that would improve the efficiency of the company and allow everyone to keep their jobs.

Traditional Costs and Variances

We have talked previously about costs and variances, and we will again. Here, however, we are addressing costs and variances in terms of traditional managerial accounting.

In the first part of the 20th century, companies were using performance standards so that they could determine how much it was going to cost to make a product or to pay for a process. This was a big step up for many companies who had previously used inferior methods for determining costs for single units of products or processes. The standard cost for these companies was the cost of what a product should be. To determine the standard cost, companies would multiply the standard use of labor, machines, energy, and materials per product by the standard price of labor, machines, energy, and materials.

The managerial accountants would then be able to compare the actual costs in order to monitor the efficiency of the production. If it cost more than the standard to make a set of products on a given day, then managerial accountants would know something had happened on that day to deviate from the standard. They could take this information to the managers, who would then make the decision of how to proceed.

This difference between the standard cost and what it actually cost is a variance, as has been discussed in the book. In 1920, a man by the name of G. Charter Harrison wrote a series of formulas to analyze cost variances. This is one part of traditional managerial accounting that still exists today so that companies can compare the budgeted costs with the actual costs.

Here is an example to help you understand variance analysis using the method created for traditional management accounting in 1920.

Sales Volume Variance

Budgeted Sales Volume: 10,000 products

Budgeted Selling Price: $25

= 10,000 x 25 = $250,000

If a machine broke down during production, this will affect the sales volume for that month, decreasing it by 1000.

Actual Sales Volume: 9,000 products

Actual Selling Price: $25

Sales Volume Variance = (-1,000) products x $25 = - $25,000

Selling Price Variance If the selling price also ended up being lower at $20.00 instead of $25.00, then using the same actual sales volume, we get the following:

Actual Sales Volume: 9,000 products

Selling Price Loss: -$5.00

Selling Price Variance = 9,000 x (-$5.00) = - $45,000

Efficiency Variance

Continuing the example, the standard use of labor per product comes in at one hour, and the standard price of that labor is $15.00. For our flexible budget, we have the following:

Actual Sales Volume: 9,000 products

Labor per Product: One Hour

Price per Labor: $15.00

Total Standard Costs Allowed (Flexible Budget) = 9,000 x 1 x 15 = $135,000

If the actual use of labor per product came in at 0.8 hour, then we get this:

Actual Sales Volume: 9,000 products

Labor per Product: 0.8 Hour

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Price per Labor Hour: $15.00

Efficiency Variance = 9,000 x 0.2 x 15 = $27,000

Labor Variance

Actual Sales Volume: 9,000 products

Labor per Product: One Hour

Price per Labor Hour: $15.00

Total Standard Costs Allowed (Flexible Budget) = 9,000 x 1 x 15 = $135,000

If the price of labor was higher, then we will come out with the following actual result, which will differ from the above standard (budgeted) amount.

Actual Sales Volume: 9,000 products

Labor per Product: One Hour

Price per Labor Hour: $17.00

Labor Variance = 9,000 x 0.2 x (-2) = - $3,600

Actual Cost

Now, to find the actual cost of the production of the productions, we use simple addition and subtraction:

Budgeted Sales: $250,000

Sales Volume Variance: -$25,000

Selling Price Variance: -$45,000

Standard Costs Allowed: -$135,000

Efficiency Variance: $27,000

Labor Variance: -$3,600

ACTUAL COST: $68,400

The actual cost from producing the product will come to $68,400. Due to problems with sales volume and other costs that we addressed above, the amount of money that the company will make is less. This was a very important tool for early managerial accountants because it allowed them to see where exactly the problems may lie and where improvement can be made. For managers, this type of information is invaluable when they are looking for how to improve the efficiency and production of the company to lower costs.

Return on Investment

Around the turn of the 20th century, mass producers began finding their own sources of raw materials and creating their own distribution channels. These firms were then able to do the processes that were previously made up by individual companies. For example, if a company manufactured boats from steel, it would simply mine for the iron ore itself. The roles of purchasing, manufacturing, transporting, and distributing these items became an important part of these firms, and each department of these large firms had their own levels of efficiency. The problem was that these measures of efficiency could not relate to the overall company profit, meaning the management accounting used in it was not used with the financial accounting of the company's financial reports. To show the measures of efficiency in the overall company profit, a new performance measure was created: return on investment. To get return on investment, a company takes the income they made and divides it by the invested capital.

