UNIT – 1

What is Management Accounting?

Definition: Management accounting, also called managerial accounting or cost accounting,

is the process of analyzing business costs and operations to prepare internal financial report,
records, and account to aid managers’ decision making process in achieving business goals.
In other words, it is the act of making sense of financial and costing data and translating that
data into useful information for management and officers within an organization.

Relationship Between Management Accounting (Vs) Cost Accounting

Management accounting collects data from cost accounting and financial accounting.
Thereafter, it analyzes and interprets the data to prepare reports and provide necessary
information to the management.

On the other hand, cost books are prepared in cost accounting system from data as received
from financial accounting at the end of each accounting period.

The difference between management and cost accounting are as follows:

S.No. Cost Accounting Management Accounting

1 The main objective of cost The primary objective of management

accounting is to assist the accounting is to provide necessary information
management in cost control to the management in the process of its
and decision-making. planning, controlling, and performance
evaluation, and decision-making.

2 Cost accounting system uses Management accounting uses both quantitative

quantitative cost data that can and qualitative data. It also uses those data that
be measured in monitory cannot be measured in terms of money.

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 terms.

3 Determination of cost and cost Efficient and effective performance of a

control are the primary roles of concern is the primary role of management
cost accounting. accounting.

4 Success of cost accounting Success of management accounting depends

does not depend upon on sound financial accounting system and cost
management accounting accounting systems of a concern.
system.

5 Cost-related data as obtained Management accounting is based on the data

from financial accounting is as received from financial accounting and cost
the base of cost accounting. accounting.

6 Provides future cost-related Provides historical and predictive information

decisions based on the for future decision-making.
historical cost information.

7 Cost accounting reports are Management accounting prepares reports

useful to the management as exclusively meant for the management.
well as the shareholders and
creditors of a concern.

8 Only cost accounting Principals of cost accounting and financial

principles are used in it. accounting are used in management
accounting.

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9 Statutory audit of cost No statutory requirement of audit for reports.
accounting reports are
necessary in some cases,
especially big business houses.

10 Cost accounting is restricted to Management accounting uses financial

cost-related data. accounting data as well as cost accounting
data.

Relationship Between Management Accounting (Vs) Financial Accounting

All monetary transactions are recorded in the books of accounts on historical cost basis.
Financial statements are prepared to ascertain the actual profit or loss of the firm and to
know the financial position of the firm of every accounting period.

Management accounting collects data from financial statements, analyzes, and then provides
this data to the management

S.no. Financial Accounting Management Accounting

1 Monitory transactions are the base of Data as obtained from financial accounting
financial accounting. is the base of management accounting.

2 Recognition, classification, recording Collection of data from financial accounting,

of financial transactions on actual provision of necessary information to the
basis, and preparation of financial management for planning, decision-making,
statement are the main functions of and evaluation are the main functions of

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 financial accounting. management accounting.

3 Support of relevant figures is required Subjective and objective, both figures may
in preparing the financial reports. be present in the management accounting
report.

4 Success of financial accounting does Success of management accounting depends

not depend on sound management on sound financial accounting system of a
accounting system. concern.

5 Financial reports are used by the Financial reports are exclusively used by the
management of a company, management only.
shareholders, creditors, and financial
institutions.

6 Statutory audit of financial statements No statutory requirement of audit for reports

of concerns is required as per prepared by management accountants.
applicable law.

7 Financial statements of a concern are The reports are prepared as and when
prepared at the end of every required by management of the concern.
accounting period.

8 To ascertain profit or loss of a concern Thorough management accounting

on actual basis and to know financial evaluation of performance is done
position of a concern financial department and section-wise, as well as

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 accounting is used. whole concern-wise.

Role Of Accounting Information In Planning And Control

The accounting information is very important for the management or the decision
making the body of an organization.
Management cannot make the decision without reasonable information for backing it
up.
To make a decision, it has to be based on genuine facts and figures. For making a
decision at every level of management, information is crucial.
Accounting gives management information regarding the financial position of
the business, such as; profit and loss, cost and earnings, liabilities and assets, etc.
Ascertainment of profit-loss and financial position, interpretation and analysis of
accounts and statements, development of accounting system, a collection of statistical
and economic data, formulation of financial principles and financial planning and
controlling results as per plan, etc. are the main functions of Accounting.
In the modem age, Accounting is directly related to financial management.
Due to entity concept and management, joint-stock Company, developed means of
communication and international business, etc. scopes of business have so much
expanded that the management is to depend on various accounting data and
information for taking various decisions.
Accounting prevents the misuse of assets, increases production and profit, controls
costs and helps increase the efficiency of the overall management.
The role of management is very important in the overall development of a business
organization.
The functions of management are planning, organizing, collecting business
elements, motivating, coordinating, controlling and budgeting, etc. Successful

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completion of these functions of management depends on an efficient accounting
system.
Accounting is a continuous system that shows the financial position of a business
entity by identifying the economic events and recording, analyzing and
presenting them.
Accounting gives information about the economic entity’s financial position.
Importance of Accounting in Planning
Proper planning is very much needed for the successful completion of various
management activities.
This planning’s cash planning, sales planning, procurement planning, determining the
quantity of stock, development planning, fixing up target-profit, etc. are very much
dependent on accounting data and information.
Accounting Importance in Organization
Accounting plays a very vital role in the proper execution of the important functions of the
management organization.
Accounting helps management-organization by providing information like percentage of
profit over the capital, capital investment position, management efficiency in controlling, etc.
Accounting Importance for Motivation
Labor-employees are to be motivated for achieving expected performance. Financial
reward is one of the main motivating factors of work.
The management is to be aware of the financial position of the business for providing
financial benefits. Accounting helps management by providing necessary information for
taking proper decisions.
Accounting Importance for Co-ordination
One of the main functions of management is to achieve the final target of the business by
coordinating various activities of different departments. Accounting helps in coordinating
various activities of different departments of the business.
It also helps the management in the adjustment of purchase with sales, an expenditure with
income, sales with debt receivable realization, etc. to a great extent.

