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CHAPTER 1: MANAGEMENT ACCOUNTING

Introduction:
Accounting may be broadly classified into two categories – accounting which is meant to
serve all parties external to the operating responsibility of the firms and the accounting which is
designed to serve internal parties who take care of the operational needs of the firm. The first
category which is conventionally referred to as financial accounting, looks to the interest of those
who have primarily a financial stake in the organization’s affairs – creditors, investors,
employees etc. On the other hand the second category of accounting is primarily concerned with
providing information relating to the conduct of the various aspects of a business like cost or
profit associated with some portions of business operations to the internal parties viz.,
management. This category of accounting is called as Management accounting.
In order to perform the primary task of decision making managers of business enterprises
need information about the past, present and future in the functional areas of management such
as personnel, finance, marketing and production. Right decision making has to be based on
quantitative and qualitative information. The management thus constantly needs accounting
information to base its decisions upon. Thus management accounting provides the information
needed by management personnel.
Definition:
The Institute of Chartered Accountants of England has defined management accounting
as: “Any form of accounting which enables a business to be conducted more efficiently can be
regarded as Management Accounting”.
As per American Accounting Association, “Management Accounting includes the
methods and concepts necessary for effective planning, for choosing among alternative business
actions and for control through the evaluation and interpretation of performances.
As per Institute of Chartered Accountants of India, “Such of its techniques and
procedures by which accounting mainly seeks to aid the management collectively have come to
be known as management accounting”.
The Chartered Institute of Management Accounts (UK) defines management accounting
as under:
“Management accounting is an integral part of management concerned with identifying,
presenting and interpreting information used for:
1. Formulating strategy
2. Planning and controlling activities
3. Decision making
4. Optimizing the use of resources
5. Disclosures to shareholders and others external to the entity
6. Disclosure to employees
7. Safeguarding assets.”

Nature of management accounting:

Managerial personnel are entrusted with authority and responsibility of operating business
activities. Management accounting provides information to the personnel are entrusted with
authority and responsibility of operating business activities. Management accounting provides
information to the managerial personnel at three levels of management viz., top, middle and
lower levels of management. It provides the management with the tools for an analysis of its
administrative action that can lay suitable emphasis on the possible alternatives in terms of costs,
prices and profits. The decisions made by management are based on quantitative information and
common sense, foresight, knowledge and experience. Management accounting includes financial
accounting information and raw material from several other disciplines such as costing, statistics,
mathematics, political science, sociology, psychology, management economics, law etc. With all
these data he can ensure optimum utilization of all the resources including employees by
maintaining sound morale of the employees, maximization of output and minimization of inputs,
analyze the managerial questions in terms of costs, revenues, profits and growth. It is thus a
highly personalized service with the help of which management can explore and exploit business
opportunities and take sound and correct decisions. It is not a precise science as it uses its own
conventions rather than standardized principles. Therefore the inferences drawn from the facts
provided, depends on the skill, judgment and common sense of different management
accountants. Thus it is said that management accounting serves as a management information
system which enables the effective management of an enterprise.

Scope of management accounting:

Management accounting is a wide and diverse subject. As stated earlier it includes various
branches of knowledge such as psychology, sociology, economics, laws, political science,
mathematics, statistics, finanacial accounting, cost accounting etc. It is thus very difficult to
define its scope, as it is a dynamic and ever growing discipline of knowledge. The important
techniques and systems used by management accounting are briefly stated below.
a. Historical cost accounting: Maintenance of books of cost accounting enables to know
the actual costs incurred by the firm.
b. Standard costing: The standard costs laid down by experts are compared with the
natural costs in order to know the deviations
c. Marginal costing: The costs are divided into fixed and variable costs which help is
making vital decisions.
d. Decision accounting: Decisions are made after studying the impact of decisions in
terms of costs, resource, profits, growth etc.
e. Budgetary control: It is a system of controlling the cost with the help of budgets.
f. Control accounting: It includes the techniques such as standard costing, budgetary
control, control reports, internal check, internal audit and reports.
g. Revaluation accounting: It is based on current costs to ensure that the investment is
intact and profits from investment are kept in mind.
h. Financial planning & policies: It consists of raising the long term and short term
finance and invest it on optimum basis and enhance the profitability of the firm.
i. Capital expenditure: The large amounts of future capital expenditure and future
profits are analysed to take important decisions.
j. Break even analysis: This is an important technique which is used to analyse the
behavior of costs viz., fixed and marginal costs, indicating the level of activity at
which the total costs would equal the total revenue and also the margin of safety.
k. Inter-period comparison: It is a technique of comparing the present performance with
the past performance.
l. Techniques of forecasting: Some techniques like decision tree, probability and
sensitivity analysis are used by management accountants for forecasting which forms
a base for planning.
m. Operations research: It consists of statistical and mathematical techniques that are
increasingly used in decision making process.
n. Statistics: The statistical techniques used by management accountant are correlation,
regression, probability, time series, standard deviation, linear programming, control
charts etc.
o. Other techniques: Other techniques employed are: Financial reporting, data
processing, project management and appraisal, management audit, efficiency audit,
cost audit, performance budgeting, tax planning, social accounting & audit, human
resource accounting, responsibility accounting and divisional performance.

