CHAPTER INTRODUCTION Introduction; Meaning and definition of management accounting; Nature of management accounting; Scope of management accounting; Ojectives or functions; Tools and techniques used in management accounting; Comparison with financial accounting; Comparison with cost accounting; Limitations; Examination questions. “The most exciting and innovative work in management today is found in accounting” Introduction Accounting is a part of information system of an enterprise. Such information is provided to people who have an interest in the organisation, such as shareholders, managers, creditors, debentureholders, bankers, tax authorities and others. Broadly speaking, on the basis of type of accounting information and the purpose for which such information is used, accounting may be divided into three categories: Accompting Peter F. Drucker Management Accounting Financial or General Cost Accounting Accounting FINANCIAL ACCOUNTING Financial accounting is mainly concemed with recording business transactions in the books of account for the purpose of presenting final accounts. The information supplied by financial accounting is summarised in the following two statements at the end of the accounting period, generally one year: (a) Profit and Loss Account showing the net profit or loss during the period. (b) Balance Sheet showing the financial position of the firm at a point of time.‘The objective of financial accounting is to provide information to external parties such as shareholders, creditors, employees, potential investors, government agencies, etc. COST ACCOUNTING Cost accounting has primarily developed to meet the needs of management. Profit and Loss ‘Account and Balance Sheet are presented to management by the financial accountant. But modem ‘management needs much more detailed information than supplied by these financial statements. Cost accounting provides detailed cost information to various levels of management for efficient performance of their functions. The information supplied by cost accounting acts as a tool of management for making optimum use of scarce resources and ultimately add to the profitability of business. Meaning Costing. The terms ‘costing’ and ‘cost accounting’ are often used interchangeably. The Chartered Institute of Management Accountants (CIMA) of UK has defined costing as, “the techniques and processes of ascertaining costs’. Wheldon* has defined costing as, “the classifying, recording and appropriate allocation of expenditure for the determination of costs, the relation of these costs to sales value and the ascertainment of profitability.” Thus, costing simply means cost finding by any process or technique. It consists of principles and rules which are used for determining: (a) the cost of manufacturing a product; e.g., motor car, furniture, chemical, steel, paper, etc. and (0) the cost of providing a service; e.g., electricity, transport, education, etc. OBJECTIVES AND FUNCTIONS OF COST ACCOUNTING The main objectives of cost accounting are as follows: 1, Ascertainment of cost. This is the primary objective of cost accounting. In other words, the basic objective of cost accounting is to ascertain the cost of products and services. For cost ascertainment different techniques and systems of costing are used in different industries. 2. Control and reduction of cost. Cost accounting aims at improving efficiency by controlling and reducing cost. This objective is becoming increasingly important because of growing competition. 3. Guide to business policy. Cost accounting aims at serving the needs of management in conducting the business with utmost efficiency. Cost data provide guidelines for various managerial decisions like make or buy, selling below cost, utilisation of idle plant capacity, introduction of a new product, etc. 4. Determination of selling price. Cost accounting provides cost information on the basis of which selling prices of products or services may be fixed. In periods of depression, cost accounting guides in deciding the extent to which the selling prices may be reduced to meet the situation. 5. Measuring and improving performance. Cost accounting measures efficiency by classifying and analysing cost data and then suggest various steps in improving performance so that profitability is increased, In order to realise these objectives, the data provided by cost accounting may have to be re- classified, re-organised and supplemented by other relevant business data from outside the formal cost accounting system..Introduction COST ACCOUNTING AND FINANCIAL ACCOUNTING — Saat iif Both cost accounting and financial accounting are concerned with So Sa ecg aa rea presentation of financial data. The two systems rest on the same principles concerti d ce and have the same sources of recording the transactions. But cost accounting is mu¢ ae eras than financial accounting. This is because in financial accounting profit or loss is ascertaine ert business as a whole whereas in cost accounting detailed cost and profit data for various B f business like departments. products, etc., are shown. This is explained in the following example Suppose a company is manufacturing three products — A, B and C. Under financial accounting an cost accounting the following types of statements are prepared. Under Financial Accounting. A