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Accounting Importance in Control
The main functions of modem management are planning and controlling.
Controlling is essential for the completion of activities according to plan. Accounting can
help management much in control.
Accounting Importance Media of Communication
Accounting plays a vital role as a media in communicating various information from
different departments, business, and management plan of actions to various departments.
For instance, in the modem age; accounting is regarded as the best media of communication
in supplying information to management regarding purchase and stock, time of purchase,
cost of purchase and sales price, etc.
Besides, the function of Accounting is to collect and provide information about the business
to various interested parties.
Accounting Importance in Budgeting
The preparation of various budgets is essential to run the business successfully. The
historical information which is needed in the preparation of the budget is supplied by
Accounting.
Accounting Importance in Professional Advice
An efficient and honest accountant helps the management with valuable professional advice
for the development of its business. In the modem age with the complexities of business
management has also become complex.
In this aspect, the role of accounting is very important. The efficiency of management
depends on the efficient use of accounting data and information. In the developed countries
accountants are regarded as efficient and successful managers.
In the modem age, in big organizations accountants are included in the management
committee. It can be said that Accounting and Management are interdependent. Accounting
is an essential tool for management.
Management is universal.
It is required at every step of an organization. And accounting information is very required
for management. Accounting aids management in planning, organization, motivation,
coordination control, budgeting.

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Accounting delivers the financial and economic information that an organization managing
process is needed. Management is the internal use of accounting information.
It this competitive business world management has to be swift and dexterous in its decision
making.
Accounting gives information that enables the management to make important decisions for
the business. Accounting is an important tool for management as it’s regarded as the
“Language of Business”.

Cost and Classification and Use :

What is Cost?

It refers to the monetary expenditure which a firm has to incur in order to purchase or hire
the factors of production. It is the expense of purchasing or hiring factor services for
production and other business activities.

Classification of Cost / Types of Cost

There are various types of cost:

On the basis of Nature of Costs –

 Fixed Cost – It is the cost of fixed inputs used in production. These costs do not vary
with the change in volume of production.
 Variable Cost – It is the cost of variable inputs used in production. These costs vary
with the change in volume of production.
 Semi Variable Cost – It refers to costs which are partly fixed and partly variable.
These types of cost do not directly affect the level of production but may vary with
change in production facilities e.g. administrative cost, maintenance cost, depreciation
cost etc.
 Total Cost – It refers to the total cost of production.

Total cost = Fixed cost + Variable Cost

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  Marginal Cost – It refers to the cost of producing one extra unit of a product.

On the basis of Expense –

 Material Cost – It refers to the cost of procurement and use of any raw material used
for production.
 Labour Cost – It refers to the payments made to permanent and temporary workers
for their services.
 Overhead cost – It refers to costs which are semi-variable and vary with the level of
production like administrative expenses, cost of indirect material and labour, indirect
expenses etc.

On the Basis of Control:

 Controllable cost – It refers to costs which can be influenced or controlled by the

actions of the organization members.
 Uncontrollable cost – It refers to costs which cannot be controlled by the actions of
the organizations members.

According to Functions or Operations of a Business:

 Preliminary Cost – costs incurred before the commencement of the actual business
e.g. rent, interest, product trial, underwriting costs etc.
 Cost of Production – cost of material, labour, overheads etc.
 Cost of Marketing and Selling – cost of marketing, selling promotion, advertising,
distribution etc.
 Cost Research and Development – cost of innovation, new or improved products,
advance production facilities etc.

According to behaviour of cost:

 Direct Cost – It refers to costs which involve a direct expense and are easily
traceable.

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  Indirect Cost – It refers to costs which are indirect and not easily traceable.
 Explicit or Accounting Cost – It refers to the payments made in monetary terms by a
firm, to the owners of factor services required for production.
 Implicit or Economic Cost – It refers to the estimated value of all the inputs owned
and put to use for production by a firm.

On the basis of relevance in Decision Making:

 Opportunity Cost – It refers to the cost of the next best alternative action that is
sacrificed in order to pursue the chosen action.
 Sunk Cost – It is the cost which is not altered by a change in current business
activity. It can be understood as an irrevocable cost of the past business activity which
has to be incurred now and is irrelevant to the current business scenario.
 Replacement Cost – It is the cost of replacing an asset, plant, machinery, equipment
etc.
 Imputed cost – These are hypothetical costs which are considered just for the
purpose of decision making and do not involve any actual cash outflow.
 Real Cost – It refers to the cost of all efforts and sacrifices made by the owners of
factors of production in production of a commodity.
 Social Cost – It refers to the cost of hardships and sacrifices that a society has to bear
due to operation of business activities.
 Conversion Cost – It refers to the cost involved in transforming raw materials into
finished products. These types of cost do not include the actual cost of raw material. It
includes the cost of direct and indirect labour, overheads and expenses

Other Types of Cost:

 Historical Cost – It refers to the actual cost of acquiring an asset or producing a

product or service.
 Normal Cost – It is a cost which normally incurred in achieving a certain level of
output under certain conditions.

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  Abnormal Cost – It is the cost which is not normally incurred at a given level of
output under normal conditions. It is an irregular cost which would not exist in ideal
conditions.
 Differential Cost – It is the change in cost due to change in level of production.
 Incremental Cost – It is the additional cost in relation to a change in the level or
nature of business activity.

Management Accounting Process:

Management accounting process takes measures and reports specific information and

economic action within the organization. This data helps the managers in planning,

performance rating, and maintaining operational status.

1. Planning:

Planning refers to questions like what, where and when. Management accountants provide

necessary information regarding what product to produce and at what time. Secondly, it

determines the availability of required raw materials and labour. Thus, planning is the first

step of the management accountant.

