Management accounting tools provide a company with internal financial management to allocate production costs to goods and evaluate a firm's performance. Common tools include cost allocation methods, transfer pricing, cost-volume-profit analysis, and budgets. Each tool typically has a specific focus and then works in tandem with the others to provide information for making decisions. Unlike financial accounting, these tools need not follow standard accounting rules from external agencies. Companies can change the management accounting tools to best suit their operations.
Cost allocation is often among the most commonly used management accounting tools. Many methods exist, although they will often fall under job order or process costing. The first method allocates costs — incurred from direct materials, direct labor, and overhead — for individual goods, such as construction projects. Each individual project will have easily traceable costs allocated by management accountants. Process costing allocates these costs based on the processes needed to produce goods; this method works when a company produces largely homogeneous goods.
In cost accounting allocation methods, the predetermined overhead rate is an important management accounting tool. This rate takes the total overhead from the production process — such as utilities, indirect staff salaries, and maintenance charges, among other items — and divides it by normal operating activity. The resulting rate is the amount of overhead applied to each product produced. This cost is in addition to the direct materials and direct labor used in the production process.
Transfer pricing allows each department within a firm to act independently. Each department will add a small portion of cost to each good and then transfer the products to another department. Standard transfer pricing is opportunity costs plus variable costs. This is essentially the cost a company can pay an outside firm to produce the good plus the incremental costs of the department. Many companies use this method and can tweak it to best represent their operations.
Cost-volume-profit analysis is a short run metric companies use to determine the total costs of producing products. The basic formula is total fixed costs plus total variable costs. Total variable costs represent the individual cost of producing goods multiplied by the expected production activity.
This management accounting tool provides companies with expanded information when compared to the standard break-even analysis. Companies can determine what portion of overall costs is associated with the fixed and variable costs. The company must pay fixed costs no matter how much revenue they earn, making this an important metric.
Budgets represent the financial road map for a company. Management accountants will review operating activities and determine what future expectations are necessary for each department. A common budget used among management accounting tools is the standard budget, which focuses on the production department. All costs from the past year will provide the expected future production expenses. As the year progresses, management accountants will compare the actual costs to the standard budget and look for variances. The variances are then reviewed to determine why they occurred and whether the variances are favorable or unfavorable.