NPL 273  Introduction to Nonprofit Leadership

Readings from The Jossey-Bass Handbook of Nonprofit Leadership and Management, Robert Herman ed. (1994)

Ch. 20  Management Accounting, David W. Young


There are two types of accounting—financial accounting (provides information to outside parties and is subject to outside audit) & managerial accounting (provides information to an organization’s managers and is normally not shared outside the organization).  This chapter focuses on managerial accounting; the previous one focuses on managerial accounting.  Read this chapter slowly!  There is nothing magical or particularly difficult about accounting—the math is simple algebra, the chapter does a good job of expressing the terms in common English.  But for most of you this is a new and different way of thinking (double-entry bookkeeping and accrual accounting are not the way you manage your personal checkbook).  You will not “get it” from a quick skimming of the chapter; but you can get it from a careful reading and re-reading (and my notes should help).


In managerial accounting, different costs are used for different purposes.  Full cost accounting focuses on determining each program’s (or each service’s) share of the organizational costs.  Differential cost accounting focuses on how costs change as circumstances change.  Management control systems analyze costs from the point of view of the individuals who control each cost.


  1. Full Cost Accounting
    1. Cost accounting focuses on the use of resources
    2. Method:

                                                               i.      Define cost object (Land, Labor, Capital; see chart on pp. 448-449 for finer subdivisions)

                                                             ii.      Determine cost centers (which units will be charged for costs)

                                                            iii.      Distinguish between direct and indirect costs

                                                           iv.      Choosing allocation bases for service center costs (allocate overhead—level  of precision depends on level of effort)

                                                             v.      Allocate service center costs to revenue centers (Stepdown method—service centers are allocated in order of their use by other centers; service center using others’ resources least is allocated first)

                                                           vi.      Choose costs system

1.      Process method:  all units of output are roughly identical, so use average cost

2.      Job order method:  units are unique; analyze costs for each unit produced

    1. Third Party Reimbursement

                                                               i.      Usually, full-cost data are not shared; however, third party reimbursement may require nonprofits to share their information (so can an IRS audit).

                                                             ii.      Usually one is not able to make cost center comparisons across organizations

  1. Differential Cost Accounting
    1. Uses:

                                                               i.      Decision to continue or eliminate a program or service

                                                             ii.      Make or buy decisions

                                                            iii.      Accept or reject special request

                                                           iv.      Sell obsolete supplies or equipment

    1. Nature of costs

                                                               i.      Fixed costs—remain the same regardless of number of units of service delivered

                                                             ii.      Step-Function costs—costs fixed within a range, then increase step-wise

                                                            iii.      Variable costs—costs change in linear fashion with volume changes

                                                           iv.      Semivariable costs—minimum initial cost, then linear increase with volume

    1. Differential Cost

                                                               i.      Full cost information can be misleading

                                                             ii.      Differential costs can include both fixed and variable costs

                                                            iii.      Assumptions are needed (make sure you document them)

                                                           iv.      Structure the information for decision-making purposes

1.      Key question is behavior of overhead (service center) costs

2.      Analyze overhead separately from program costs

3.      “Contribution” is the amount “deducted” from a program’s revenue after its program-specific costs have been deducted.

4.      In short run, a program that is losing money on a full-cost basis, but is still contributing its share to covering organizational overhead, would generally not be eliminated.

                                                             v.      Ignore sunk costs (like depreciation)

    1. Break-Even Analysis

                                                               i.      Determine the volume of activity at which total revenue equals total costs (TR=TC)

1.      TR = Price x Volume (or, px)

2.      TC = Fixed Costs (a)  + Variable Costs (unit cost x volume, or bx)

3.      Therefore, px = a + bx

                                                             ii.      Unit Contribution Margin

1.      p-b (price minus unit variable cost)

2.      displays how much each unit sold contributes to recovery of fixed costs

                                                            iii.      Special Considerations

1.      Break-even with semivariable and/or step-function costs

2.      Break-even with multiple products or services (analysis is very unstable)

    1. Differential Cost Analysis Under Cost-Based Reimbursement: 

                                                               i.      Third-party payers often prefer to reimburse based on costs rather than paying what is charged.  This way, the third-party shares in any cost savings.

                                                             ii.      On the other hand, an organization’s incentive to engage in cost-reducing efforts is lessened considerably by a system in which reimbursement falls by the amount it saves.

    1. Differential Cost Analysis and Allocated Overhead

                                                               i.      Service center costs will not fall by as much as the allocated reduction due to differential cost reduction, since part of the service center cost is in fixed costs.

  1. Management Control Systems:  providing incentives to individuals who control costs
    1. Management Control Systems Defined

                                                               i.      Contingency theory suggests that there is no “right” way to organize; rather must provide “fit” with

1.      environment

2.      strategic thrust

3.      values & motivations

                                                             ii.      Concern  is with control rather than management of resources.

1.      Structure (what the system is)

2.      Process (what the system does)

    1. Management Control Structure

                                                               i.      Responsibility Centers (and what managers are held responsible for)

1.      Revenue center (revenue generated)

2.      Expense centers

a.       Standard (expense per unit of outcome, but not total expense)

b.      Discretionary (total  expense incurred by unit, although no measurable unit of outcome)

3.      Profit center (total expense and revenue)

4.      Investment center (total expense and revenue as a percentage of assets used)

                                                             ii.      Design of Responsibility Centers: 

1.      Design organization responsibilities so individuals are responsible for financial results over which they have control.

2.      For nonprofits, program results are often as important as financial results

3.      When either strategy or organizational structure shifts, senior managers must reconsider responsibility center structure.

                                                            iii.      Motivation

1.      Goal  congruence between individual center and organization as a whole

2.      Transfer prices can affect the apparent outcome

                                                           iv.      Role of Full Cost Information

                                                             v.      Effect on  Strategy

    1. Management Control Process (much of it is informal)

                                                               i.      Programming

1.      frequently looks out 5-10 years

2.      new program bias

                                                             ii.      Budget Formulation:  Goal is to eliminate slack.  Budget should be relatively difficult to attain, but attainable.

1.      set  of guidelines (developed by senior management, communicated to line mangers)

2.      participation by managers up and down the line

3.      central staff serves as checks & balances

4.      hierarchy of information which eliminates excessive detail at each stage

5.      negotiation phase to account for circumstances

6.      final approval and sign-off by senior management

                                                            iii.      Operating and Measurement:  information should be integrated (reconcilable from one report to another) and should include nonmonetary items.

1.      financial statements

2.      full cost analyses

3.      separate fixed and variable costs (where appropriate)

4.      classify revenues and expenses by programs and responsibility centers

                                                           iv.      Reporting & Evaluation:  Three possible courses of action

1.      Change in operations

2.      Revision of budget

3.      Revision of program

    1. Recent Approaches

                                                               i.      Cost Drivers—any activity that can be directly linked to an increase in costs

1.      Process

a.       identify forces control each cost driver

b.      align responsibility with control

c.       link to budget using target costing (redesign process to minimize costs)

2.      Shifts focus from responsibility centers to clients

a.       Manage number and kinds of resources used (rather than managing the costs for resources taken as given)

b.      Line managers address resources per client

c.       Senior management addresses efficiency of resource provision

                                                             ii.      Administrative Systems focus

1.      Senior  management focuses on entire set of activities to produce a result

2.      Departments considered part of larger whole

3.      Total Quality Management

4.      Costs controlled by managing the processes taking place, rather than focusing on units of activity.



© 2004 A.J.Filipovitch
Revised 28 July 2004