2. Performance rating:

It is impossible to complete any task with no efforts. Thus, the next step of the Management

accountant is to provide data on the inputs of employees from different departments. This

data helps in analyzing the input rate and the resultant profit. Moreover, it helps in rewarding

the deserving candidate.

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3. Maintaining operational status:

Planning and input rating are followed by operational status. Here, the management

accountant keeps a record of the functions that take place in the company. For example, it

keeps a track of the work in progress and the stage of completion at which the production is

in.

Further, it also helps in calculating and analyzing the cost of production altogether. It also
contributes in identifying the pace decreasing obstacles and helps the managers in tackling
those errors. The management system provides data for financial accounting as well.

Role of Management Accountant:

Management accountants are also known as Corporate accountants. The major role of the

management accountant is to work on tasks related to the financial security of the company

and also other accounts related matters. They play a vital role in an organization’s overall

strategy and management

Job responsibilities of a management accountant are,

1. Budgeting

2. Handling taxes

3. Managing company assets

4. Provide guidelines for strategic planning

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 UNIT – II

MIS and Reporting

Essential Characteristics or Features of a Good Report
Report provides factual information depending on which decisions are made. So everyone
should be taken to ensure that a report has all the essential qualities which turn it into a good
report. A good report must have the following qualities:

1. Precision
In a good report, the report writer is very clear about the exact and definite purpose of
writing the report. His investigation, analysis, recommendations and others are directed by
this central purpose. Precision of a report provides the unity to the report and makes it a
valuable document for best usage.

2. Accuracy of Facts
Information contained in a report must be based on accurate fact. Since decisions are taken
on the basis of report information, any inaccurate information or statistics will lead to wrong
decision. It will hamper to achieve the organizational goal.

3. Relevancy
The facts presented in a report should not be only accurate but also be relevant. Irrelevant
facts make a report confusing and likely to be misleading to make proper decision.

4. Reader-Orientation
While drafting any report, it is necessary to keep in mind about the person who is going to
read it. That's why a good report is always reader oriented. Readers knowledge and level of
understanding should be considered by the writer of report. Well reader-oriented information
qualify a report to be a good one.

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5. Simple Language
This is just another essential features of a good report. A good report is written in a simple
language avoiding vague and unclear words. The language of the report should not be
influenced by the writer's emotion or goal. The message of a good report should be self-
explanatory.

6. Conciseness
A good report should be concise but it does not mean that a report can never be long. Rather
it means that a good report or a business report is one that transmits maximum information
with minimum words. It avoids unnecessary detail and includes everything which are
significant and necessary to present proper information.

7. Grammatical Accuracy
A good report is free from errors. Any faulty construction of a sentence may make its
meaning different to the reader's mind. And sometimes it may become confusing or
ambiguous.
8. Unbiased Recommendation
Recommendation on report usually make effect on the reader mind. So if recommendations
are made at the end of a report, they must be impartial and objective. They should come as
logical conclusion for investigation and analysis.

9. Clarity
Clarity depends on proper arrangement of facts. A good report is absolutely clear. Reporter
should make his purpose clear, define his sources, state his findings and finally make
necessary recommendation. To be an effective communication through report, A report must
be clear to understand for making communication success.

10. Attractive Presentation

Presentation of a report is also a factor which should be consider for a good report. A good
report provides a catchy and smart look and creates attention of the reader. Structure,

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content, language, typing and presentation style of a good report should be attractive to make
a clear impression in the mind of its reader.

The inclusion of above factors, features or characteristics, make a good report to be effective
and fruitful. It also helps to achieve the report goal. A reporter who is making the report,
always should be careful about those factors to make his report a good one.

General Principles of good reporting :

Proper Flow of Information: The information should be free flow from the proper place to
the right end user of the report. Hence, the information should be presented in the right
format and at a proper time so that it helps in planning and co-ordination. The flow of report
should not be delayed at any cost. Flow of information is a continuous activity.
Information may flow upward, downward or side ways within an organization. Orders,
instructions, plans etc may flow from top to bottom. Reports of grievances, suggestions etc.
may flow from bottom to top. Notifications, letters, settlements and complaints may flow
from outside. Annual Report, Financial Statement Analysis Report, Directors Report,
Auditors report etc. may flow from inside to outside. Information flows as sideways from
one manager to another at the same level through meetings, discussion etc.

2. Proper Timing: The very purpose of preparation of report is controlling the unfavorable
activities. Hence, the report should be submitted at the required time at any cost. If not
so, there is no use of preparing such report. Moreover, the efforts used for preparing the
report and time are also waste. In the case of routine report, the time schedule should be
strictly adhered to. The absence of information at required time leads to taking wrong
decision.

3. Accurate Information: The report contains only accurate information. If wrong

information are included in the report, it may lead to take wrong decision. Hence, the supply
of accurate information helps the managerial executives to understand the
situation very clearly. At the same time, the presentation of accurate information in the

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report should not involve excessive cost of preparation and should not result in the delay in
the presentation of report.

Relevant Information: Proper attention should be devoted to include only relevant

information in the report. The inclusion of irrelevant information is waste one and increase
the time in the report preparation. Moreover, the irrelevant information confuse the end
user of the report.
5. Basis of Comparison: The information bestowed by reports will be helpful when it carries
provision to compare with past figures, standards set or objectives. The trend of the variation
can be find out only through the comparison. Corrective action can be taken with the help
of comparative information
.
6. Reports should be Clear and Simple: The very purpose of preparing a report is
helping the management in planning, coordinating and controlling. Hence, the report
should be presented in very simple terms and can be clearly understood by anybody. If not
so, there is no meaning of preparing a report. The method of presenting a report is in such a
way that attracts the eye of the readers and enables them to arrived at a conclusion. The
arrangement of information in a report is in brief, complete, clear and simple.