Profit and Loss Account is prepared to compute profit as shown below (data is assumed): Profit and Loss Account for the year ending 31st March, 2021 z z To Materials 75,000| By Sales 1,50,000 To Wages 20,000 To Other expenses 25,000 To Profit (Balancing figure) 30,000 1,50,000 1,50,000 This statement shows that total profit is 7 30,000 but it does not disclose the details of profit/loss of each of products A, B and C in the total profit. This is revealed by cost accounting. Under Cost Accounting. A detailed statement is prepared as follows : (Data of above Profit and Loss Account with further assumptions). Statement of Cost and Profit for the year ending 31st March, 2021 Total Product A Product B Product C e z z z Materials 75,000 40,000 12,000 23,000 Wages 20,000 10,000 5,000 5,000 Other expenses 25,000 20,000 3,000 2,000 Total cost 1,20,000 70,000 20,000 30,000 Sales 1,50,000 96,000 28,000 26,000 Profit/Loss (-) 30,000 26,000 8,000 © 4,000 In cost accounts, detailed costs are compiled for each product so that cost and profit on each product can be known. In the above Statement of Cost and Profit, it can be seen that total profit is % 30,000 i.e. the same amount as in financial Profit and Loss Account. In addition, cost accounts show that in the total profit of € 30,000, Product A is contributing % 26,000 and Product Bf 8,000, whereas Product C is showing a loss of & 4,000. When management gets this information, it should investigate to find out the reasons of loss in Product C. If Product C cannot be made profitable, its production Should be stopped to improve the overall profit picture of the company. However, this types of information is not revealed by financial accounting.14 The main p' explained below: st joints of difference between Cos Cost and Management necouncing ‘Accounting and Financial Accounting are ct Cost Accounting Basis Financial Accounting The main purpose of cost 1. Purpose fi nancial accounting is The main purpose of Financi to prepare Profit and Loss Account ana Balance Sheet for reporting to owners shareholders and other outside agencies, i,e., extemal users. accounting is to provide detailed cost information to management, ie., internal users. 2. Statutory requirements These accounts are obligatory to be prepared according to the legal requirements of Companies Act and Income Tax Act. Maintenance of these accounts is voluntary except in certain industries where it has been made obligatory to keep cost records under the Companies Act. 3. Analysis of cost and Profit Financial accounts reveal the profit or loss of the business as a whole for a particular period. It does not show the figures of cost and profit for individual products, departments and processes. Cost accounts show the detailed cost and profit data for each product line, department, process, etc. 4, Periodicity of reporting Financial reports (Profit and Loss Account and Balance Sheet) are prepared periodically, usually on an annual basis, Cost reporting is a continuous Process and may be on daily, weekly, monthly basis, ete. 5. Control aspect It lays emphasis on the recording of financial transactions and does not attach importance to control aspect. It provides for a detailed system of controls with the help of certain special techniques like standard costing and budgetary control. 6. Historical and pre- determined costs It is concerned almost exclusively with historical records. The historical nature of financial accounting can be easily understood in the context of the purposes for which it was designed, It is concemed not only with historical costs but also with pre- determined costs. This is because cost accounting does not end with what has happened in the past. It extends to plans and policies to improve performance in the future, 1. Format of presenting ‘information 8. Types of transactions recorded Financial accounting has a single ‘uniform format of Presenting information, Le., Profit and Loss Account, Balance Sheet Flow Statement, neat Financial accountin, i 9 records only ext. actions like sales, purchases, “nts peda Waa Pe Cost accounting has varied forms of presenting cost information which are tailored to meet the needs of management and thus lacks a uniform format. Cost accounting not only records ; [extemal transactions but also ‘internal or inter-departmental transactions fc like issue of Materials pS ike issue of materialsby store-keeper to production departments. 3 types of Financial accounting prepares general purpose | Cost accounting generates special pectawrens statements like Profit and Loss Account and | purpose statements and reports prepared Balance Sheet. That is to say that financial | like Report on Loss of Materials, accounting must produce information that is | Idle Time Report, Variance Report, used by many classes of people, none of whom | etc. Cost accounting identifies the have explicitly defined informational needs. | user, discusses his problems and needs and provides tailored information. MANAGEMENT ACCOUNTING Meaning and Definition The term ‘management accounting’ is the modem concept of accounts as a tool of management. It is a broad term and is concerned with all such accounting information that is useful to management. In simple words, the term management accounting is applied to the provision of accounting information for