Management Accounting : lesson -1

Topic-1 Introduction to Management

Accounting
• Management Accounting:
• Meaning
• Definition
• Objectives
• Nature and Scope
• Role of Management Accountant
• Relationship between Financial Accounting and Management Accounting
• Relationship between Cost Accounting and Management Accounting
• Short term cost behaviour
 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:

FINANCIAL ACCOUNTING
Financial accounting is mainly concerned 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:
•Profit and Loss Account showing the net profit or loss during the period.
•Balance Sheet showing the financial position of the firm at a point of time.

Accounting
Meaning of Management Accounting
• 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.

• In the words of Robert Anthony, “Management accounting is concerned with accounting information
that is useful to management.

• “The most exciting and innovative work in management today is

found in accounting”
Peter F. Drucke
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 —
(i)formulating strategy;
(ii)planning and controlling activities;
(iii)decision-making:
(iv)optimising the use of resources;
(v)disclosure to shareholders and others external to the entity:
(vi)disclosure to employees; and
(vii)safeguarding assets.”
Relationship of Management Accounting to Cost Accounting and Financial Accounting

• The three types of accounting, i.e., financial accounting, cost accounting and management accounting are
closely linked.
• The management accounting uses the principles and practices not only of cost accounting but also of
financial accounting
CHARACTERISTICS OR NATURE OF MANAGEMENT ACCOUNTING

• Useful in decision making.

• Financial and cost accounting information
• Internal use
• Purely optional
• Concerned with future
• Flexibility in presentation of information.
1.Useful in decision making. The essential aim of management accounting is to assist management in decision
making and control. It is concerned 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
internal 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 desirability.

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.
5.Reporting to management. For effective and timely decisions, there should be a system of prompt and intelligent
reporting to management. Both routine and special reports are prepared for submission to top management, middle
order management and operating level management depending on their requirements.
6.Cost control procedures:Any system of management accounting is 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 internal financial controls like internal
audit and internal 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

•Main functions of management accounting are as follows:

•1.Planning:Information and data provided by management accounting helps management to forecast and prepare short-term
and long-term plans for the 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, purchases, etc., there should be full
coordination so that there is no contradiction. By proper financial reporting, management accounting helps in achieving
coordination in various business activities and accomplishing the set goals.
•3.Controlling:Controlling is a very important function of management and management accounting 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.

•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.
• 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 areas follow
Basis Financial Accounting Management Accounting
1.External and internal Financial accounting information is mainly intended for external users like Management accounting information is mainly meant for internal
user investors, shareholders, creditors, Govt. authorities, etc. user, i.e., management.

2. Accounting method It is based on double entry system for recording business transactions. It is not based on double entry system.

3.Statutory requirements Financial accounting is mandatory. Under company law and tax laws, financial Management accounting is optional though its utility makes it highly
accounting is obligatory to satisfy various statutory provisions. desireable to adopt it.

4. Analysis of cost and Financial accounting shows the profit/loss of the business as a whole. It does not Management accounting provides detailed information about
profit show the cost and profit for individual products, processes or departments, etc. individual products, plants, departments or any other responsibility
centre.

5. Past and future data It is concerned with recording transactions which have already taken place, i.e., it It is future oriented and concentrates on what is likely to happen in
represents past or historical records. future though it may use past data for future projections.

6. Periodic and Financial reports, i.e.. Profit & Loss Account and Balance Sheet are prepared usually Management accounting reports are prepared frequently, i.e., these
continuous reporting on a year to year basis. may be monthly, weekly or even daily depending on managerial
requirements.

7. Publication and audit Financial statements, i.e., P&L A/c and Balance Sheet are published for general
public use and also sent to shareholders. These are required to be audited by the Management accounting statements are for internal use and thus
Chartered Accountants neither published for general public use nor these are required to
be audited by Chartered Accountants.
COST ACCOUNTING AND MANAGEMENT ACCOUNTING — COMPARISON

• An examination of the meaning and definitions of cost accounting and management accounting indicates that
the distinction between the two is quite vague.
• Many eminent writers even consider these two areas as synonymous while others distinguish between the two.
Horngren, a renowned author on the subject, has gone to the extent of saying, “Modern cost accounting is
often called management accounting.
• Why ? Because cost accountants look at their organisation through manager’s eyes.” Thus managerial aspects
of cost accounting are inseparable from management accounting. One point on which all agree is that these
two types of accounting do not have clear cut territorial boundaries.
• However, distinction between cost accounting and management accounting may be made on the following
points:
Basis Cost Accounting Management Accounting
1. Scope Scope of cost accounting is limited to providing cost information for managerial uses. cope 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.

2. 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
3. Various techniques used by cost accounting include standard costing and variance Management accounting also uses all these techniques used in cost
analysis, marginal costing and cost volume profit analysis, budgetary control, uniform accounting but in addition it also uses techniques like ratio analysis,
employed costing and inter-firm comparison, etc 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

4. 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.

5. Statutory Maintenance of cost records has been made compulsory in selected industries as Management accounting is purely voluntary and its use depends
notified by the Govt. from time to time. upon its utility to management.
requirements 6. 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.

6. Data base It is based on data derived from financial accounts. It is based on data derived from cost accounting, financial
accounting and other sources.

7. Status
in 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
organisation hierarchy than the cost accountant.
 LIMITATIONS OF MANAGEMENT ACCOUNTING
•Management accounting is a very useful tool of management. However, it suffers from certain limitations as stated
below :

•1.Based on historical data:Management accounting helps management in making decisions for the future but it is
mainly based on the historical data supplied by financial accounting and cost accounting. This implies that historical
data is used for making future decisions. The accuracy and dependability of such data will leave their mark on the
quality of managerial decisions. In other words, if past data is not accurate, management decisions may not be correct.

•2.Lack of wide knowledge:The management accountant should have knowledge of not only financial and cost
accounting but also many allied subjects like economics, management, taxation, statistical and mathematical techniques
etc. Lack of knowledge of these subjects on the part of management accountant limits the quality of management
accounting.

•3.Complicated approach:Management accounting provides mass of data using various acounting 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.
•4.Not a substitute of management:Management accounting only provides information to
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 requires heavy investment and small concerns may not be able to afford
it.
•6.Developing stage:Management accounting is a relatively recent development and it has
not fully developed as yet. This limits the utility of this system to management in making
perfect and correct decisions.
•7.Lack of objectivity:The interpretation of information provided by management
accounting may be influenced by personal bias of the interpreter of data. This tells upon the
quality of managerial decisions.
•8.Resistance from staff. The existing accounting and management staff may not welcome
the introduction of management accounting system. This may be because they look at the
system with suspicion that it will add to their work a
Short-term cost behaviour:
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