Unit - 1 MODULE - 1 Introduction to Management Accounting

• Introduction and Meaning of Management Accounting • Definition • Relation of Management Accounting with Cost Accounting and

Financial Accounting • Role of Management Accounting • Nature of Management Accounting • Scope of Management Accounting • Tools and Techniques • Difference between Management Accounting and Cost Accounting • Difference between Management Accounting and Financial

Accounting • Functions of Management Accounting • Concepts of Management Accounting • Limita

tions of Management Accounting

IInnttrroodduuccttiioonn && MMeeaanniinngg:: The term management accounting has its base in accounting for

managers, through which managers get necessary information on

executing their functions. In other words, it helps a manager in planning,

organizing, directing and controlling the business operations in an orderly

manner. Accounting, generally, is referred to as the process of recording

and classifying the monetary transactions of a business concern for the

purpose of analyzing and reporting the result to various parties. Financial

accounting does this work effectively. It meets the aims and objectives of

various persons, say, shareholders, creditors, bankers, etc, outside the

organization. Thus, it is the primary duty of an accountant to record and

analyze the transactions of the business and prepare the final accounts in

order to take certain decisions. Financial accounting does convey

meaningful information to the outsiders, but it at times fails to communicate

the valuable information to the management. Owing the rise of joint stock

companies and large scale enterprises, the complexities of operating a

business firm has also increased.

A manager requires organized information, not just raw data, so as to

take important decisions. Decision making in any business enterprise is a

primary function of management. Financial accounting does provide

various sets of accounts and statements to assess the working of a

concern, but it does not provide enough information and in appropriate form

which can help a manager to arrive at a particular decision. Financial

accounting gives an overall picture of an enterprise, while the mangers are

interested in minute details to correct the deviations. Again, managers

require information continuously. They cannot wait for a year to end and

then receive the final accounts. They must get information on a weekly or

monthly basis. These growing requirements have changed the picture of

the basic traditional accounting of recording in to a powerful tool of

forecasting, budgeting, budgetary control, etc. This has led to the formation

of the management accounting, whereby; an organization plans, organizes,

directs and controls the resources of the organization through above

mentioned tools. When accounting is considered in the form of functions of

management providing adequate and appropriate information for

management requirements, it is referred to as ‘Management Accounting’.

Meaning and Definitions: In simple terms, any accounting system which aids management in

carrying out its managerial functions effectively may be termed as

Management Accounting. It is generally referred to as Accounting for

Managers. It is an accounting system designed to provide adequate and

appropriate information/details to the management in order to carry out its

functions. It helps in the creation of various policies to conduct the day to

day activities. It is also known as “Management Oriented Accounting” or

“Accounting for Management”.

Management Accounting is the term used to describe the accounting

methods, systems and techniques which, coupled with special knowledge

and ability assist management in its task of maximizing profits or

minimizing losses.

- Rober N. Anthony

Management Accounting is accounting for effective management.

- Bose

Management Accounting is the application of appropriate techniques and

concepts in processing historical and projected economic data of an entity

to assist management in establishing plans for reasonable economic

objectives in the making of rational decisions with a view towards

achieving these objectives.

- American Accounting Association

The following definition is given by the Management Accounting Team of the Anglo-American Council of Productivity.

Management Accounting is the presentation of accounting information in

such a way as to assist management in the creation of policy and in the

day to day operations of an undertaking.

"Management Accounting is the term used to describe the accounting

methods, systems and techniques which, coupled with special knowledge

and ability, assist management in its task of maximizing profits or

minimizing losses."

- J. Batty

"Any form of accounting which enables a business to be conducted more

efficiently can be regarded as management accounting."

- Institute of Chartered Accountants of England and Wales

"Such of its techniques and procedures by which accounting mainly seeks

to aid the management collectively have come to be known as

management accounting."

- The Institute of Chartered Accountants of India

"Management Accounting is an integral part of management concerned

with identifying, presenting and interpreting information used for:

1. Formulating strategy

2. Planning and controlling activities

3. Decision making

4. Optimizing the use of resources

5. Disclosure to shareholders and other external to the entity

6. Disclosure to employees

7. Safeguarding assets”

- The CIMA (UK) Thus, the above mentioned definitions clearly state that management

accounting is concerned with accounting information which is useful to the

management. Management covers all rearrangements, combinations and

adjustment of the traditional accounting figures which may be required to

provide the managers with the information from which they can control the

business. It encompasses accounting methods, system and techniques

which are employed with knowledge, skills and ability, to aid management

in its task of maximizing profits of the concern.