management activities such as planning, controlling and decision-making, etc. According to the Institute of Chartered Accountants of England, “any ‘form of accounting which enables a business to be conducted more efficiently” may be regarded as management accounting. Management accounting information can help managers identify problems, solve problems and evaluate performance. In the words of Robert Anthony, “Management accounting is concerned with accounting information that is useful to management.” The Institute of Cost and Works Accountants of India (ICWAI) has defined management accounting as “a system of collection and presentation of relevant economic information relating to an enterprise for planning, controlling and decision making.” ‘The Chartered Institute of Management Accountants (CIMA) of UK has given a very authoritative and comprehensive definition as follows: “Management accounting is an integral part of management concerned with identifying, presenting and interpreting information used for — (}) formulating strategy; (ii) planning and controlling activities; (iif) decision-making: (iv) optimising the use of resources; (V) disclosure to shareholders and others extemal to the entity: (vi) disclosure to employees; and (vii) safeguarding assets.” ' According to National Association of Accountants (USA), management accounting is “the process of identification, measurement, accumulation, analysis, preparation and communication of financial information used by management to plan, evaluate and control within the organisation and to assure appropriate use and accountability for its resources. These definitions make it clear that management accounting plays a vital role in providing the necessary information to managers in performing their functions of planning, controlling, organising and decision-making. Management accounting should serve as a decision support system to all levels of management. Management accounting provides that information which enables a business to be conducted more efficiently.Cost and Management Accounting An F Financial Accounting ting to Cost Accounting ue id agement Accounting ing, cost accounting and | Financial ite, financial accounting, accounting uses the | Accounting, Cost linked, The Seeraey financial accounting. | Accounting ang Relationship of Man: yes of accounting, re ent accounting are closely ‘management accour ting but for | Management ana¢ iot only of cost accounting ly useful fo: principles and practices n is ting proves extermely Accounting are Information provided by financial accounting provll T™ and Balance Sheet closely related, anagem counting. For example, Profit and Loss account nts, etc, fauagerthe bass of ratio analysis and comparative finan Ci oe of planing 7 i used by the management accounting as importan ing detailed cost computation and ae atl Financial accounting records also become basis of preparing detal d provides detailed and control. Financial p38 is a more detailed application of financial accounting ae Taegan ee about products, services, departments, oS a aaa 3 aera i ing, controlling and decision making pr . 1. : ae esa tinaaad its relaionship to eost accounting and financial accounting. FINANCIAL ACCOUNTING cost ACCOUNTING MANAGEMENT ‘ACCOUNTING Fig. 1.1. Relationship of Financial, Cost and ‘Management Accounting. Management Accountant is The Controller In USA, the management accountant i " ‘Financic the te manage ‘ant is called ‘Controller or ‘Financial Controller and he is a part of jement accountant plays a very important role is isati ai ; lays i in an organisation. He J Manage: 'yses and interprets accounting information and meets the informational needs accounting fs the / a management accountant’ | financial controllera part of the line function. It is very important that status of the management accountant in the organisation is clearly defined so that the scope of his work and responsibilities are accordingly determined. CHARACTERISTICS OR NATURE OF MANAGEMENT ACCOUNTING It is clear from the definitions of management accounting that it is concemed with accounting data that is useful in decision making. The main characteristics of management accounting are as follows : 1. Useful in decision making. The essential aim of management accounting is to assist management in decision making and control. It is concemed with all such information which can prove useful to management in decision making. 2, Financial and cost accounting information. Basic accounting information useful for management accounting s derived from financial and cost accounting records. 3. Internal use. Information provided by management accounting is exclusively for use by management for intemal use. Such information is not to be given to parties external to the business like shareholders, creditors, banks, etc. 4, Purely optional. Management accounting is a purely voluntary technique and there is no statutory obligation. Its adoption by any firm depends upon its utility and desireability. 