7. Cost: The management incur some expenses with regard to report preparation. Such
expenses should be commensurate with the benefits derived from the report preparation. If
possible, more benefits may be available than the expenses incurred. In this way, reporting
system can be installed. In other words, there should be an endeavor to make the system as
economical as possible.

8. Evaluation of Responsibility: The reporting system has been installed in such a way to
evaluate the managerial responsibility. The standards or targets are fixed for each
functional department. The record of actual performance is monitored along with the
standards so as to enable management to assess the performance of different individuals.

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 Methods Of Reporting

Reporting Method # 1. Written Reporting:

Written reporting is the most common mode of reporting. It may be in form of a letter,
circular or manual. Written reporting is most popular mode, reason being, reports can be kept
as legal records by using this mode and can be used as reference sources. Written rep orts are
always carefully formulated. Written reporting, sometimes saves time and money. However
it suffers from poor expression of senders

A number of written reports may be sent to different levels of management:

(a) Formal Financial Statements:
Reporting Method # 1. Written Reporting:
Written reporting is the most common mode of reporting. It may be in form of a letter,
circular or manual. Written reporting is most popular mode, reason being, reports can be kept
as legal records by using this mode and can be used as reference sources. Written rep orts are
always carefully formulated. Written reporting, sometimes saves time and money. However
it suffers from poor expression of senders.

A number of written reports may be sent to different levels of management:

(a) Formal Financial Statements:
(1) Income Statement

(2) Balance Sheet

(3) Fund Flow Statement

(4) Cash Flow Statement

Reporting Method # 2. Graphic Reporting:

The reports may be presented in the form of charts, diagrams and pictures. These reports
have the advantage of quick grasp of trends of information presented. A look at the chart or
diagram may enable the reader to have an idea about the information. In the modern times

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graphs and charts are becoming more popular as a mode of presenting any kind of
information. Various management professionals express their views through graphs and
charts. Graphical presentation being most effective medium of reporting removes dullness
and confusions which we usually find in other forms of reporting.

Graphical presentation do includes following types of diagrams and charts:

(i) Bar Charts

(ii) Pie Chart

(iii) Zee Chart

(iv) Break even Chart

(v) Flowchart

(vi) Control Chart

(vii) Progress Chart

Reporting Method # 3. Oral Reporting:

Oral reporting may be done in the following forms:
(a) Group meetings

(b) Conversation with individuals.

Oral reporting is helpful only to a limited extent. It cannot form a part of important
managerial decision making. For the purpose, the reports must be in writing so that these
may be referred in future discussions too. A combination of written, graphic and oral
reporting may be useful for effective and efficient reporting in an organisation.

Meaning of Reconciliation:
Where cost accounts and financial accounts are separately maintained in two different sets of
books, the profit or loss shown by one may not agree with that shown by other. Therefore, it
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becomes necessary that periodically the profit or loss shown by the two sets of accounts is
reconciled.

Need for Reconciliation:

(a) It reveals the reasons for difference in profit or loss between cost and financial accounts.

(b) It ensures that no income or expenditure item has been omitted to record and there is no
under- or over-recovery of overheads.

(c) It helps in checking the arithmetical accuracy of both the sets of accounts.

It ensures the reliability of cost accounts in order to correct ascertainment of cost of

production.

(e) It facilities internal control by highlighting the variations causing increase or decrease in
profit.

(f) It promotes co-ordination and co-operation between cost and financial accounting
departments in order to generate correct and reliable accounting data.

(g) It enables management to formulate policies regarding overheads, depreciation and stock
valuation.

h) It ensures managerial decision-making.

3. Reconciliation Procedure:
The cost and financial accounts are reconciled by preparing a Reconciliation Statement or a
Memorandum Reconciliation Account.

(a) Reconciliation Statement:

The same principles of bank reconciliation will apply here. One may start with the profit
shown by one set of accounts (usually cost accounts) as base profit and items which do not

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tally are either added to it or deducted from it to get the profit shown by other set of accounts
(i.e., financial accounts).

Methods of Reconcilation :

To ensure the reliability of the financial records, reconciliations must, therefore, be

performed for all balance sheet accounts on a regular and ongoing basis. A robust
reconciliation process improves the accuracy of the financial reporting function and allows
the finance department to publish financial reports with confidence.[5]

There are two ways in which reconciliation can take place:

1. Using a documentation review, “document review is a formalised technique of data

collection involving the examination of existing records or documents.”[6] This is the
most common approach of account reconciliation. This method is done by using
accounting software.
2. The second method used is analytics review. “Any process by which a person or
company looks at an account or financial statement and attempts to identify any
irregularities. This may involve comparing financial and non-financial
information.”[7] Reconciliation of accounts using this method is undertaken by
estimating the transactions that should be in an account, usually based on other data,
for example historical activity.[8]

In both cases where mistakes are identified as a result of the reconciliation, adjustments
should be undertaken in order for the account balance to match the supporting information.

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 UNIT – 3

Responsibility Accounting

Concept And Meaning:

Responsibility accounting is a system of dividing an organization into similar units, each of
which is to be assigned particular responsibilities. These units may be in the form of
divisions, segments, departments, branches, product lines and so on. Each department is
comprised of individuals who are responsible for particular tasks or managerial functions.
The managers of various departments should ensure that the people in their department are
doing well to achieve the goal. Responsibility accounting refers to the various concepts and
tools used by managerial accountants to measure the performance of people and departments
in order to ensure that the achievement of the goals set by the top management.

Responsibility accounting, therefore, represents a method of measuring the performances of

various divisions of an organization. The test to identify the division is that the operating
performance is separately identifiable and measurable in some way that is of practical
significance to the management. Responsibility accounting collects and reports planned and
actual accounting information about the inputs and outputs of responsibility centers.

