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MANAGEMENT ACCOUNTING
• FUNDAMENTALS OF ACCOUNTS
• An account is a summarised record
of relevant transactions at one place
relating to a particular head. It
records not only the amount of
transactions but also their effect and
direction.
• Debit and Credit are simply additions
to or subtractions from an account.
 Fundamentals of Accounts
• The three rules of accounting are
• Debit the receiver and Credit the
giver
• Debit what comes in and Credit what
goes out
• Debit all expenses and Credit all
gains and profits
 Classification of Accounts
• Personal Account
• Real Account
• Nominal Account
Classification of Accounts
(Contd.)
 Classification of Accounts
(Contd.)
• Assets accounts
• Liabilities accounts
• Capital accounts
• Revenue accounts
• Expenses accounts
• Assets = liabilities + capital + profits –
losses
• Profits = revenue – expenses
• Losses = expenses - revenue
 Rules of Debit and Credit

• Increase in assets are debits and

decrease are credits
• Increase in liabilities are credits and
decrease are debits
• Increase in capital are credits and
decrease are debits
• Increase in expenses are debits and
decrease are credits
• Increase in revenues are credits and
decrease are debits
 Financial Statements
• Financial Statements are compilation
of accounting information for the
external users.
• They include
• Profit and Loss Account
• Balance Sheet
• Schedules and Notes forming part of
the above
 Financial Statements
(Contd.)
• Capital Expenditure is the amount spent
by an enterprise on purchase of fixed
assets that are used in the business to
earn income and not intended for resale.
• Capital expenditure normally yields
benefits over a period extending beyond
the accounting period.
• Revenue expenditure is the amount spent
on running of a business
• The benefit of the revenue expenditure is
exhausted in the accounting period in
which it is incurred.
Distinction between
Capital and Revenue
 Management Accounting
• Definition
• Management accounting is the
process of identification,
measurement, accumulation,
analysis, preparation, interpretation
and communication of information
that assists managers in specific
decision making within the
framework of fulfilling the
organizational objectives.
 Types of Decisions

• The decisions, managers are concerned

with, can be categorized as –
• Planning decisions
• Control decisions
 Planning Decisions
• Planning Decisions are concerned
with the establishment of goals for
the organization and the choosing of
plans to accomplish these goals
• Management accounting information
is needed to take Planning decisions
 Control Decisions
• Control decisions result from implementing
the plans and monitoring the actual results
to see if goals are being achieved
• If goals are not being achieved, either
corrective steps must be taken resulting in
goal achievement or goals themselves
have to be revised to attainable levels
• Cost accounting data are needed for
taking Control decisions
 Financial Accounting vs.
Management Accounting
• Financial Accounting covers the process
of book keeping, finalization of accounts,
preparation of financial statements,
communication of accounting information
to users and interpretation thereof
• Management Accounting is concerned
with accounting information that is useful
to management
• Financial Accounting emphasizes the
preparation of reports of an organization
for external users whereas Management
Accounting emphasizes the preparation
 Financial Accounting vs.
Management Accounting
• External users vs. Internal users
• Record of financial history vs. Emphasis on
the future
• GAAP vs. Own rules
• Objectivity and verifiability vs. Flexibility
• Emphasis on accuracy vs.Acceptance of
estimates
• Focus on company as a whole vs. Focus on
segments of a company
• Bound by conventional accounting systems
vs. Use of other disciplines such as
 Cost Accounting vs.
Management Accounting
• Cost Accounting is mainly concerned
with the techniques of product costing
and deals with only cost and price data.
It is limited to product costing
procedures and related information
processing. It helps management in
planning and controlling costs relating
to both production and distribution
channels. Cost Accounting is a “Line
function”
• Management Accounting is not confined
Management Accounting
Framework
 Management Accounting
Framework
• Data accumulation is done through
Financial Accounting and Cost Accounting
systems. Financial records are maintained
through financial accounting system and
cost records are maintained through cost
accounting systems
• In Management Accounting system, data
support is taken from financial accounting
and cost accounting and also data
accumulation is carried out from external
sources. Accumulated data are reclassified
as per the requirements of the
 Contents of Management
Accounting
• Management process is a series of
activities involved in planning,
implementation and control. Each phase of
management process requires decision
making
• Management Accounting supports
managerial decision making providing the
required information
• Information generated in management
accounting process includes-
- Financial Statement Analysis
- Cash flow information
 Statements of Financial
Information
• Balance Sheet
• Profit and Loss Account
• Statement of changes in financial
position
- Cash flow statement
- Fund flow statement
 Contents of Balance Sheet
• The balance sheet provides
information about the financial
standing/position of a company at a
particular point in time i.e. as March
31, 2006
• It is a snapshot of the financial status
of the company
• The financial position of the company
is valid for only one day i.e. the
reference day
 Contents of Balance Sheet
• The financial position as disclosed by the
balance sheet refers to its resources and
obligations and the interests of its owners
in the business.