5. Concerned with future. As management accounting is concerned with decision making, it is related with future because decisions are taken for future course of action and not the past. 6. Flexibility in presentation of information. Unlike financial accounting, in management accounting there are no prescribed formats for presentation of information to management. The form of presentation of information is left to the wisdom of the management accountant who decides which is the most useful format of providing the relevent information, depending upon the utility of each type of form and information. SCOPE OF MANAGEMENT ACCOUNTING Management accounting has a very wide scope. It includes not only financial accounting and cost accounting but also all types of internal financial controls, internal audit, tax accounting, office services, cost control and other methods and control procedures. Thus scope of management accounting, inter alia includes the following: 1. Financial accounting. Financial accounting provides basic historical data which helps management to forecast and plan its financial activities for the future period. Thus for an effective and successful management accounting, there should be a proper and well designed financial accounting system. 2. Cost accounting. Many of the techniques of cost control like standard costing and budgetary control and techniques of profit planning and decision-making like marginal costing, CVP analysis and differential cost analysis are used by the management accounting. 3. Budgeting and forecasting. In order to plan business activities for the future, forecasting and budgeting play a very significant role. Forecasting helps in the preparation of budgets and budgeting helps management accountant in exercising budgetary control. 4, Tax planning. In order to take advantage of various provisions of tax laws, management accountant has to depend upon tax accounting and planning to minimise its tax liabilities and save more funds for the business. The scope of management accounting is very wide to include all internal financial controls.Cost and Management Accounting 18 decisions, there should be a system of d special reports are prepared for j level management depending 5, Reporting to management. For effective and timely prompt and intelligent reporting to management. Both routine and | submission to top management, middle order management and operatin: on their requirements. oe ; 6. Cost control procedures. Any system of management accounting 1s incomplete without effective cost control procedures like inventory control, labour control, overhead control, budgetary control, etc. . : 7, Statistical tools. Various tools of analysing and presenting statistical data like graphs, tables, charts, etc., are used in preparing reports for use by the management. ; : 8. Internal control and internal audit. Management accountant heavily depends on intemal financial controls like intemal audit and intemal check to plug loop holes in the financial system of the concern. : : 9 Financial analysis and interpretation. Management accountant employs various techniques to analyse and interpret financial data to make it understandable and useable to the management. Such analysis helps management to achieve objectives of management in a more efficient manner 10. Office services. Management accountant is expected to maintain and control office routines and procedures like filing, copying, communicating, electronic data processing and other allied services. FUNCTIONS (OR OBJECTIVES) OF MANAGEMENT ACCOUNTING Management accounting helps management in performing its functions more efficiently. Main functions of management accounting are as follows: 1. Planning, Information and data provided by management accounting ‘management to forecast and prepare short-term and long-term plans for the helps future activities of the business and formulate corporate strategy. For this purpose management accounting techniques like budgeting, standard costing, marginal costing, probability, correlation and regression, etc., are used. 2. Coordinating. Management accounting techniques of planning also help in coordinating various business activities. For example, while preparing budgets for various departments like production, sales, etc,, there should be full coordination so that there is no contradiction. By proper financial purchases, reporting, management accounting helps in achieving coordination in various business activities and accomplishing the set goals. agement accounting 3. Controlling, Controlling is a very important function of management and man: helps in controlling performance by control techniques such as standard costing, budgetary control, control ratios, internal audit, etc. ‘4, Communication. Management accounting system prepares reports for presentation to various levels of management which show the performance of various sections of the business. Such communication in the form of reports to various levels of management helps to exercise effective control on various business activities and successfully running the business. 5, Financial analysis and interpretation. In order to make accounting data easily understandable, the management accounting offers various techniques of analysing, interpreting and presenting this data in non-accounting language so that every one in the organisation understands it. Ratio analysis, cash flow and funds flow statements, trend analysis, etc., are some of the management accounting techniques which may be used for financial analysis and interpretation. 