Relation of Management Accounting with Cost Accounting and Financial Accounting: Three types of Accounting such as Financial Accounting, Cost Accounting

and Management Accounting are strongly interconnected. The

Management Accounting uses the principles and practices not only of cost

accounting but also of financial accounting. Cost accounting is a more

detailed application of financial accounting and management accounting

goes a step further. The following chart explains that relation of

Management Accounting with Cost Accounting and Financial Accounting.

Preparing Revenue statement and 

Position Statement 

Evaluating Cost for Control and optimum 

competence   

FIANANCIAL ACCOUNTING 

COST ACCOUNTING 

Help Management for Planning, Control and 

Decision Making  

MANAGEMENT ACCOUNTING 

ROLE OF MANAGEMENT ACCOUNTING: Management Accounting, as a key input, provides valuable services

to management in all the functional areas. It plays a major role in various

managerial functions and thereby helping them to take effective decisions

which are discussed below:

1. Planning: Planning basically involves deciding future course of actions

based on the current status of the given resources. It involves

formulation of policies, setting up goals and objectives and deciding a

sequence of activities. Management accounting makes an important

contribution by supplying valuable information and data for analyzing

the problem and taking the accurate decision. Information is the

important factor required to plan anything.

2. Organizing: It basically involves grouping of activities in such a way that

they operate in a coordinated way in order to achieve the common

objective. It identifies the relation between authority and

responsibility. Management accounting contributes here by creating

various centres which carry various tasks to be performed in order to

obtain the pre-determined objective. This gives a sound organization

structure with a clear-cut distinction of authority and responsibility.

3. Coordinating: This includes interlinking of different divisions of the business

enterprise in a way so as to achieve the objectives of the organization

as a whole. There is a requirement of a kind of coordination between

various departments such as production, purchase, finance, human

resource, sales, etc. An effective way to achieve coordination

between the departments is to allot them respective budgets which

are inter-connected. Thus, management accounting is used in

designing budgets for an efficient allocation and coordination of

resources.

4. Controlling: Controlling means, establishing standards or standard

performance, measuring actual performance, comparing the actual

performance with the established standards and then at the end

taking corrective actions for the deviations. The techniques such as

budgetary control, standard costing and departmental operating

statements greatly help in performing this function. Thus, as a matter

of fact, the entire system of controlling is designed and operated by

the management accounting practices.

5. Motivating: Motivation means channelizing strong motives or urges of an

individual into action so as to obtain goal directed behavior. It

involves maintenance of a high degree of morale in the organization.

The supervisor should know whom to motivate, to what extent to

motivate, which tools to be used to motivate, etc. These burning

questions can only be answered if the decision making authority has

certain reports to find out the functionality of the resources. Periodical

departmental profit and loss accounts, budgets and reports go a long

way in achieving this objective.

6. Communicating: Communication involves transmission of ideas, symbols, facts,

information, etc from one person to another through a channel. The

orders of the supervisors should be communicated to the

subordinates while the results achieved by the subordinates should

be reported to the supervisors. Moreover, the management also owes

a responsibility to supply information to various other parties such as

creditors, bankers, investors, shareholders, etc. Management

Accounting helps the management in performance of this function by

developing a suitable system of reporting which emphasizes and

highlights the relevant facts.

TTOOOOLLSS aanndd TTEECCHHNNIIQQUUEESS:: 1. Financial planning:

Financial planning involves determining financial structure of an

enterprise. It includes determining financial objectives, both, long

term as well as short term, formulating various policies relating to

finance and developing various procedures to achieve the objectives.

Here, the concern is to take a decision about raising finance. That is,

the sources of finance should be precisely decided along with the

cost at which they are procured. The firm should minimize the cost of

the capital and should define the usage of the capital at a proper

place so as to generate the desired revenue. Thus, the financial

planning is a technique used by management accounting so as to

assist the management in taking important decisions.

2. Analysis of financial statements: The analysis part of financial statements and its interpretation

are one of the most important things that are made use of by

management accounting. Management accounting uses various

techniques such as ratio analysis, fund flow statement, trend

analysis, etc to analyze the statements and bring out conclusion so

as to take wise decision.