This new performance measure allowed management to monitor the real and potential profit of each activity within the company. It was an amazing step forward for managerial accounting in its quest to become a part of the overall financial structure of the company.

Balanced Scorecard


The balanced scorecard uses the concept of measuring whether the small scale activities of a company are aligned with large scale objectives in the company, as well as its vision and its strategy.

The balanced scorecard offers a complete view of a business because it focuses on financial accounts, as well as operational, marketing, and development inputs. This provides managers with a complete view that helps them plan the actions that will be in the best long term interests of the company.

The rationale behind this methodology is that organizations are not able to directly influence the financial outcomes of their products because there is always a lag before the product at sales point. In addition, only using financial methods to determine the strategic course of the company is not recommended. Balanced scorecard methods emphasize measuring areas where management can directly intervene for the benefit of the company. This helps 'balance' the company through the balanced scorecard performance method.

Development of the Balanced Scorecard

Early scorecards worked to achieve the balance within the company by having managers select measures from three categories: Customers, Internal Business Processes, and Learning and Growth.

While activity based costing dates back to the early parts of the 20thcentury, the balanced scorecard method came about in 1992 through a series of journal articles published by Robert Kaplan and David Norton. Those two men published a book in 1996 called The Balanced Scorecard based on the principles created in those papers.

Since the early 1990's, the balanced scorecard has become a widely used theory that is used extensively by many companies throughout North America. Even though the methodology is relatively new, the principles crated by Kaplan and Norton proved to be limited in practice, even though the principles looked good. Through work by many companies since 1992, the balanced scorecard has changed to have a much greater emphasis in the design process of the product than there was before.

Using the new method of design for the balanced scorecard, measures are now selected on a set of strategic objectives that are plotted on a strategy map. This allows the strategic objectives of the company to be spread across a set of perspectives, without it becoming too complicated.

Managerial accountants are able to identify five to six goals in each perspective, and then interlink those goals by plotting them on a diagram. This is the style of balanced scorecard that has been used extensively since 1996.

A few years later, the design approach to balanced scorecard changed once again. The problem with the change in the second generationdesign of the balanced scorecard (mentioned above) was that it was still relatively complicated. And, as well, it ignored the fact that opportunities will arise that will influence the goals of the company. The new, third generation of design, would have to be in the now and have the ability to roll forward and test the impact of the goal. This led to the creation of the "Vision Statement." By creating a "Destination Statement" at the beginning of the entire design process, it was easier to create strategic outcome objectives that would respond to the statement.

In 2007, the fourth generation of the design process was introduced. It created linkages between the tactical, operational, and strategic levels in a company, through scorecards that identify sources and root causes.

Use of the Balanced Scorecard

There are four processes by which a balanced scorecard is implemented in a company:

  1. It translates the vision of the company into operational goals. Often called translating the vision, it translates goals like being the best supplier into measures that have meaning to employees and managers. By using a balanced scorecard, management is forced to clarify this vision into a set of objectives for the company to help people reach that goal.
  2. It communicates the vision of the company and couples it with individual performance of the employees. This strategy must translate goals and performance measures into the balanced scorecard for units and employees. Rewards are then linked to these measures.
  3. It provides a business planning tool for managers. Managers set targets that are in line with the long term goals of the company. Managers need to identify the strategic initiatives that are required, and allocate the necessary resources with help from managerial accountants. In addition, managers set milestones to measure the progress towards the long term goals.
  4. It provides feedback and learning that allows managers to adjust their strategy based on the results. Higher customer satisfaction, for example, is often coupled with faster payment of invoices, and those faster payments result in a higher return on capital for the company. When a company implements a strategy, it may find not find out the immediate benefits in the cause and effect relationship initially, it may take some time. This may cause some companies to develop new strategies before realizing the current strategy is working.