Role Of Responsibility Accounting

Following are the main roles or contribution of responsibility accounting:

1. Decentralization
By dividing the total organization in smaller subunits, the organization becomes more
manageable.
2. Performance Evaluation
Responsibility accounting establishes a sound and fair system of performance evaluation of
each manager and personnel. The performance of each responsibility center is measured and
presented periodically on performance report.

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3. Motivation
Responsibility accounting emphasizes on the individual achievement-based performance
evaluation. Therefore, the job becomes more challenging for the employees and motivates
them to use their full potentiality in achieving the results.

4. Transfer Pricing
Responsibility accounting divides the organization in different autonomous responsibility
centers or subunits. In such circumstances, product or service of one division or unit can be
transferred to another division or unit within the same organization charging a transfer price.
This creates an inter-competitive environment to make each subunit of the organization more
profitable and efficient.

5. Drop Or Continue Decision

If the organization is divided into subunits, it becomes possible to measure division wise or
product wise profitability of the organization. If saving in costs exceeds the foregone
revenues, the center can be discontinued.

Process of Responsibility Accounting

Responsibility accounting is a concept that views the organization in parts or sub-systems
rather than in total or a single system. Of course, the ultimate goal is to achieve
organization's objective but that does not come at once. Total achievement is the aggregation
of the achievements individual sector.
Responsibility accounting encompasses the following steps:

1. Identifying The Responsibility Centers

The basis of responsibility accounting system is the designation of each sub-unit in the
organization as a particular type of responsibility center. A responsibility center is a sub-unit
in an organization whose manger is held accountable for specific financial results of sub-
unit's activities. The important criteria for creating a responsibility center is that the unit of

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the organization should be separable and identifiable for operating purposes and its
performance measurement should be possible. An organization can be broadly subdivided
into four main responsibility centers as cost center, revenue center, profit center and
investment center.

2. Delegation Of Authority And Responsibility Or Decentralization

To increase managerial and operational efficiency, the manger of each subunit should be
assigned specific authority and responsibility for the activity of that division. No one can be
held accountable without having any prior responsibility and responsibility always
accompanies corresponding authority. Responsibility centers are the decision centers also,
and the decision requires the power or authority.

3. Controllable Of The Object

The manger of a cost center can be held accountable only for the costs, which are
controllable by him. Therefore, it is an essential part of responsibility accounting to identify
the controllable and non-controllable costs. The same thing applies in the case of revenues,
profits and investment.

4. Establishing Performance Evaluation Criteria

Main purpose o responsibility accounting is to measure the divisional or subunit
performance. Performance evaluation is a yardstick measurement of whether the results are
obtained as ought to be or not. Most often the following criteria are applied for divisional
performance evaluation.
• Standard Costing
• Budgetary control
• Profitability ratios
• Valuation measures

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5. Electing Cost Allocation Bases
Divisional profitability heavily depends on the bases of allocation of joint overheads and
corporate overheads. Switching from one method to another of cost allocation over the
products or divisions, product wise profitability change to a great deal. Remember that for
decision-making purpose, such allocated overheads should be carefully treated and well
understood.

Responsibility Centers for Responsibility Accounting

1. Cost Center
A cost center is an organizational sub-unit such as department or division, whose manager is
held accountable for the costs incurred in that division. For example, a Power and Airco
Department can can be defined as a cost center within the Operation and Maintenance
Department in United Telecommunication Company. Manager of a cost center is responsible
for controllable costs incurred in the department, but is not responsible for revenue, profit or
investment in that center. A cost center is a responsibility center in which inputs, but not
outputs are measured in monetary value.

2. Revenue Center
A manager of a revenue center is held accountable for the revenue attributed to the sub-unit.
Revenue centers are responsibility centers where managers are accountable only for financial
outputs in the form of generating sales revenue. A revenue center's manger may also be held
accountable for selling expenses such as sales persons' salaries, commissions, and order
receiving costs.

3. Profit Center
Profits are the excess of revenue over the total expenses. Therefore, the manager of a profit
center is held accountable for the revenues, costs, and profits of the center. A profit center is
a responsibility center in which inputs are measured in terms of expenses and outputs are
measured in terms of revenues.

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4. Investment Center
The manger of investment center is held accountable for the division's profit and the invested
capital used by the center to generate its profits. Investment centers consider not only costs
and revenues but also the assets used in the division. Performance of an investment center are
measured in terms of assets turnover and return on the capital employed.
Advantages of Responsibility Accounting

1. Assigning of Responsibility:
Each and every individual in the organisation is assigned some responsibility and they are
accountable for their work. Everybody knows what is expected of him. The responsibility
can easily be identified and satisfactory and unsatisfactory performances of various persons
are known. Nobody can shift responsibility to anybody else if something goes wrong. So,
under this system responsibility is assigned individually.

2. Improves Performance:
The assigning of tasks to specific persons acts as a motivational factor too. The person’s in-
charge for different activities know that their performance will be reported to the top
management. They will try to improve their performance. On the other hand, it acts as a
deterrent for low performance also because persons know that they are accountable for their
work and they will have to explain for their low performance.

3.Helpful in Cost Planning:

Under the system of responsibility accounting, full information is collected about costs and
revenues. This data is helpful in planning of future costs and revenues, fixing of standards
and preparing of budgets.

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4. Delegation and Control:
This system enables management to delegate authority while retaining overall control. The
authority is delegated according to the requirements of the task assigned. On the other hand,
responsibility of various persons is fixed which is helpful in controlling their work. The
control remains with top management because performance of every cost centre is regularly
reported to it. So management is able to delegate authority and at the same time to retain
control.

5. Helpful in Decision-Making:
Responsibility accounting is not only a control device but also helpful in decision-making.
The information collected under this system is helpful to management in planning its future
actions. The past performance of various cost centres also helps in fixing their future targets.
So this system enables management to take important decisions.