Functions of management accounting:

1. Modification of data: The management accounting system modifies the data furnished by
financial accounting to serve the managerial needs in such a way that the process of
classification and combination which enables to retain similarities without eliminating
dissimilarities.
2. Validating the data: To make reliable decisions valid data should be made available to
managers. The effectiveness of managerial function depends too much upon the accuracy
and adequacy of the data. It is the function of management accounting to present before
the management the required data with some sort of reasonable accuracy and it need not
be with perfect accuracy.
 3. Analysis and interpretation of data: Though management accounting is concerned with
recording of business transactions, the analysis and interpretation of such data, in
analyzing and interpreting the data lies the essence of management accounting. To
discharge this function management accounting uses a number of tools like Marginal
costing, budgeting, standard costing etc.
4. Communicating the data: The collected and interpreted data must be communicated to
those who are interested in it or to whom it has some meaning. Otherwise these data may
not yield any meaningful result and the whole process of collecting, validating and
interpreting would amount to be a futile exercise. The communication of the data should
be done within a reasonable time. Data delayed is decision delayed and a delayed
decision may delay the prosperity of its concern. To accomplish this function of
management accounting several reports and statements are being used.

Functions of a management accountant: Although it is understood that all the functions of

management accounting are to be performed by the management accountant, the following may
be said to be the important role of the management accountant in the management of a company.
1. Collection of data: The management accountant has to collect data about the
problems faced by the management through primary and secondary sources.
2. Analysis of data: After the collection of data, the management accountant has to
analyse it for the purpose of interpretation using various tools and techniques.
3. Presentation of data: The management accountant is required to present the data to the
management in columns and rows to facilitate proper understanding.
4. Planning: The management accountant assists the management in long range planning
as well as in formulation of policies of the organisation.
5. Controlling: The management accountant follows different techniques like standard
costing, budgetary control etc to ensure adequate control for implementation of plans
and achievement of objectives.
6. Reporting: Reporting being a very important function of a management accountant,
he has to prepare different types of reports periodically and communicated to the
concerned departments to meet the requirements at different levels of management for
necessary action.
7. Co-ordinating: The management accountant has to co-ordinate the various activities
of the organization for the preparation of master budget and other such activities.
8. Decision making: The management accountant has to assist the management in taking
realistic decisions through analysis and interpretation of data that suggests a particular
course of action with the help of various tools of management accounting.

Management accounting vs. financial accounting

Financial accounting and management accounting are two interrelated facets of the accounting
system. They are not independent of each other but they are interdependent. Financial accounting
provides the basic data which are analysed and interpreted suitably and in the required manner
by management accounting. Although there exists close relationships between financial
accounting and management accounting, distinction is always drawn between financial
accounting and management accounting since they differ in their emphasis and approaches.

Dimension Management Accounting Financial Accounting

1. Objective To provide information for internal To make periodical reports to
management shareholders, creditors,
debenture holders and the
Government.
2. Structure Varies according to use of the Unified structure
information
3. Sources of Whatever is useful to management Generally accepted
principles accounting principles
(GAAPs)
4. Need Optional Statutory obligation

5. Time-orientation Historical and estimates of the future Historical

6. Report entity Responsibility centers Overall organization

7. Purpose A means to the end of assisting External reporting /

management statements for outside users
8. Users Relatively small group: known Relatively large group:
identity mostly unknown
9. Information Monetary and non-monetary Primarily monetary
content
10. Information Many approximations Few approximations
precision
11. Report frequency Varies with purpose, monthly and Quarterly and annual
weekly.
12. Report timeliness Reports issued promptly after end of Delay of weeks or even
period covered months
13. Period of Reports are for shorter durations. The Generally adopts twelve
reporting data is also collected for preparing months period for reporting
long term plans for five or more financial performance.
years.
14. Liability Virtually none. Few lawsuits but threat is
potential always present.
15. Record Costs and revenues reported by Records maintained in the
maintenance & responsibility centres or cost centres form of personal, property
reporting and nominal accounts.