3. Historical cost accounting: Entering the actual costs after they have incurred is called

historical cost accounting. Although, management accounting does

not use past data, but in case of standard costing though, these data

prove to be very useful and hence it is useful to management

accounting.

4. Standard costing: Standard costing is a crucial tool to control cost which is the

basic aim of management accounting. This basically involves

preparation of standard costs of various activities, measuring the

actual performance, comparing it with standard costs and correcting

the deviations, if any found.

5. Budgetary control Budgetary control is an instrument used for planning and

controlling the operations of the business enterprise. This activity

basically calls for comparing the actual performance with the set

standards and thus, correcting deviation. The major aim of budgetary

control is to ensure that the funds are utilized optimally, and thus, a

firm can produce goods at the minimum cost and sell them at a price

which will help them achieve a desired level of profit. Thus it is used

under management accounting.

6. Marginal costing: This method helps the management to measure changes in the

costs with the changes in the output level or volume of production.

This is one of the costing methods which is used to measure costs

and profitability of a concerned product at different lines of

production.

7. Decision accounting: More often than not, management encounters problems related

to various alternative solutions. From the available solutions, the

purpose is to select the best decision which proves beneficial for the

company. Decisions are generally made after studying the data of

costs, prices and submitted by management accounting and then the

best one is chosen for implementation.

8. Revaluation accounting: Revaluation accounting is basically meant for replacement of

fixed assets in the times of rising prices. It ensures the maintenance

and preservation of the capital for the purpose of replacing the fixed

asset after its life gets over.

9. Ratio accounting: Ratio analysis is basically a technique through which a firm’s

performance is analyzed and interpreted by means of accounting

ratios so as to take certain decisions. It helps the management to get

a clear picture of firm’s performance at various levels and time

periods and also allows the management to have a comparative

analysis. Based on these, the firm can take a proper decision.

10. Internal auditing: Auditing is an independent appraisal system designed within

the organization in order to review the performance of accounting,

finance and other operations as a basis for protective and

constructive service to the management. It primarily deals with the

matters relating to accounts and brings about effectiveness in the

organization by putting a mandatory regular check on the activities.

11. Management information system: Today’s world is an informative world. No firm could survive

without adequate information. Management accounting with this

regard provides adequate and appropriate information to the

management so as to take various decisions. It provides necessary

information to all the levels of management according as their

requirements.

12. Statistical techniques: Management accounting, in order to operate more effectively,

also calls for certain statistical tools such as time series, regression

analysis, sampling, correlation, etc which are highly useful for

planning and forecasting. Through these tools, one can prepare

graphs, charts, diagrams, etc. to make the information look more

impressive and comprehensive.

NNaattuurree ooff MMaannaaggeemmeenntt AAccccoouunnttiinngg::

As discussed earlier that management accounting is essentially

accounting information which facilitates the management in making

important decisions that would generate maximum profits out of the

business activities. On the basis of the previous discussion and various

definitions, following are few characteristics of management accounting:

1. Forecasting: Management accounting is basically concerned with the future.

It is not restricted only to the collection and analysis of historical data

or facts but also attempts to emphasize on what should have been

done. Thus, it is more focused on activities that are going to take

place in the future, for decisions that a manager takes is always for

the future course of action and not for the past. All the tools and

techniques used under management accounting is future oriented.

2. Disseminate information: Management accounting, through its techniques, generates

data or information which it provides to the management. It does not

help in making decision or providing an opinion on it. The task of

arriving at a decision remains with the management. Management

accounting, however, only supplies information necessary to take any

important decision.

3. Increase in efficiency: Management accounting provides information that helps

generate various alternatives for the management. Out of various

alternatives, the management chooses the best one which gives

maximum profit and incurs minimum cost. Thus, by providing efficient

and effective data to the management, it helps the management to

make an effective decision and thereby helps in increasing efficiency

of the firm.

4. Usage of techniques and concepts: Information, when available randomly, does not help in making

effective decisions. It has to be so organized as to interpret the same.

Management accounting through various techniques and concepts

makes accounting data more useful. The techniques usually

employed include marginal costing, standard costing, break-even

analysis, and budgetary control among others.

