The Shift to Predictive Accounting – Part I

The gap between what the CFO and accountants report and what internal managers want and need does not mean that information produced by the accountants is of little value. In the last few decades, management accountants have made significant strides in improving the utility and accuracy of the costs they calculate and report. The gap is being caused by a shift in managers’ needs – from just needing to know what things cost (such as a product cost) and what happened – to a need for detailed information about what their future costs and profits will be and why. Examples include driver-based rolling financial forecasts and true marginal cost analysis for what-if scenarios.


The shift to a predictive accounting 

Despite the accountants advancing a step to catch up with the increasing needs of managers to make good decisions, the managers have advanced two steps such as with lean quality management practices. In order to understand this widening gap, and more importantly how accountants can narrow and ideally close the gap, let’s examine the broad landscape of accounting.

What is the purpose of management accounting?
Contrary to beliefs that the only purpose of managerial accounting is to collect, transform and report data, its primary purpose is first and foremost to influence behavior at all levels – from the desk of the CEO down to each employee – and it should do so by supporting decisions. A secondary purpose is to stimulate investigation and discovery by signaling relevant information (and consequently bringing focus) and by generating questions to stimulate conversations.

The widening gap between what accountants report and what decision makers need involves the shift from analyzing descriptive historical information to analyzing predictive information, such as budgets and what-if scenarios. This shift to anticipatory, proactive management where organizational changes and adjustments, such as staffing levels, can be made before things happen and before minor problems become big ones. This involves predictive analytics.

An accounting framework and taxonomy
The domain of accounting has three components: tax accounting, financial accounting, and managerial accounting. There are two types of data sources for all three components: (1) financial transactions and bookkeeping, such as purchases and payroll, and (2) non-financial measures such as payroll hours worked, retail items sold, or gallons of liquid produced.

The financial accounting component is intended for external reporting, such as for regulatory agencies, banks, stockholders and the investment community. Financial accounting follows compliance rules aimed at economic valuation, and as such is typically not adequate or sufficient for internal decision making. And the tax accounting component is in its own world of legislated rules. Commercial accounting software now makes these tasks immeasurably easier.

Our area of concern – the management accounting component – can be divided into three categories: cost accounting, cost reporting and analysis, and decision support with cost planning. To oversimplify a distinction between financial and managerial accounting, financial accounting is about valuation and managerial accounting is about value creation through good decision making.

The managerial accounting component, our focus here, is comprised of three elements. Each is a recipient of cost measurements using the source data inputs that transforms incurred expenses (or their obligations) into calculated costs:

  • Cost Accounting represents the assignment of expenses into outputs, such as the cost of goods sold and the value of inventories. This primarily provides external reporting to comply with regulatory agencies.
  • Cost Reporting and Analysis represents the insights, inferences, and analysis of what has already taken place in the business in order to track performance.
  • Decision Support with Cost Planning involves decision making and taking. It also represents using the historical cost reporting information in combination with other economic information, including forecasts and planned changes (e.g., processes, products, services, channels) in order to make the types of decisions that lead to a financially successful future.

Cost reporting and analysis is about explanation. Decision support with cost planning is about possibilities.

Next post on how to close the accounting gap… Stay tuned!


Performance Management processes

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