Transfer Pricing: Transfer pricing is the setting of the price for goods and services sold
between controlled (or related) legal entities within an enterprise. For example, if a
subsidiary company sells goods to a parent company, the cost of those goods paid by the
parent to the subsidiary is the transfer price. Legal entities considered under the control of a
single corporation include branches and companies that are wholly or majority owned
ultimately by the parent corporation. Certain jurisdictions consider entities to be under
common control if they share family members on their boards of directors. Transfer pricing
can be used as a profit allocation method to attribute a multinational corporation's net profit
(or loss) before tax to countries where it does business. Transfer pricing results in the setting
of prices among divisions within an enterprise.

Risks and benefits

However, some of the risks and benefits associated with transfer pricing are as follows:

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Benefits:

1. Transfer pricing helps in reducing the duty costs by shipping goods into high tariff
countries at minimal transfer prices so that duty base associated with these transactions are
low.

2. Reducing income taxes in high tax countries by overpricing goods that are transferred to
units in those countries where the tax rate is comparatively lower thereby giving them a
higher profit margin.

Risks:

1. There can be a disagreement among the organizational division managers as what the
policies should be regarding the transfer policies.

2. There are a lot of additional costs that are linked with the required time and manpower
which is required to execute transfer pricing and help in designing the accounting system.

3. It gets difficult to estimate the right amount of pricing policy for intangibles such as
services, as transfer pricing does not work well as these departments do not provide
measurable benefits.

4. The issue of transfer pricing may give rise to dysfunctional behavior among managers
of organizational units. Another matter of concern is the process of transfer pricing is
highly complicated and time-consuming in large multi-nationals.

5. Buyer and seller perform different functions from each other that undertakes different
types of risks. For instance, the seller may or may not provide the warranty for the product.
But the price a buyer would pay would be affected by the difference. The risks that impact
prices are as follows

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· Financial & currency risk

· Collection risk

· Market and entrepreneurial risk

· Product obsolescence risk

· Credit risk

Price Level Accounting : Meaning:-

It is a technique of accounting by which the transactions are recorded at current values and
the impact of changes in the prices on the accounting transaction is neutralized or at least
such impact is pointed out along with transactions recorded on historical cost concept. Price
level accounting is also known as “ Inflation Accounting” for the reason that prices are
usually changing on the higher side.

Advantages:-
Helps in determining profits:- In historial based accounting, real profits cannot be determined
in the profit of changes in price . The real profits can be revealed with the help of accounting
for price level changes.
True and fair view reporting:- The problem of non- reporting of true and fair view is solved
with the help of inflation accounting. Balance sheet is prepared with the help of current value
of items instead of historical acquisition cost.
Real Assessment of performance of an enterprise:- Accounting for price level changes also
helps the management and other users of financial statements to have a better look upon real
performance of the enterprise in inflationary situations.
More realistic return on Investment:- Current cost are also very helpful in determination of
more realistic rate of return on capital employed as effect of inflation is included.
It provide accurate picyure of profitability by matching current revenue with current cost.

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Limitations:-
Estimation of replacement cost is difficult:- It is very difficult to determine true replacement
cost of any fixed asset. Determination of replacement cost with the help of different alternate
methods suffers from problem of subjectivity.
Too many calculation:- All methods of accounting for price level changes involves a number
of calculations. Accounting work become more complex and complicated with increased
number of calculations.
Elements of subjectivity:- It has been observed that all the methods of accounting for price
level changes are subject to personal preference. So, there is an element of subjectivity.
Every person cant understand , analyze and interpret the adjusted financial statements.
Inflation accounting is a complicated , time consuming and confusing process, as it requires
heavy work of adjustments and calculations.
This method is not suitable for taxation purpose.

Current Purchasing Power (CPP) Method

The introduction of current purchasing power (CPP) method is one of the greatest
revolutions in the field of accounting. Under current purchasing power (CPP) method, any
established and approved general price index is used to convert the values of various items in
the balance sheet and profit and loss account. It involves the restatement of some or all of the
items in the historical financial statement for changes in the general price level. For this
purpose, approved price index is used to convert the various items of historical financial
statement. This method helps to present financial statement in terms of units of equal
purchasing power.
Characteristics of CPP Method

1. A supplementary statement is prepared and annexed to historical financial statement. The

supplementary statement includes re-statement of income statement and re-stated balance
sheet.

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2. Any statement prepared under CPP method is based on the historical statement.

3. Consumer price index or wholesale price index is used as conversion factor for re-stated of
historical items.

4. All the items in financial statement are classified into monetary and non-monetary items.
Non-monetary items are adjusted, there is no need of any adjustment for the monetary items.

5. Net gain or loss account of monetary items is to be accounted in the profit and loss
account.
Objectives And Methods Of Accounting For Price Level Changes

Historical cost accounting financial statements are prepared on the assumption that monetary
unit is stable. But in reality, monetary unit is never stable and most of the countries have
been facing high rates of inflation. Therefore, financial statements prepared under historical
cost accounting do not reflect current economic realities. They fail to give realistic and
correct picture of the state if affairs of a concern. To overcome the limitation of historical
cost accounting, there is a need to consider the effects of changes in value of money as a
result of changes of price of goods and services. Following are the objectives of accounting
for price level changes.

* To show the true result of the operations i.e. real profit or loss.
* To show the true financial position in current values.
* To show the realistic value of fixed assets in financial statement.
* To provide sufficient depreciation to generate funds for the replacement of fixed assets.
* To indicate the real capital employed.
* To make distinction between holding gain or loss and operating gain or loss.
* To make accounting records reliable for the various users.

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Methods Of Accounting For Price Level Changes
There are many methods of adjustments for the effects of changes in prices. The generally
accepted methods of accounting for price level changes are as under:
1. Current purchasing power method or general purchasing power method(CPP or GPP)
2. Current cost accounting method(CCA method)
3. A hybrid method i.e mixture of CPP and CCA method.