5. No fixed model: Management does not have strict rules and system which has

to be followed as it is in the case of double entry system. The usage

of data differs from organization to organization. It is purely a

subjective matter when it comes to development and usage of the

bits of information produced through management accounting.

6. Aids management: As discussed earlier, it assists management in carrying out its

functions effectively. It provides various customized data which helps

in planning, organizing and controlling the activities at various levels

and time periods. It provides accurate information and at the right

time to the management so as to enable them to make a right

decision.

7. Cause and effect analysis: The most distinguishing feature of management accounting is

that it portrays cause and effect relation between the variables. If the

firm had earned profit, then it displays the reasons for the same and if

the firm had incurred loss then, it gives reason for loss as well. Thus,

on this ground, management is also at times called as science.

8. Helps in achieving objectives: The ultimate aim of any business concern is to earn profit. All

other plans and strategy prepared are directed towards earning a

handsome profit. Management accounting, by providing information

and assisting management, tries to do the same. It aids management

so that managers can take effective decisions which are directed

towards the achievement of certain objectives. Thus, management

accounting, directly or indirectly, helps in achieving objectives of the

concern.

SSccooppee ooff MMaannaaggeemmeenntt AAccccoouunnttiinngg:: The management accounting is very wide and broad in its scope. It

embraces a variety of aspects of business operations. The ultimate

objective of management accounting is to aid management in effective

functioning of planning, organizing and controlling. The following are some

of the areas included within the scope of management accounting:

1. Financial accounting: It is a general accounting practice which includes recording of

transaction taken place in the business, posting it into respective

ledger account, balancing them and preparing a trial balance. On the

basis of the trail balance, the entry is made in trading, profit and loss

and balance sheet. These accounts and statements in turn show the

real position of where the business stands. On the basis of these

accounts and statement, management can take effective decisions.

These accounts and statements help the management to analyze the

situation and interpret the data for some meaningful usage to the

operations. Management accounting, thus, is incomplete without the

availability of data on financial accounting.

2. Cost accounting: Cost accounting is one of the branches of accounting. Cost

accounting is basically a process or technique to ascertain costs. It

provides valuable data for planning, organizing and controlling

business operations through various tools, viz. standard costing,

marginal costing, budgetary control, etc.

3. Budgeting and forecasting: Budgetary control is an instrument used for planning and

controlling the operations of the business enterprise. This activity

basically calls for comparing the actual performance with the set

standards and thus correcting deviation. The major aim of budgetary

control is to ensure that the funds are utilized optimally, and thus, a

firm can produce goods at minimum cost and sell them at a price

which will help them achieve a desired level of profit. Forecasting, on

the other hand, is a prediction made of what is going to happen in

future as a result of a given situation.

4. Statistics: Management accounting, in order to operate more effectively,

also calls for certain statistical tools such as time series, regression

analysis, sampling, correlation, etc. which are highly useful for

planning and forecasting. Through these tools, one can prepare

graphs, charts, diagrams, etc to make the information look more

impressive and comprehensive.

5. Inventory control: Management accounting also embraces inventory control as it

involves major portion of the total cost. The management should

determine accurate levels of different stockpiles, such as minimum

stock level, maximum stock level, re-ordering level for stock control.

The study of inventory management helps the managers in taking

wise decisions.

6. Analysis and interpretation of data: Analyzing the financial data is very important and interpreting

them in a correct way is equally significant. Financial accounting

provides valuable data which can be used for a comparative study

over the years so as to analyze the situation of the company and

differences in financial statements, and then, take appropriate

actions.

7. Reporting: Once the data has been analyzed and interpreted, the next task

before the management is to communicate those valuable data to the

interested parties, both inside and outside the organization. For that,

the management needs to prepare various reports which make the

data presentable in a proper form from the core numerical form.

These reports can be sent monthly, quarterly or yearly to the

interested parties in order to arrive at a decision.

8. Methods and procedures: Management accounting also hold in its arms maintenance of

proper data processing and other office management services,

reporting on the best use of mechanical and electronic devices. It

defines various methods and techniques on how to do a particular

work.

