SRI VIDYA MANDIR ARTS & SCIENCE COLLEGE

(Autonomous)
KATTERI – 636 902, UTHANGARAI (TK), KRISHNAGIRI (DT)

DEPARTMENT OF COMMERCE (B.Com)

COURSE NAME: MANAGEMENT ACCOUNTING

CLASS: III B.Com
STAFF: Dr. C. Gomathi

UNIT – I
Management Accounting – Meaning – Objectives – Functions – Importance and
Scope – Distinguish Between Management Accounting, Cost Accounting and Financial
Accounting – Advantages and Limitations of Management Accounting. Financial Statement
Analysis – Nature, Objectives, Tools – Methods – Comparative Statements, Common Size
Statement and Trend Analysis.
UNIT – II
Ratio Analysis– Uses and Limitations of Ratio Analysis – Types of Ratios – Analysis
of Profitability – Solvency – Turnover ratios.
UNIT – III
Fund Flow Analysis: Uses, Significance and Importance of Fund Flow Statement –
Cash Flow Analysis (New Format) – Comparison Between Fund Flow Analysis and Cash
Flow Analysis.
UNIT – IV
Budgets and Budgetary Control – Definition – Importance – Essentials –
Classification of Budgets – Master Budget – Preparation of Production Budget, Purchase
Budget, Sales Budget, Cash Budget, Material Budget and Flexible Budget.
UNIT – V
Marginal Costing – Significance and Limitations of Marginal Costing – Absorption
Costing – P/V ratio – BEP and Margin of Safety– Practical Application of Marginal Costing
Technique to Different Situations.
 UNIT- I

MEANING OF MANAGEMENT ACCOUNTING:

Management accounting is accounting for effective management .

Accounting which is provides the necessary information to the management for
discharging its functions.
Management accounting is the presentation of accounting information in such a way
as to assist management in the creation of policy and in the day- to-day operation of
undertaking.

DEFINITION OF MANAGEMENT ACCOUNTING:

“Management accounting is concerned with accounting information that is useful to

management”.-Robert N.Anthony
The Chartered Institute of Management Accountants (CIMA) London, defines
Management Accounting as follows: “The application of professional knowledge and
skill in the preparation of accounting information in such a way as to assist
management in the formation of policies and in the planning and control of the
operations of the undertaking.”

(1) NATURE (or) CHARACTERISTICS OF MANAGEMENT ACCOUNTING:

1. Forecasting:
It is not confined only to the collection of historical data or facts but also attempts to
highlight upon “What should have been”.
2. Supplying information:
It provides information to the management and not decision.
3. Increase in efficiency:
It is basically concerned with “the problem of choice”.
4. Techniques and concepts:
It uses special techniques and concepts to make accounting data more useful.
5. Cause and effect analysis:
 It attempts to examine the “cause” and “Effect” of different variables. This may be the
reason that management accounting is called as science.
6. No fixed norms:
No set of rules and formats like double entry system of book keeping.
7. Assists management:
It assists management in several ways in its functions but does not replace it.

8. Achieving of objectives:
The principal objective is ‘to serve the needs of management’.

(2) SCOPE OF MANAGEMENT ACCOUNTING:

1. Financial accounting:
Financial accounting is the general accounting which relates to the recording of
business transactions in the books of primary entry, posting them into respective ledger
accounts, balancing them and preparing a trail balance. Hence management accounting
cannot obtain full control and coordination of operations without a well-designed financial
accounting system.
2. Cost accounting:
Costing is a branch of accounting. It is the process and technique of ascertaining
costs. Planning, decision making and control are the basic managerial functions.
3. Budgeting and forecasting:
Budgeting is expressing the plans, policies and goals of the enterprise for a definite
period in future. Forecasting is a prediction of what will happen as a result of a given set of
circumstances.
4. Statistical methods:
Statistical tools such as graphs, charts, diagrams, pictorial presentation, index
numbers etc. make the information more impressive, comprehensive and intelligible.
5. Inventory control:
It includes control over inventory from the time it is acquired till its final disposal.
Inventory control is significant as it involves large sums.
6. Interpretation of data:
 Analysis and interpretation of financial statements are important parts of management
accounting. After analyzing, the interpretation is made and the reports drawn from these are
presented to the management in a simple language.
7. Reporting:
The interpreted information in the form of quantitative expression must be
communicated to those who are interested in it. At the same time these data should be
communicated within reasonable time.
8. Internal Audit:
It needs devising a system of internal control by establishing internal audit coverage
for all operating units. It helps the management to fix responsibilities to individuals.
9. Tax Accounting:
Income statements are prepared and tax liabilities are calculated. The management is
informed about tax burden from central government.
10. Methods and procedures:
This includes maintenance of proper data processing and other office management
services, reporting on best use of mechanical and electronic devices.