• The balance sheet contains information
regarding assets, liabilities and
shareholders’ equity
• The balance sheet can be present in either
of the two forms:
- the account form
- the report form
 Assets
• Assets are the valuable resources owned
by a business
• Assets need to satisfy three requirements:
- the resources must be valuable i.e. it is
cash or convertible into cash or it can
provide future benefits to the operations of
the firm
- the resources must be owned in the legal
sense. Mere possession or control would
not constitute an asset
- the resource must be acquired at a cost
 Assets
• The assets in the balance sheet are
listed either in the order of liquidity
i.e. promptness with which they are
expected to be converted into cash
or
• In the reverse order i.e. fixity or
listing of the least liquid asset first,
followed by others
 Assets
• All assets are grouped into categories i.e.
assets with similar characteristics are put
in one category
• The standard classification of assets
divides them into-
- fixed assets / long term assets
- current assets
- investments
- other assets
 Fixed assets
• These assets are fixed in the sense that
they are acquired to be retained in the
business on a long term basis to produce
goods and services and not for resale
• They are long term resources and are held
for more than one accounting year
• These assets are significant as the future
earnings/profits of the company are
determined by them
 Categories of Fixed Assets
• Tangible
• Intangible
 Tangible Fixed Assets
• These assets have a physical existence
and generate goods and services
• Examples are land, buildings, plant,
machinery, furniture, etc
• They are shown in the balance sheet at
their cost to the firm at the time of their
purchase
• The cost of these assets are allocated over
their useful life
• The yearly allocation is called
“Depreciation”
 Tangible Fixed Assets
(Contd.)
• As a result of depreciation, the amount of
tangible fixed assets shown in the balance
sheet every year declines to the extent of
depreciation charged that year
• By the end of the useful life of the asset,
value becomes nil or the salvage value, if
any
• Salvage value signifies the amount
realizable by the sale of the asset at the
end of its useful life
 Intangible Fixed Assets
• These assets do not generate goods and
services directly
• They reflect the rights of the company
• Examples – patents, copyrights,
trademarks, goodwill, etc
• They confer certain exclusive rights on
their owners
• Intangibles are also written off over a
period of time
 Current Assets
• The second category of assets in the
balance sheet are current assets
• In contrast to the fixed assets, current
assets are short term in nature
• As short term assets, they refer to assets /
resources which are either held in the form
of cash or expected to be realized in cash
within the accounting period or the normal
operating cycle of the business
• The term “operating cycle” means the
time span during which the cash is
converted into inventory, inventory into
 Current assets (Contd.)
• Current assets are also known as “liquid
assets”
• They include-
- cash
- marketable securities
- accounts receivables/debtors
- bills receivables
- inventory
 Current Assets (Contd.)
• Cash
• Most liquid form of current asset
• Cash in hand and at bank
• To meet obligations / acquire assets
without any delay
 Current Assets (Contd.)
• Marketable Securities
• Short term investments which are
readily marketable and can be
converted into cash within a year
• Outlet to invest temporarily
available surplus/idle funds
• Declared at cost or market value
whichever is lower and the other
amount is indicated in the financial
statement
 Current Assets (Contd.)
• Accounts Receivable
• The amount the customers owe to
the firm, arising out of the sale of
goods on credit
• They are called the sundry debtors
• The unrecoverable portion is termed
as bad debts and written off out of
the P & L a/c
 Current assets (Contd.)
• Bills Receivable
• Amount owed by outsiders for which
written acknowledgements of the
obligations are available
• IOUs are drawn and exchanged
• Temporary credit can be arranged by
discounting these IOUs
 Current Assets (Contd.)