16. Role of Transcends beyond book-keeping Limits the role to a book-

accountant into the managerial process of keeper.
planning, organizing, control and
 evaluating and also to different
functional areas.

Management accounting vs. cost accounting

Costing has been defined as classifying, recording and appropriate allocation of
expenditure for the determination of the costs of products or services. Cost accounting will tell
the management as to how the business has fared at each stage of operation. But cost accounting
will not tell them anything about the future policy to be adopted. It is here that management
accounting differs from cost accounting. The aim of management accounting is not to collect
information as such but to utilize the information collected in order to help the management to
formulate their future policy and to make important policy decisions.
Though there is a difference between management accounting and cost accounting in
their objective yet their functions are complementary in nature. Management accounting depends
heavily on cost data and other information derived from cost records. In one way, management
accounting is an expansion of cost accounting. Like cost accounting, management accounting
involves reporting at frequent intervals rather than at the end of a year or half-year.
Cost accounting deals primarily with cost data. But management accounting involves the
consideration of both costs and revenues. It is a broader concept than cost accounting. It not only
reports costs but also uses them to assist management in planning possible alternate courses of
action.
Conceptually speaking management accounting is a blending together of cost accounting,
financial accounting and all aspects of financial management. It has a wider scope as a tool of
management. But it is not a substitute for other accounting functions. It is a continuous process
of reporting cost and financial data as well as other relevant information to management.
 CHAPTER 2: COST ACCOUNTING, JOB COSTING & BATCH COSTING

Cost: Cost means the amount of expenditure incurred on a particular thing. CAS-1 (Cost
Accounting Standard 1, issued by the ICWA, India) defines Cost as: Cost is a measurement, in
monetary terms, of the amount of resources used for the purpose of production of goods or
rendering services.

Costing: Costing means the process of ascertainment of costs. Costing involves the following
steps (i) Ascertaining or collecting costs (ii) Analysing or classifying costs into basic elements
such as Material, Labour, Expenses etc. and (iii) Allocating total costs to a ‘particular thing’ i.e. a
product, a contract or a process. Thus cost can now be defined as the total expenditure, duly
classified into materials, labour, expenses etc. allocated to a particular product or contract or
process.

Cost Accounting: The Institute of Cost and Management Accountant, England (ICMA) has
defined Cost Accounting as – “the process of accounting for the costs from the point at which
expenditure incurred, to the establishment of its ultimate relationship with cost centres and cost
units. In its widest sense, it embraces the preparation of statistical data, the application of cost
control methods and the ascertainment of the profitability of activities carried out or planned”.

Cost accounting is a term broader than costing. It covers costing plus the reporting and control of
costs. Thus Cost Accounting = Costing + Cost Reporting + Cost Control. Cost accounting can be
defined as the technique of recording, classification, allocation, reporting and control of costs.

Objectives of cost accounting:

Cost accounting has the following basic aspects or objectives:
1. Costing: It involves the following basic aspects or 5 ‘A’s:
a. Ascertain costs relating to a particular period,
b. Analyse or classify costs under different heads of accounts such as material,
labour, expenses etc.,
c. Allocate costs fully to the direct expenses or the specific costs such as raw
materials, labour to the relevant products, contracts or processes,
d. Apportion or distribute common costs to each product, contract or process on a
suitable basis and
e. Absorb the total expenses of a department over its products so as to finalise the
cost of each product that is then reported to the management.
2. Cost reporting: Cost reporting has the following aspects:-
a. What to report or the nature of information to be presented should be relevant and
precise.
b. Whom to report will determine the scope of the report to be submitted to the top
management.
c. When to report – daily, weekly, monthly, quarterly or yearly etc.
d. How to report or the format will depend on the factors mentioned above. Once the
cost report is received, management can take action to control the costs.
3. Cost Control: Cost control has been defined by the ICMA as “the guidance and regulation
by executive action of the costs of operating an undertaking”. Thus cost control means
the control of costs by management. Following are the aspects or stages of cost control.
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