(3) OBJECTIVES OF MANAGEMENT ACCOUNTING

The primary objective is to enable the management to maximize profits or minimize

losses.
The fundamental objective of management accounting is to assist management in
their functions. The other main objectives are,
1. Planning and policy formulation:
Planning is one of the primary functions of management. It involves forecasting on
the basis of available information.
2. Help in the interpretation process:
The main object is to present financial information. The financial information must be
presented in easily understandable manner.
3. Helps in decision making:
Management accounting makes decision making process more modern and scientific
by providing significant information relating to various alternatives.
4. Controlling:
The actual results are compared with pre-determined objectives. The management is
able to control performance of each and every individual with the help of management
accounting devices.
5. Reporting:
This facilitates management to take proper and timely decisions. It presents the
different alternative plans before the management in a comparative manner.
6. Motivating:
Delegation increases the job satisfaction of employees and encourages them to look
forward. so it serves as a motivational devise.

7. Helps in organizing:
“Return on capital employed” is one of the tools if management accounting. All these
aspects are helpful in setting up effective and efficient organization.
8. Coordinating operations:
It provides tools which are helpful in coordinating the activities of different sections.
(4) FUNCTIONS OF MANAGEMENT ACCOUNTING:

The basic function of management accounting is to assist the management in

performing its functions effectively. The other functions are,
1. Modification of data:
Accounting data as such are not suitable for managerial decision making and control
purposes. The modification of data in similar groups makes the data more useful and
understandable.
2. Planning and forecasting:
Under the process of planning, management formulates policies and executes plans to
achieve the desired objectives.

3. Financial analysis and interpretation:

The accounting data is analyzed and interpreted meaningfully for effective planning
and decision making. The interpretation is most important function of management
accounting.
4. Communication:
Management accounting is an important medium of communication. Different levels
of management need different types of information.
5. Facilitate managerial control:
Management accounting enables all accounting efforts to be directed towards the
attainment of goals efficiently by controlling then operations of the company more
effectively.
6. Use of qualitative information:
Financial data and its analysis and interpretation are not sufficient for decision
making.
7. Decision making:
Management accounting supplies analytical information regarding various
alternatives and the choice of management is made easy.
8. Coordinating:
Coordination is the essence of managerial activity. It helps to increase the efficiency
of organizations.

(5) TOOLS OF MANAGEMENT ACCOUNTING

Management accounting uses the following tools to properly discharge its duty
towards management
(1) Financial Accounting:
As stated earlier management accounting is mainly concerned with re-arranging the
information provided by the financial accounting in a way most suitable for managerial
decision-making. Hence, it cannot effectively discharge its functions without a properly
designed financial accounting system.
(2) Financial Statement Analysis:
Financial statement analysis is concerned with methodical classification and
evaluation of the information provided by the income statement and the balance sheet so as to
afford full diagnosis of the profitability and financial soundness of the business. Hence,
financial statement analysis is also a useful tool of management accounting.
(3) Funds Flow Analysis:
This is based on funds flow statement, which reveals the changes in the working
capital position over a period of time. Working capital is considered to be the life-blood of
the business and hence its effective and efficient management is necessary for the very
survival of the business. Funds flow analysis is, therefore, an important tool of management
accounting.
(4) Cash Flow Analysis:
Cash flow analysis helps the business in its liquidity planning. It tells the management
about the sources and applications of cash. It enables an enterprise for adjusting the liquidity
position, re-arranging the maturity structure of its debts and making arrangements for
availability of cash at the times desired.
(5) Budgetary Control:
This involves framing of budgets, comparison of actual performance with the
budgeted figures, computation of variances, and undertaking remedial measures for
minimizing the variances or revising the budgets, if necessary. The technique of budgetary
control helps the management in planning their operations and improving their performance.
Hence, it is an important tool of management accounting.
(6) Management Reporting:
The efficiency of a business to a large extent is governed by the pertinence and
regularity of the information provided to the managerial personnel. As a matter of fact, the
ultimate effectiveness of information is itself dependent upon the form and timing of its
presentation. Hence, effective and efficient management information or reporting system is
one of the important tools of management accounting.
(7) Cost Analysis:
In today’s world of competition, the importance of cost analysis cannot be under
emphasized. Cost analysis includes applications of costing methods, viz., job costing, process
costing, etc., arid costing techniques, viz., marginal costing, absorption costing, uniform
costing etc. All these methods and techniques come in the ambit of “Cost Accounting”.