6. Qualitative information. Apart from monetary and quantitative data, management accounting provides qualitative information which helps in taking better decisions. Quality of goods, customers and employees, legal judgements, opinion polls, logic, etc., are some of the examples of qualitative information supplied and used by the management accounting system for better management.Introduction 1.9 7. Tax policies. Management accounting system is responsible for tax policies and procedures and supervises and coordinates the reports prepared by various authorities, 8. Decision-making. Correct decision-making is crucial to the success of a business. Management accounting has certain special techniques which help management in short-term and long-term decisions. For example, techniques like marginal costing, differential costing, discounted cash flow, etc., help in decisions such as pricing of products, make or buy, discontinuance of a product line, capital expenditure, etc. Tools and Techniques used in Management Accounting Management accounting uses a number of tools and techniques to help management in achieving business goals. Some of the important tools and techniques are as follows: 1. Budgeting 2, Standard costing and variance analysis. 3. Marginal costing and cost volume profit analysis. 4, Ratio analysis. 5. Comparative financial statements. 6. Differential cost analysis. 7. Funds flow statement. 8. Cash flow statement. 9, Responsibility accounting. 10. Accounting for price level changes. 11, Statistical and graphical techniques. 12. Discounted cash flow. 13, Risk analysis. 14, Learning curve. 15. Value analysis. 16. Work study, etc. Bm FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING — COMPARISON Financial accounting and management accounting are two major sub-systems of accounting information system. Both are concerned with revenues and expenses, assets and liabilities and cash flows. Both therefore involve financial statements. But the major differences between the two arise because they serve different audiences. The main points of difference between the two are as follows : Basis Financial Accounting Management Accounting 1. External and internal | Financial accounting information is mainly] Management accounting information is users intended for extemal users like investors,| mainly meant for internal user, iLe., shareholders, creditors, Govt. authorities, etc. | management. 2. Accounting method [It is based on double entry system for| it is not based on double entry cystem. recording business transactions. 3. Statutory Financial accounting is mandatory. Under| Management accounting is optional requirements company law and tax laws, financiall though its utility makes it highly accounting is obligatory to satisfy various| desireable to adopt it. statutory provisions.Management accounting provides whole. It does not fit for individual etc. of the business as a show the cost and pro products, processes or departments, detailed information about individual products, plants, departments or any other responsibility centre. Te is future oriented and concentrates il F tions Tr is concerned with recording transaction: ‘which have already taken place, ie, it represents past or historical records. i a i 5 on what is likely to happen in future though it may use past data for future projections. Financial reports, i.e. Profit & Loss Account and Balance Sheet are prepared usually on a year to year basis. Periodic and conti- noous reporting ‘Management accounting reports are prepared frequently, i, these may be monthly, weekly or even daily depending on managerial require ments. ” 7, Aecounting standards | Companies are required to prepare financial issued by the Institute of Chartered Accountants of India. accounts according to Accounting Standards | by ‘Management accounting is not bound accounting standards.It may use any practice which generates useful information to management. Financial accounting prepares general Types of statements In management accounting special prepared purpose statements Profit and Loss Account | purpose reports are prepared, eg., and Balance Sheet which are used’ by] performance report of sales manager or extemal users. any other department manager which are used by top level management, 9. Publication and andit | Financial ‘statements, i.e, P&L A/c and| Management accounting statements are Balance Sheet are published for general public use and also sent to Mders.These are required to be audited by the Chartered Accountants. for internal use and thus neither published for general public use nor these are required to be audited by Chartered Accountants. . Monetary and non- Financial accounting provides i 5 monetary measure- 9 provides information ments in tems of money only. Management accounting may apply monetary or non-monetary units of measurement. For example information may be expressed in terms of Zor units of quantity, machine hours, labour hours, ete, jement ugh manager's eyes.” Thus a lagement uniting ting do not fags tt accounting, One point on 9 and manag ve cle wena ut temitorial boundaries. wnting may be made on theBasis Cost Accounting ‘Management Accounting 1. Scope Scope of cost accounting is limited to providing cost information for ‘managerial uses. Scope of management accounting is broader than that of cost accounting as it provides all types of information, i.e.. cost accounting