Companies around the world have been found to use balanced scorecards for a variety of purposes including:

  1. Driving their strategy execution.
  2. Clarifying the strategy of the company and making that an operational strategy.
  3. Identifying and aligning the strategic vision of the company.
  4. Linking the budget with the strategic vision of the company.
  5. Aligning the entire organization with the strategic vision of the managers.
  6. Conducting strategic performance reviews to improve on the strategic vision of the company.

The balanced scorecard is often referred to as a strategic map or a strategic linkage model for its use by companies to help define and navigate the future competitive success of the company. The balanced scorecard is a framework that incorporates all of the measures, including abstract and quantitative, to measure the true importance of the company and its strategy.

The balanced scorecard method has proven so successful with its variety of uses that in a survey done in 1997, 64 percent of the companies surveyed were measuring their performance from a perspective that used a similar method to that of the balanced scorecard. Government agencies, military units, business units, corporations, non-profit organizations, and schools around North America have implemented the balanced scorecard methodology as well.

Variants and Criticisms

Nothing is perfect and since the 1990's, variations of the balanced scorecard have emerged, as have the criticisms of it. Variations of the balanced scorecard include "The Performance Prism and Results Based Management." These variations have arisen to deal with design issues relating to the balanced scorecards that can be used in specific organizations.

The criticism of balanced scorecards includes:

  • The scores are not based on any proven financial theory and therefore have no basis for the decision.
  • The process is subjective and has no provision to assess quantities.
  • It has no bottom line score or unified view with clear recommendations.
  • Positive feedback from users of the balanced scorecard may be due to a placebo effect.

The Four Perspectives of the Balanced Scorecard

There are four perspectives that have been created by the balanced scorecard to assist in the gathering and selection of performance measures in a company. These perspectives are:

  1. Financial.
  2. Customer.
  3. Internal Process.
  4. Innovation and Learning.

Financial Perspective

This perspective examines the company's implementation and creation of a strategy that contributes to the improvement of the bottom line for the company. This usually represents the long term goals of the company, and therefore incorporates tangible outcomes. For the financial perspective, three measures have been proposed by its creators Kaplan and Norton. These stages are:

  1. Rapid growth.
  2. Sustain.
  3. Harvest.

Objectives in the growth stage will be linked with the growth of the company, which leads to increased sales, new customers, and an increase in the revenue of the company.

In the sustain stage, the measures evaluate how effective the company is at managing its operations and costs, as well as in determining its return on investment.

In the harvest stage, measures will be based on the cash flow of measures like payback periods and revenue volume.

Customer Perspective

The customer perspective is defined by the value that the organization applies to satisfied customers, which will create greater sales for the company by focusing on the most desired customer demographic. The measures used in this perspective should focus on the value that the customer gets. This can include the quality, time, performance, and service towards the customer. Typically, the value will be centered on three factors:

  1. Operational Excellence.
  2. Customer Intimacy.
  3. Product Leadership
Internal Process Perspective
This perspective is concerned with the processes that create and deliver what was addressed in the customer value portion. Its primary focus is the activities and processes that are required for the company to be able to excel at a level that is expected by the customers. This will include both short term and long term goals for the company to facilitate the improvement. Kaplan and Norton created clusters that will group similar value processes into an organization to make it easier. These are:
  • Operations Management.
  • Customer Management.
  • Innovation.
  • Regulatory and Social.

Innovative and Learning Perspective

This is an important part of the company's strategy to focus on the assets of a company that creates and supports the value and internal processes. This perspective is concerned with the jobs, systems, and climate of the company. For the objectives of the other three perspectives to be achieved, this perspective must be on solid ground. Typically, improving in the learning perspective will result in the decrease of short term financial results to create a long term gain for the company.

Performance Indicators

There are several performance indicators that are used in a balanced scorecard depending on the perspective.


  • Cash Flow is the balance of cash being received and paid by the company over a certain period of time.
  • Return on Investment is the ratio of money gained or lost on an investment that is relative to the money that has been invested.
  • Financial Result is the difference between the earnings before interest and taxes and the earnings before taxes.
  • Return on Capital Employed is the measure of the return of a company's capital employed.
  • Return on Equity is the rate of return on ownership interest of the common stock owners.


  • Number of activities is the activities being conducted on a product or process.
  • Opportunity Success Rate is the hierarchy of metrics which focus on the effectiveness of a manufacturing operation.
  • Accident Ratios are how many accidents occur in relation to the number of products or processes completed.
  • Overall Equipment Effectiveness is how effective each piece of equipment in the factory is.