(6) LIMITATIONS OF MANAGEMENT ACCOUNTING

In the present corporate world, management accounting is of great importance but it
has some limitations like any other science:-
(1) Based on Financial and Cost Accounting
Most of the information presented by management accounting is based on the
financial and cost accounting. The information in their statements is generally based on
historical figures, which make the information of management accounting less useful.

(2) Wide Scope

Management accountant tries to provide forecasts, analysis and reports for all the
areas of management, which has a very wide scope thus making it very hard for him to
generate such information.
(3) Lack of Continuity in Efforts
The conclusions derived by management accountant are of no use till they are
constantly and cautiously used by the management.
(4) Effect of Human Factor
The information whatsoever is collected in the management accounting is affected by
the “personal biases” and human factor, the conclusions drawn from them are also affected.
(5) Lack of Thorough Knowledge
The right conclusions, from the information collected in management accounting, can
be drawn only if the person is having in-depth knowledge of accountancy, statistics,
economics, auditing, management and engineering etc.
(6) Not an Alternative of Administration
Management accounting is just a tool in the hands of management and it cannot
replace the administration and management. Management accounting provides basis for
decision-making and not the decision.
(7) Effect of Time Factor
Most of the information gathered by management accountant is of historical nature.
Sometimes quick decisions are needed regarding the project and at such time management
accountant cannot reproduce effective information, which is a failure.
(8) Top Heavy Structure
For the establishment of management accounting system there is a requirement of a
broad organization and employees, which makes it a costly affair, therefore it can be adopted
only by large organisations.
(9) Evolutionary Stage
The tools of management accounting has not developed fully as yet, there is a
constant change in it from time to time, which makes them instable for use.
(10) Use of Alternative Techniques
In management accounting various techniques can be used for solving a problem.
Different conclusions will be drawn for the same problem on using different tools.

(7) ADVANTAGES OF MANAGEMENT ACCOUNTING:

1. Helps in decision making:

Helps to make decisions like pricing, make or buy, acceptance of orders, selection of
product mix etc,.
2. Helps in planning:
Planning includes profit, budget, capital investment and financing.
3. Helps in organizing:
It helps to develop organizational structure.
4. Facilitates communication:
It provides up to date information to evaluate the performance.
5. Helps in coordinating:
It helps to coordinate the department activities and to achieve their goals.
6. Evaluation and control of performance:
It assists to find weak area to take corrective actions.
7. Interpretation of financial information:
This will helps to quick decision making.
8. Economic appraisal:
It includes social and economic forces.
(8) Qualities of Management Accountant
Generally a controller should have following qualities:
(1) Knowledge of Accounting-
He should have full knowledge of financial and cost accounting. If he does not have
that then how would he provide correct information to the managers.
(2) Knowledge of Statistics –
The proper knowledge of statistics is necessary to present the information in the form
of graphs, charts, tables etc. to make them more understandable. .
(3) Knowledge of Economics –
Most of the economic decisions of the organisation are based on the principles of
economics. Thus, he should have its knowledge, price fixation, production decisions,
capital expenditure etc.
(4) Knowledge of Law-
The law complexities are increasing day by day, thus controller should know all the
laws which can affect the business. New capital issue, distribution of dividend, depreciation
and reserve accounts, publishing and auditing etc. are bounded by legal obligations which
have to be fulfilled.
(5) Knowledge of Psychology-
He needs to take work from his colleagues and subordinates. If he has good
knowledge of psychology then he can maintain good relations with them.
(6) Knowledge of Mercantile and Industrial Laws –
Companies Act, Partnership Act, Sale of Goods Act, Factories Act etc. are some
legislation which must be known to him.
(7) Effective Personality-
Controller should have qualities like good nature, dignity, integrity, honesty, hard
work, fun-loving etc.
(8) Deep Interest in the Firm-
Controller should be able to relate his success with the success of the firm.
(9) Understanding-
He should of in depth understanding about the problems of the firm then only he can
be effective or otherwise he will be unsuccessful.
(10) Balanced Outlook-
He should be able to think in balanced way about the original present situation and the
potentialities of future.
 Unit II

RATIO ANALYSIS

MEANING OF RATIO ANALYSIS

Ratio is relationship expressed in mathematical terms between two accounting figures

which are connected with each other in some way or other.