as well as financial accounting information for managerial uses. Emphasis Main emphasis is on cost ascertainment and cost control to ensure maximum profit. Main emphasis is on planning, controlling and decision-making to maximise profit. . ‘Techniques employed Various techniques used by cost accounting include standard costing and variance analysis, marginal costing and cost volume profit analysis, budgetary control, uniform costing and inter-firm comparison, etc. ‘Management accounting also uses all these techniques used in cost accounting but in addition it also uses techniques like ratio analysis, funds flow statement, statistical analysis, operations research and certain techniques from various branches of knowledge like mathematics, economics, etc., whichsoever can help management in its tasks. . Evolution Evolution of cost accounting is mainly due to the limitations of financial accounting. Evolution of management accounting is due to the limitations of cost accounting. In fact, management accounting is an extension of the managerial aspects of cost accounting. . Statutory requirements Maintenance of cost records has been made compulsory in selected industries as notified by the Govt. from time to time. Management accounting is purely voluntary and its use depends upon its utility to management. . Data base It is based on data derived from financial accounts. It is based on data derived from cost accounting, financial accoun- ting and other sources. . Status in organisation In the organisational set up, cost account-ant is placed at a lower level in hierarchy than the management accountant. Management accountant is generally placed at a higher level of hierarchy than the cost accountant. . Installation Cost accounting system can be installed without management accounting. Management accounting cannot be installed without a proper system of cost accounting:cam a LIMITATIONS OF MANAGEMENT ACCOUNTING However, it Management accounting is a very pee of management. suffers from certain limitations as stated : ng helps management in based OnE esatical ata Management ity Dans et te sent "asta snaking decisions for the future but it is mainly Taga Sees Hie nasbacsald fee supplied by financial accounting and cost accounting. a ity of such Lot management, data is used for making future decisions. The accuracy an dependabii other words, f past ase data will leave their mark on the quility fe managerial decisions. Rot A a iar of as eee accountant should have knowledge of not only ci i allied subjects like economics, management, taxation, financial and cost accounting but also many. ie a Bee herae statistical and mathematical techniques ee Lack of peered af ese. subj Patt of ‘countant limits the quality of management accounting. : : masons approach. Management accounting provides mass of data using various acountin and non-accounting subjects for decision making purpose. But sometimes management avoids this complicated and lengthy course of decision making and makes decisions based on intuition, This leads to unscientific approach to decision making, oe 4. Not a substitute of management. Management accounting only provides information tp management for decision making but it is not a substitute of management and administration, 5. Costly system. The installation of management accounting system in an organisation is a costly affair as it requires a wide net-work of management information system, rules and regulations. All this Tequires heavy investment and small concems may not be able to afford it. Management accounting is a tool of management but 4 7. Lack of objectivity. The interpretati be influenced by decisions. Sr Resistance from staff. The existing accounti Soduction of management accounting sae “This may be aagement staff may not welcome te Suspicion that it will add ‘to their work and responsibiitie, ° — ey look at the system with EXAMINATION QUESTIONS Short Answer Questions 1, Define Cost. Accounting. Define : jement accounting a ee Ta : by management accounting ? (BBM Bangalore) ion of management ; ? & five thee points of companicer net 2cOunting with financial ‘ ; What is the difference betwen eeMED financial sec 2ccounting and cost accounting ? Fis ce between cost accounting and mand and jement accountin: A any three objectives of jement acne nt AMAGement pear ig. s ie is the status of manay accountancy, accounting ? Give two Points. . Seat Re of management eR san oy sation > 10. Name any five tectniguee aeuent accounting 2 fanisation 2 management accounting, aIntroduction 1.13 Essay Type Questions 1, Define management accounting explain its objectives. 2. What are the functions of management accounting ? 3, How is management accounting an improvement over financial accounting ? Discuss. 4, Explain the distinsion between Financial accounting and cost accounting ? 5, In what respects cost accounting is different from management accounting ? 6. Discuss the role of management accountant in a moder organisation. 7. Explain the nature and scope of management accounting. 8, Discuss management accounting as an effective tool of financial control. 9 “There is an intimate relationship between mana'gement accounting and finance functions.” Elucidate. 10. “Management accounting is concemed with accounting information which is useful to management.” Explain.