DDiiffffeerreennccee bbeettwweeeenn MMaannaaggeemmeenntt AAccccoouunnttiinngg aanndd

FFiinnaanncciiaall AAccccoouunnttiinngg:: Financial and management accounting are closely interrelated since

management accounting, to a large extent, is just a mere extension of

financial accounting. Most of the data for exercising management

accounting comes from financial accounting only. In spite of such a close

relation between the two, there are certain fundamental differences

between them, which are discussed below:

Objectives: The main aim behind practicing financial accounting is to supply

data or information in the form of profit and loss account and balance

sheet to external parties like shareholders, bankers, investors,

government, etc. This information is provided at some definite period

of time where the internal management does not share any interest.

Management accounting, on the other hand, is mainly responsible for

the data for the internal management team so as to operate

effectively. Thus, the former is basically meant for external reporting

while the latter is for internal reporting process.

Performance: Financial accounting measures an overall performance of the

business concern by portraying the information through profit and

loss account and balance sheet. It displays the financial position of

the firm at a particular date. In case of management accounting, it

provides the data of all relative departments and their function

performed in the business. Thus, it measures the performance of

each individual activity rather than giving the overall picture. Thus,

financial accounting cannot reveal what part of the business is going

wrong and why. While management accounting provide a detailed

analysis of the adverse impacts generated by individual section of a

business.

Data usage: Financial accounting is historical in nature and thus uses past

data to record the transaction and thereby displays the result. It

analyzes the past data and then provides the report in the present.

Management accounting, on the other hand, is based on future and

therefore supplies the data for present and future duly analyzed and

in a detailed structure.

Monetary management: Under financial accounting, those transactions which involve

monetary effect are taken into consideration. Non-monetary

transactions are not taken into account in financial accounting

practices. However, in case of management accounting, non-

monetary events also find their way to enter into the books. For

example: new technology, human resource, etc. These all affect the

business to a large extent and thus cannot be avoided.

Reporting: The period of reporting, in case of financial accounting, is

longer than management accounting. Usually, profit and loss account

and balance sheet are prepared at the end of the financial year or

probably half-yearly. This goes well as the data is to be provided to

the outside parties generally. But the management needs a

continuous availability of the data and report in order to improve on

the current lines of conducting business. This is fulfilled by

management accounting. Management accounting provides

information at frequent intervals which financial accounting fails to

provide.

Nature: Financial accounting has been said to be more objective than

management accounting. Financial accounting is generally counted

as a positive science while management accounting is subjective in

nature as it is highly based on judgments rather than measurements.

Legality: With reference to legality of the concept, financial accounting is

more or less a mandatory practice for every business unit while

management accounting, on the other hand, is voluntary. There is no

compulsion as to whether or not a firm should practice management.

Coverage: Financial accounting is broad in nature covering all the aspects

of the concern while management accounting is limited in this case

focusing mainly on the needs of the management. It covers those

aspects which are important from the managerial perspective of

decision making.

Publication and audit: Financial accounts like Profit and loss account and balance

sheet are to be published for the use of general public and are also

subject to audit by a chartered accountant. In case of management

accounting, there are no such provisions made. All the details and

reports are generally meant for the internal use for the management

only.

Methodology: Financial accounting and management accounting also differ in

respect of their methodology. In financial accounting, the information

is recorded or maintained in the form of various accounts and

statements while in case of management accounting, costs and

revenues are mostly reported by various responsibility centres.

Difference between Management Accounting and Cost Accounting:

Basis Management Accounting Cost Accounting Objective The purpose of management

accounting is to provide information to the management for planning and coordinating the activities of the business

The objective of cost accounting is to record the cost of producing a product or providing a service. The cost is recorded product-wise or unit-wise

Scope The scope of management accounting is very wide. It includes financial accounting, cost accounting, budgeting, tax planning, reporting to the management, interpretation of financial data, etc.

Cost accounting deals primarily with cost ascertainment

Nature Management accounting is generally concerned with the projection of figures for future

Cost accounting uses both past and present figures

Data used Management accounting uses both quantitative and qualitative information

Only quantitative aspects are used in cost accounting

Development The management accounting has been developed only in the last 30 years

The development of cost accounting is related to industrial revolution. Cost accounting was able to provide information not only about cost structure but also for planning and decision-making

Principle Followed

No specific rules and procedures are followed in reporting management accounting

Certain principles and procedures are followed for recording costs of different products. The same rules are applicable at different times too.