Working Capital Adjustment

When a business is sold, sometimes an adjustment to the purchase price is needed to make up
any difference between available working capital at the time of closing, and the working
capital needed to maintain day-to-day business operations. Such an adjustment is commonly
referred to as a working capital adjustment.

Working Capital Adjustment Formula

Working capital is defined as Current Assets less Current Liabilities, where assets include
cash and cash equivalents, inventories, prepaid expenses, and accounts receivable. Liabilities
include short-term debt, accounts payable, and accrued liabilities.

Successful Working Capital Adjustments

In order to have a smooth, timely, and agreeable working capital adjustment, the purchaser
and seller should come to some basic understandings and agreements in the early phases of a
transaction process. This includes an understanding of the definition for any accounting
terms used in the working capital equation (and what assets and liabilities may be excluded)
along with a reference balance sheet.
Additionally, the purchaser and seller should make some decisions about:
– What accounting standard will be applied? Will GAAP or previous financial reporting
standards be followed?
– Will the statements be audited or reviewed by a CPA firm?
– In the event of a dispute, will you work with an expert or an arbitrator?

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Merits of Inflation Accounting:
:
1. Since assets are shown at current values, Balance Sheet exhibits a fair view of the financial
position of a firm.

2. Depreciation is calculated on the value of assets to the business and not on their historical
cost—a correct method. It facilitates easy replacement.

3. Profit and Loss Account will not overstate business income.

4. Inflation accounting shows current profit based on current prices.

5. Profit or loss is determined by matching the cost and the revenue at current values which
are comparable—a realistic assessment of performance.

6. Financial ratios based on figures, adjusted to current value, are more meaningful.

7. Inflation accounting gives correct information, based on current price to the workers and
shareholders. In the absence of this, workers may claim for higher wages and shareholders
too claim for higher dividends.

Demerits of Inflation Accounting:

1. The system is not acceptable to Income tax authorities.

2. Too much calculations make complications.

3. Changes in prices are a never ending process.

4. The amount of depreciation will be lower in times of deflation.

5. The profit calculated on the system of price level accounting may not be a realistic profit.

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 UNIT- 4

BUDGETARY CONTROL
Meaning of Budgetary Control:
Management has in its armory a number of weapons which it uses according to its efficacy
and necessity to control the business, particularly as a device for financial control. One of
such weapons or tools—very effective as a controlling device — is the budgetary control so
far as financial aspect is concerned.

The following steps are involved in a budgetary control system:

1. Establish a plan or target of performance, which coordinates all the activities of the
business.

2. Record the actual performance.

3. Compare the actual performance with that planned.

4. Calculate the differences, or variances and the reasons for them.

5. Act immediately, if necessary, to remedy the situation.

Difference between Fixed Budget and Flexible Budget

1. Fixed Budget:
1. Costs are not classified according to their variability, i.e., fixed, variable and semi-
variable.

2. Fixed budget is inflexible and remains the same irrespective of the volume of business
activity.

Fixed budget assumes that conditions would remain static.

4. Accurate forecasting of results is difficult.

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5. Actual and budgeted performances cannot be correctly compared if the volume of output
differs.

6. This budget has a limited application and is ineffective as a tool for cost control.

2. Flexible Budget:
1. Costs are classified according to the nature of their variability.

2. Fixed budget can be suitably re-casted quickly to suit changed conditions.

Fixed budget is designed to change according to a change in the level of activity.

4. Flexible budget clearly shows the impact of various expenses on the operational aspect of
the business.

5. Comparisons are realistic since the changed plan figures are placed against actual ones.

6. This budget has more applications and can be used as a tool for effective cost control.

7. Under flexible budgeting, series of fixed budgets are prepared for different levels of acti-
vity.

8. Cost can be easily ascertained at different levels of activity. The task of fixing prices
becomes easy.

Types of Budgets

Some of types of Budgets are: (i) Sales Budget (ii) Production budget (iii) Financial budget
(iv) Overheads budget (v) Personnel budget and (vi) Master budget!

(i) Sales Budget:

A sales budget is an estimate of expected total sales revenue and selling expenses of the firm.
It is known as a nerve centre or backbone of the enterprise. It is the starting point on which
other budgets are also based. It is a forecasting of sales for the period both in quantity and
value. It shows what product will be sold, in what quantities, and at what prices.

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(ii) Production budget:
Production budget is prepared on the basis of the sales budget. But it also takes into account
the stock levels required to be maintained. It contains the manufacturing programmes of the
enterprise. It is helpful in anticipating the cost of production.

The nature of production budget will differ from enterprise to enterprise. For practical
purposes, the overall budget should be divided into production per article per month, looking
into the estimate of the likely quantity of demand. It is the responsibility of production
department to adjust its production according to sales forecast

(iii) Financial budget:

This budget shows the requirement of capital for both long-term and short-term needs of the
enterprise at various points of time in future. Its objective is to ensure regular supply of
adequate funds at the right time. An important part of the financial budget is the cash budget.

Cash budget contains estimated receipts and payments of cash over the specified future
period. It serves as an effective device for control and coordination of activities that involves
receipt and payment of cash. It helps to detect possible shortage or excess of cash in
business. The financial budget also contains estimates of the firm’s profits and expenditure
i.e., the operating budget.

(iv) Overheads budget:

It includes the estimated costs of indirect materials, indirect labour and indirect factory
expenses needed during the budget period for the attainment of budgeted production targets.
In other words, an estimate of factory overheads, distribution overheads and administrative
overheads is known as the overheads budget. The capital expenditure budget contains a
forecast of the capital investment.

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This budget is prepared on departmental basis for effective control over costs. The factory or
manufacturing overheads can be divided into three categories: (i) fixed, (ii) variable, (iii)
semi-variable. This classification helps in the formulation of overhead budgets for each
department.