• Inventory
• It includes
• The goods which are held for sale in the
course of business (finished goods)
• The goods which are in the process of
production (work in progress or semi
finished goods)
• The goods which are to be consumed in
the process of production (raw materials)
 Investments
• The third category of assets is
investments
• They represent investment of funds
in the securities of another company
• They are long term assets outside
the business of the firm
• The purpose is to earn a return
and/or to control another comapny
 Other Assets
• Included in this category are the
Deferred Charges
• Example: Advertisement, Preliminary
expenses, etc
 Liabilities
• Liabilities are defined as the claims
of outsiders against the firm
• They represent the amount that the
firm owes to outsiders other than the
owners
• The assets are financed by different
sources
• Depending on the periodicity of the
funds, liabilities are classified into -
Long term and short term sources
 Long term Liabilities
• Sources of funds included in this category
are available for periods exceeding one
year
• Such liabilities represent obligations of a
firm payable after the accounting period
• Example: Debentures, Bonds, Mortgages,
Secured loans from FIs and banks
• They have to be redeemed/repaid either
as a lump sum on maturity or over a
period of time in instalments
 Current Liabilities or Short
term Liabilities
• These Liabilities are payable to
outsiders in a short period, usually
within the accounting period or the
operating cycle of the firm
• Example: Accounts payable, Bills
payable, Tax payable, Accrued
expenses, Short term bank credit
• Accounts and Bills payable are
considered as Trade Credit
 Current Liabilities (Contd.)
• Trade Credit
• The claims of outsiders who have sold
goods to the firm on credit for a short
period
• Usually these are unsecured
• Such liabilities extended without any
written commitment are Accounts Payable
or Sundry Creditors
• Such liabilities extended with formal
agreements through IOUs are Bills payable
 Current Liabilities (Contd.)
• Short term Bank Credit
• Liabilities contracted through banks
for a short period for the purpose of
running the business
• Example: cash credit, overdraft,
loans and advances
 Current Liabilities (Contd.)
• Tax Payable refers to the amount
payable to the Government as taxes
• Accrued Expenses represents
obligations which are payable and
kept outstanding by the firm
• Example: outstanding wages,
salaries, rent, commission, etc
 Owners’ Equity or Capital
• The next main component of the balance
sheet is the owners’ equity
• It represents the residual claim of the
owners on the assets of the company after
settling all the external liabilities
• The owners of the company are called the
shareholders
• Two types of shareholders – equity and
preference
 Preference Capital
• These shareholders are entitled to a stated
amount of dividend and return of principal
on maturity
• In this sense, they are akin to that of a
lender
• But, he is entitled to the dividend only if
the company has made profits
• In this sense, they are the owners
 Equity Capital
• They are the residual claimants of the
profits
• After all the external liability holders and
the preference shareholders have been
paid, the balance amount, if any, belongs
to the Equity shareholders
• Components: Paid up capital which is the
initial investments made by this group and
Retained earnings/Reserves and Surplus
which is the undistributed part of the
residual profits over the years which has
been put back in business
 Common Doubts
• Why is share capital shown as a
liability?
• Depreciation – what is its nature?
• Accumulated losses – treatment?
• Goodwill – what is its nature?
• What is the significance of the
auditor’s report?
 Contents of Profit and Loss
Account
• Revenues : Turnover
Other income
Sale of fixed assets
• Expenses
• Profit / Loss
 Revenues
• Revenue is defined as the income
that accrues to the firm by sale of
goods and services or through
investments
• Sales Revenue is the amount
earned through sale of
goods/services
• Gross sales is the total sales, while
Net sales is gross sales minus the
 Revenue (Contd.)
• Other income is earned through
other sources of investments
• Examples: Interest, dividend, royalty,
commission, fee, etc
• Sale of Fixed Assets are the
revenues which come into the
business when unused / unwanted
assets are sold and money recovered
by the company
 Expenses
• The cost of earning the revenues are
the expenses
• Examples: variable expenses like
cost of manufacture, cost of selling,
fixed expenses like salaries,
administrative expenses
 Expenses (Contd.)
• Cost of goods consumed
• This is the value of the inputs used to
manufacture the final product
• It is calculated as –
• Opening stock
+ Purchases
- Closing Stock
 Expenses (Contd.)
• Manufacturing expenses
• These include all expenses related to plant
and manufacturing operations like power
and fuel, repairs and maintenance, stores
consumed, water consumed, etc
• Excise Duty
• This is the amount paid to the Govt. as a
tax, before the goods are dispatched from
the factory
 Expenses (Contd.)
• Salaries and Wages
• These are the cost of labour and
other staff and will also include all
other employee benefits and
amenities.
• The other benefits include Provident
Fund, ESI contributions, medical
benefits, LTC, bonus, gratuity,
pension, other superannuation
benefits, etc
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