FFuunnccttiioonnss ooff MMaannaaggeemmeenntt AAccccoouunnttiinngg:: The basic function of management accounting is to assist the management in performing its functions effectively. The basic functions of manager/management are planning, organizing, directing and controlling. The management accounting assists in the performance of each of these functions in the ways mentioned below:

1. Provides data: Management accounting serves as an important source of data

for the planning of management. The accounting information and documents are a repository of a vast quantity of data about the past progress of the enterprise which are a must for making forecasts for the future.

2. Modifies data:

In order to facilitate managerial decision making and making it more effective and accurate, accounting data must have to be properly compiled and classified. Thus, modification of data is an important function as it processes the data so as to derive some meaningful conclusion.

3. Analyses and interprets data:

The data obtained from the accounting area is analyzed meaningfully for effective planning and decision-making. For this purpose, the data so collected is offered in a comparative form. Ratios are also calculated and likely trends are projected as well.

4. Serves as a means of communicating: The management accounting practices provide means for

communicating management plans upward, downward and outward through the organization. At an initial stage, it helps in identifying the viability or feasibility of various segments of plans. Later on, it helps all parties to inform about the plans that have been agreed upon and their roles in the given plans.

5. Facilitates control:

Management accounting assists in transforming given objectives and tactics into specified goals for attainment by a specified time and secures effective accomplishment of these goals in an efficient manner. All this is made possible through budgets and budgetary control and standard costing which are integral parts of management accounting.

6. Use of qualitative information: The quantitative information does have its vital importance in

the case of decision making by a management. Management accounting does not limit itself to accounting data for assisting the management in decision making but also uses such information which may not be capable of being measured in monetary terms. Such information may be collected from special field/in house surveys, statistical accumulation, engineering records, etc.

CONCEPT OF MANAGEMENT ACCOUNTING: Concept refers to the rule of the game of Management Accounting that helps and guides an accountant in presenting his responsibility. It is a science but not an exact science. Many of the conclusions drawn on the basis of it depend to a greater extent upon the intelligent interpretation of data and because of which it may be given direction only under exceptional situations. The general practices, which have been adopted by the Management Accountants to deal with an exceptional situation from time to time, have now taken the form of conventions. These concepts may be taken as directions while using management accounting and are listed as follows:

1. At the time of recording transactions, accounting should be made limited to business transactions only.

2. Cost and revenues ought to be matched as far as possible. 3. The methods, procedures and principles should be reliable and

consistent. 4. All anticipated profits should be credited on realization basis while

losses should be granted in advance. 5. All the accounting revelations whether relating to past, present or

future should be intended to meet the special needs of the business. 6. Capital employed should be kept intact at present price. 7. Management accounting information should be integrated and must

be futuristic. 8. Direct cost should be allocated to cost centres and it should be

recovered from products.

9. Reports and statements should not be utilized as a substitute for personal contact with the persons at higher levels of authority.

10. The object of control at source accounting should be followed.

Limitation of Management Accounting: Although management accounting is helpful in providing guidelines for planning, directing and controlling functions, its effectiveness is still limited by a number of reasons. Unless these limitations are taken into account, while using the management accounting system, the so called benefits of management accounting cannot be availed. The limitations of management accounting are as follows:

• Based on accounting records: Management accounting is mainly concerned with the re-arrangement or modification of a data. The data used for making the future decisions is historical. The correctness of the managerial decisions will depend upon the quality of data. If the financial data collected is incorrect, then management accounting fails to provide the right direction.

• Constant efforts: The conclusions and decisions drawn by the management accountant are not executed automatically. Thus, there is need for continuous and coordinated efforts of each management level to execute these decisions.

• Widespread Knowledge: It requires the knowledge of a number of related subjects. Management should have a thorough knowledge of the accounting

principles, statistics, economics, principles of management etc., to have an effective management accounting.

• Expensive System: It is very expensive. The installation of management accounting system requires a very complicated organization and several rules and regulations. This results in a huge investment which only large scale entities can afford.

• Resistance: Setting up of management accounting system requires basic changes in the organizational set up. New rules and regulations are also necessitated to be framed which affect a number of workforce and hence there is a possibility of resistance from some quarters or the others.

• Incommensurability : Management is only in the progressive phase; the techniques and tools used by this system give fluctuating results. Its conventions are not as accurate and established as of other branches of accounting. The conclusions taken from analysis and the interpretations are not the similar.