(V) Personnel budget:

It lays down manpower requirements of all departments for the budget period. It shows
labour requirements in terms of labour hours, cost and grade of workers. It facilitates the
personnel managers in providing required number of workers to the departments either by
transfers or by new appointments.

(Vi) Master budget:

The Institute of Cost and Management Accountants, England defines master budget as the
summary budget incorporating all the functional budgets, which is finally approved, adopted
and applied. Thus, master budget is prepared by consolidating departmental or functional
budgets.

It is a summarised budget incorporating all functional budgets. It projects a comprehensive

picture of the proposed activities and anticipated results during the budget period. It must be
approved by the top management of the enterprise. Though practices differ, a master budget
generally includes, sales, production, costs-materials, labour, factory overhead, profit,
appropriation of profit and major financial ratios.

UNIT - 5

Management Audit
Meaning of Management Audit:
“Management audit can be defined as an objective and independent appraisal of the
effectiveness of managers and the effectiveness of the corporate structure in the achievement

36
of company objectives and policies. Its aim is to identify existing and potential management
weaknesses within an organization and to recommend ways to rectify these weaknesses”. –
CIMA Official Terminology.
Objective of Management Audit:
a) To ensure optimum utilization of human resources and available physical facilities.

(b) To point out deficiencies in objectives, policies, procedures and planning.

(c) To suggest improved methods of operations.

(d) To point out weak links in organizational structure and in internal control system and
suggesting improvements.

Need of Management Audit

These days, reports on matters of policies and their implementation is very important to
improve the efficiency of the management. Management Auditors advise the management
on various matters related to performance of various departments as well as of the
organization as a whole. Management Auditors may or may not be any finance and
accountancy person. Management Auditors evaluate the actual performance by comparing it
with predetermined standards. Auditors reveal any kind of defect and irregularities in the
working of management. It can be said management audit helps in improving the
performance and efficiency of management.

Objectives of Management Audit

 It helps management in setting sound and effective targets.

 To suggest management to obtain desired results and to reveal any defect and
irregularities in the process of management.

 Management audit help in effective discharge of their duties.

 To help in co-ordination of various department.

 To help in training of personnel and marketing strategies.

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  To compare input with outputs.

 To ensure strong relations with outsiders.

 To ensure most efficient internal organization.

Advantages of Management Audit

 It is helpful in making plan, objectives and policies of the management.

 It is helpful to efficiently achieve the set objectives of the management by

coordinating with the personnel.

 It is very helpful to create strong communication system with outsiders and within
the various departments.

 It is helpful to evaluate the performance of management.

 To establish good relations with employees.

 To elaborate duties, rights and liabilities of staff members and to make market
strategies.

 It is helpful in preparation of budgets of organizations.

 It is helpful in preparation of budgets.

 It is helpful in resource management.

Types of Audits

 Compliance audit. This is an examination of the policies and procedures of an

entity or department, to see if it is in compliance with internal or regulatory
standards. This audit is most commonly used in regulated industries or
educational institutions.

 Construction audit. This is an analysis of the costs incurred for a specific

construction project. Activities may include an analysis of the contracts granted to
contractors, prices paid, overhead costs allowed for reimbursement, change

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 orders, and the timeliness of completion. The intent is to ensure that the costs
incurred for a project were reasonable.

 Financial audit. This is an analysis of the fairness of the information contained

within an entity's financial statements. It is conducted by a CPA firm, which is
independent of the entity under review. This is the most commonly conducted
type of audit.

 Information systems audit. This involves a review of the controls over software
development, data processing, and access to computer systems. The intent is to
spot any issues that could impair the ability of IT systems to provide accurate
information to users, as well as to ensure that unauthorized parties do not have
access to the data.

 Investigative audit. This is an investigation of a specific area or individual when

there is a suspicion of inappropriate or fraudulent activity. The intent is to locate
and remedy control breaches, as well as to collect evidence in case charges are to
be brought against someone.

 Operational audit. This is a detailed analysis of the goals, planning processes,

procedures, and results of the operations of a business. The audit may be
conducted internally or by an external entity. The intended result is an evaluation
of operations, likely with recommendations for improvement.

 Tax audit. This is an analysis of the tax returns submitted by an individual or

business entity, to see if the tax information and any resulting income tax
payment is valid. These audits are usually targeted at returns that result in
excessively low tax payments, to see if an additional assessment can be made.

Conducting of Management Audit

 The Management auditors may not need the verification of accounts since his object
is to evaluate the performance of Managerial functions and not the study of

39
 accounting accuracy. The following procedure may be followed for conducting
Management Audit.

 1. Collection of Information: Management auditors require information for the

appraisal of various Managerial aspects. A questionnaire should be prepared for
collecting relevant information. The questions should cover information about
objectives, planning process, organization, control systems: procedures, functional
areas etc. The questions should be so framed that they provide full information about
every aspect.
 2. Examination Of Information: The Management auditors should carefully
examine the information may also be required to reach certain conclusions. The
information should be carefully studied to ascertain the real position of organisation.
 3. Authentication of Information: The Management auditor may collect information
from various persons. The information collected should be authenticated by the
persons supplying it. When they get information from any source then the persons
supplying it must put their signatures so to authenticate information.
 Confirmation of Information: The management auditor may like to confirm the
information supplied by different sources. It may be counter-hecked from other
sources etc. It can be confirmed by putting oral or written ques ions to certain
persons. This is very important for reaching reliable conclusions.
 5. Observation: The management auditor may observe certain activities himself If he
sees the things being done himself then he can undertake his work in a better way. He
may prepare organization charts, flow charts etc. himself after making observations.
This will give him more insight in to the activities undertaken.
 6. Comparison of Information: The information collected by management auditor
should be compared with the objects and standards set earlier. Sometimes,
information is compared with that of previous years. This will give on idea of actual
performance of the enterprise. This will help in assessing the comparative
performance of the unit.

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