Ratios can be expressed in two ways namely ‘Times’ and ‘Percentage’.

CLASSIFICATION OF RATIO ANALYSIS

Accounting Ratios can be classified into different categories depending

upon the basis of classification.

I. TRADITIONAL CLASSIFICATION

The traditional classification has been on the basis of the financial statements
(income statement and position statement) to which the determinants of a ratio belong.
On this basis, the ratios could be classified as:

1. Profit and loss Account Ratios (Income Statement Ratios)

Ratios calculated on the basis of the items of profit and loss account
only are called profit and loss account ratios. For example: Gross Profit ratio;
Net profit ratio, Stock Turnover ratio.

2. Balance Sheet Ratios (Position Statement Ratios)

Ratio calculated on the basis of the figures of balance sheet only are
called balance sheet ratios. For example: current ratio, debt – equity ratio.

3. Composite Ratios (Inter –Statement Ratios)

 Ratio based on figures of both profit and loss account as well as
balance sheet are known as composite ratios. For example: ROI (Return on
Investments)
II. Functional Classification

The main function of ratio is to test a firm’s liquidity, efficiency,

solvencyand profitability. On the basis of functions of ratios or under functional
classification, there are four groups of ratios. They are:

1. Liquidity Ratio

2. Efficiency Ratio

3. Solvency Ratio

4. Profitability Ratio

Accounting
Ratio

Liquidity Ratio Efficiency Solvency Ratio Profitability

Ratio Ratio

1. Liquidity Ratio

The ratio that are used to test the liquidity position of a firm are called liquidity ratio.
 Liquidity refers to the ability of a firm in settling its current liabilities
as and when they become due. It is also known as short-term solvency.

(i) Current Ratio

(ii) Quick Ratio

(iii) Super –quick Ratio

(i) Current Ratio

Current ratio establishes relationship between current assets and current

liabilities. Current assets are those assets that can be converted into cash say within a
year. And, current liabilities are those liabilities that should be settled within a short
period say one year.

Current ratio is also known as working capital ratio as the excess of current
assets over current liabilities is called working capital.

EFFICIENCY RATIOS / ACTIVITY RATIO

The efficiency or activity ratio are those ratio calculated to measure the operational
efficiency of a business concern. Indeed, these ratio are of much useful in measuring the
speed with which assets are converted into sales. Therefore, these ratios are also called
‘Velocity’ ratio. As efficiency ratio or activity ratio indicate the speed with which assets are
turned over into sales, these ratio are also called turnover ratio. As these ratio reveal the
performance of a business concern, they are also called ‘performance ratio’.

The movement of assets in general and the movement of current assets in particular
exhibit the efficiency of business concern. For example, if stock is quickly moved into cash it
shows that the firm performs well so also when debtors are quickly realized or converted into
cash it shows that the firm is so efficient. Thus, the other name of efficiency ratios is
“current assets movement ratio”.

All the ratio coming under this category are calculated with reference to either sales or
cost of goods sold (i.e, cost of sales). And, the result is generally expressed in number of
times.

The Important Turnover Ratios are:

1. Inventory Turnover Ratio

2. Debtors Turnover Ratio

3. Creditors Turnover Ratio

4. Working capital Turnover Ratio

5. Total capital Turnover Ratio

6. Fixed assets Turnover Ratio

7. Total Assets Turnover Ratio

 1. Inventory Turnover Ratio (or) Stock Turnover Ratio (or) Stock Velocity

This ratio indicates whether investment in inventory is efficiently used

or not. It indicates the number of times the stock has been turned over during
the period and as such it evaluates the efficiency with which a firm is able to
manage its inventory.

SOLVENCY RATIOS

Solvency refers to the ability of a firm in meeting its long-term obligations. By

solvency, we mean long-term solvency of a firm. This is because liquidity means short-
term solvency.

Solvency ratios are those ratios calculated to determine or test the firm’s ability to
meet its long-term liabilities. The long-term liabilities of a firm includes bonds and
debentures, long- term loans from banks and financial institutions and other long-term
creditors.