Learning and Growth

  • Investment Rate is the rate of investment growth within the company based on its external investments.
  • Illness Rate is the calculation that compares employee illness related absences against working time.
  • Internal Promotion Percentage is ratio of how many promotions to new positions come internally.
  • Employee Turnover is how many employees quit each year.
  • Gender Ratios are how many males to females there are in the company.

Total Quality Management (TQM)

The last thing we will look at with managerial accounting is Total Quality Management. Total Quality Management is a strategy employed by managerial accountants and managers that uses the awareness of quality in the company's processes. It has proven to be so successful that Total Quality Management is now being used in the manufacturing industry, as well as in the education, in the call center industries, in the government, and even in NASA.

What Is TQM?

Total Quality Management is composed of three areas:

  • Total. This involves the entire organization, its product life cycle and the supply chain.
  • Quality. This is the quality of the products and processes being put out by the company.
  • Management. This is the system of managing the company using steps like planning, organizing, controlling, leading, staffing, provisioning, and organizing.

The International Organization for Standardization defines Total Quality Management as an approach taken by managers in an organization that is based on quality and the participation of all members of the company for the purpose of long term success in the company. This long term success comes from customer satisfaction and it benefits the employees and shareholders of the company, thereby benefiting society. Total Quality Management also has the goal of reducing variations in the processes so there can be a greater efficiency and consistency obtained.

In Japan, there are four processes towards Total Quality Management, which differ from the three used in the Western World:

  1. Kaizen is a continuous process improvement to make processes visible, repeatable, and measurable.
  2. Atarimge Hinshitsu is following the philosophy that things will work as they are supposed to work.
  3. Kansei is examining the method by which a user applies the product which will lead to the improvement of the product.
  4. Miryokuteki Hinshitsu is following the philosophy that things have an aesthetic quality to them.

Essentially, Total Quality Management adopts the following guidelines. These guidelines have been set up to help managerial accountants to determine the best report recommendations for the course of the company. Managers then use these findings based on the Total Quality Management system to help make the company successful. These guidelines are:

  • Quality always comes before short term profits.
  • The customer always comes before the producer.
  • Customers are the next process with no company barriers.
  • Decisions always are based on facts and data from managerial accountants.
  • Management participates with, and is respectful of, the employees.
  • Management is driven by committees that handle product handling, product design, production planning, manufacturing, distribution, sale, and purchasing.

Development of Total Quality Management

The origin of Total Quality Management is not entirely clear, but most experts feel that it originated in a 1951 book by Armand Feigenbaum called Quality Control: Principles, Practice and Administration. CalledTotal Quality Control at the time, it went on the idea that sparked interest in Total Quality Management for decades to come.

As well, Total Quality Management has existed as a Japanese expression for many years.

Total Quality Management began to appear in its present form in the 1980's. There are two theories as to where it came from. One theory states that its name came about as a miscommunication from Japanese to English due to little difference between the words control andmanagement in Japanese. However, another theory states that the words Total Quality Management originated during a conference in 1974 by Koji Kabayashi.

The term Total Quality Management was also being used by the U.S. Naval Air Systems Command in 1984 due to its management approach to quality improvement.

Regardless of its origin, Total Quality Management has become one of the leading methods by which managerial accountants are able help managers form decisions. While this is not accounting as in financial numbers, it still uses many accounting methods to help determine the course of action for a company by looking at quality, production methods, and more, expressed in a numeric form so that it can be calculated properly.

Managerial accounting is one way that managers are able to help determine the direction of their business through tools that are similar to common accounting procedures like financial reports and budgets. However, managerial accounting also deals with other types of information that is harder to quantify. As a result, managerial accountants use a variety of tools at their disposal to turn pieces of information that may not be in numeric form and turn it into something that managers can look at, like a financial report. That is the power of managerial accounting. It is why managerial accountants are so sought after by companies as a means to help them look at the processes of the company in a completely different manner. Going beyond just the financial, these companies are then able to see their company as a whole, by looking at the various parts within the company to make it more efficient and more profitable for the employees and shareholders.