The solvency position of a firm can be determined/tested with the help of

the following ratios:

1. Debt-equity Ratio

2. Proprietary Ratio

3. Fixed Assets to Net Worth Ratio

4. Fixed Assets to Long-term Funds Ratio

5. Capital Gearing Ratio

6. Current Assets to Net-worth Ratio

7. Interest Coverage Ratio

8. Solvency Ratio

Let us see the concept, computation and significance of various solvency ratios one by
one
 1. Debt – Equity Ratio

Debt- Equity ratio is calculated to know the extent of outsiders funds and share holders
funds used in acquiring the assets for a firm. In other words, it is calculated to measure the
relative claim of outsiders and owners against the assets of a firm. It is also known as
external- internal equity ratio or debt-to net-worth ratio.

USES AND LIMITATIONS OF RATIOANALYSIS

Ratio analysis is used as a device to analyse and interpret the financial health and
soundness of an enterprise. The use of ratios is not confined to management accountant or
financial managers only. There are different parties interested in the ratio analysis for
knowing the financial position of a firm for varied purposes.

Advantages of Ratio Analysis

Following are some of the advantages of ratio analysis:

i. Simplifies Financial Statements. Ratio analysis simplifies the comprehension of

financial statements. Ratios tell the whole story of changes in the financial
condition of the business.

ii. Facilities Inter-firm Comparison Possible. Ratio analysis provides data for
inter- firm comparison. Ratio highlights the factors associated with successful and
unsuccessful firms. They also reveal strong firms and weak firms, over-valued
and under-valued firms.

iii. Makes Intra-firm Comparison Possible: Ratio analysis also makes possible
comparison of the performance of the different divisions of the firm. The ratios are
helpful in deciding about their efficiency or otherwise in the past and likely
performance in the future.

iv. Helps in Planning. Ratio analysis helps in planning and forecasting. Over a
period of time a firm or industry develops certain norms that may indicate future
success or failure. If relationship changes in firm’s data over different time
periods, the ratios may provide clues on trends and future problems.
 v. Helps in decision-making. Financial statements are prepared primarily for
decision- making. But the information provided in financial statements is not an
end in itself and no meaningful conclusion can be drawn from these statements
alone. Ratio analysis helps in making decisions from the information provided in
these financial statements.

vi. Helps in financial forecasting and planning: Ratio analysis is of much help in
financial forecasting and planning. Planning is looking ahead and the ratios
calculated for a number of years work as a guide for the future. Meaningful
conclusions can be drawn for future from these ratios. Thus, ratio analysis helps
in forecasting and planning.

vii. Helps in Communication. The financial strength and weakness of a firm are
communicated in a more easy and understandable manner by the use of ratios. The
information contained in the financial statement is conveyed in a meaningful
manner to the one for whom it is meant. Thus, rations help in communication and
enhance the value of the financial statements.

viii. Helps in co-ordination. Ratios even help in co-ordination which is of utmost

importance in effective business management. Better communication of efficiency
and weakness of an enterprise results in better co-ordination in the enterprise.

Thus, “ratios can assist management in its basic function of forecasting,

planning, co-ordination, control and communication.

Limitations of Ratio Analysis

Ratio analysis is of great use in arriving at managerial decisions.

Nevertheless, it suffers from following limitations:

1. Limited Use of Single Ratio. A single ratio, usually, does not convey much of a
sense. To make a better interpretation a number of ratios have to be calculated which
is likely to confuse the analyst than help him in making any meaningfulconclusion.

2. Lack of Adequate Standards. There are no well accepted standards or rules of thumb
for all ratios: It renders interpretation of the ratio difficult.
3. Inherent Limitations of Accounting. Like financial statements, ratios also suffer
from the inherent weakness of accounting records like their historical nature. Ratios of
the past are not necessarily true indicators of the future.

4. Window Dressing: Financial statements can easily be window dressed to present a

better picture of its financial and profitability position to outsiders. Hence, one has to
be very careful in making a decision from ratios calculated from such financial
statements. But it may be very difficult for an outsider to know about the window
dressing made by a firm.

5. Personal Bias. Ratios are only means of financial analysis and not an end in itself.
Ratios have to be interpreted and different people may interpret the same ratio in
different ways.

6. Incomparable. Not only industries differ in their nature but also the firms of the
similar business widely differ in their size and accounting procedures, etc. It makes
comparison of ratios difficult and misleading. Moreover, comparisons are made
difficult due to differences in definitions of various financial terms used in the ratio
analysis.

7. Price Level Changes. While making ratio analysis, no consideration is made to the
changes in price levels and this makes the interpretation of ratios invalid.

8. Ratios are not Substitutes. Ratio analysis is merely a tool of financial analysis.
Hence, ratios become useless if separated from the statements from which they are
computed.