MANAGEMENT ACCOUNTING

& CONTROL SYSTEMS

 MODULE 1

MANAGEMENT CONTROL SYSTEMS

 MANAGEMENT CONTROL SYSTEMS

The Management Control System refers to a framework or set-

up by which the manager can ensure control over the
actions of his subordinates as well as control over the whole
operations in an organisation.

The main purpose of the control system is to assist in target

fixing, collecting information on actual performance,
comparing actuals with targets, reporting the variations and
initiating suitable action to ensure that the targets are
achieved efficiently and effectively.
Defn. Anthony
“It is a total system that embraces all aspects of
the firm’s operations because an important
management function is to assure that all parts
of the operation are in balance with one another
and in order to examine balance, management
needs information about each of the parts”.
Characteristics of Management control system:
1. It focuses on programmes and responsibility centers. A
programme is a product, product line, research and
development project, etc.
2. The infn in a MCS is of two types: i)planned data i e
programmes, budgets and standards and ii) actual data
i e infn on what is actually happening, both inside the
orgn and in the external envt
3. MCS is a total system. It embraces all aspects of a
company’s operation.
4. It is built around a financial structure; i e resources and
revenues are expressed in monetary units.
5. It follows a definite pattern and timetable, month after
month and year after year.
6. It is a coordinated, integrated system; data on the actual
performance be structured in the same way i e, have the
same definitions and the same account content as data on
planned performance.
 Phases of Management Control Systems

The Mgmt Control process involves the following phases:

1. Programming
2. Budgeting
3. Operating and Accounting
4. Reporting and Analysis
Phase I – Programming
It is the process of deciding on the programmes that the company will
undertake and the approximate amount of resources that are to be
allocated to each programme.
Programs are the principal activities that the orgn has decided to
undertake in order to implement the strategies that it has decided
upon.
Eg. Product, a product line, setting up a plant, modification, etc

Phase II - Budgeting
It is a plan expressed in quantitative, usually, monetary terms that
covers a specified period of time, usually one year.
In the process of Budgeting each programme is translated into terms
that correspond to the sphere of responsibility of each manager who
is charged with executing the programme.
Phase III - Operating and Accounting:
During the period of actual operations, records are kept of
resources actually consumed and of revenues actually
earned. These records are structured so that cost and
revenue data are classified both by programs and by
responsibility centers. For this purpose, data on actual
results are reported in such a way that they can be readily
compared with the plan as set forth in the budget.
Phase IV – Reporting and Analysis:
MCS serves as a communication device. The information
that is communicated consists of both accounting and
non-accounting data. This information keeps the
managers informed about what is going on in the
organisation and helps coordination of different
responsibility centers.

Reports are also used as a basis for control. Such reports

are derived from an analysis that compares actual
performance with planned performance and attempts to
explain the difference. Based on these formal reports,
and also on information received through informal
communication channels, managers decide what action
should be taken.
 Levels of Management

An orgn consists of 3 distinct levels of management;

Corporate Management: It consists of executives who are
responsible for the performance of the orgn as a whole.
The Chairman or MD and executives in charge of specific
functions such as finance, manufacturing, marketing or
personnel constitute the corporate mgmt. They are
responsible for the overall performance of the orgn
Divisional Management: It consists of executives
responsible for total performance of particular regions or
product divisions.
Operating Management: It consists of executives charged
with the management of unit operations / or responsible
for the accomplishment of specific operations tasks. Eg.
Branch Manager, production Manager of a specific
production unit.
Levels of Decision Making:
1. The institutional level for strategic thinking and planning
2. The managerial level which focuses on gathering,
coordinating and allocating resources for the orgn; eg.,
planning budgets, deciding on capital expenditures,
formulating personnel practices;
3. The technical level, involving the acquisition and
utilisation of technical knowledge for operational controls,
eg., inventory controls and production scheduling.
The total planning and control system of an orgn is
subdivided into 3 categories;
i. Strategic planning
ii. Management control
iii. Operational control
Strategic Planning:
It is the process of deciding on the goals of the orgn, on
changes in these goals, on the resources used to attain
these goals and on the policies that are to govern the
acquisition, use and disposition of these resources. It is a
long range plan carried on at the top level of the
management after analysing its own strengths and
weaknesses and on the basis of the threats it faces and
the opportunities available to it.
Eg. Decisions to expand, diversify, etc
Management Control:
It is the process of evaluating, monitoring and controlling
the various sub-units of the orgn so that there is effective
and efficient allocation & utilisation of resources in
achieving the predetermined goals. It focuses on the
managers of organisational sub-units and hence its focus
is on line managers responsible for the performance of
their departments. Management control is exercised by
evaluating the performance of each ‘responsibility center’
against planned performance.
Eg. Legal department of a company.
Operational control or Technical control:
It is the process of assuring that specific tasks are carried
out effectively and efficiently. The focus of operational
control is on individual tasks or transactions: scheduling
and controlling individual jobs through a shop, procuring
specific items for inventory, specific personnel actions, etc.
Eg. Inventory control system.
 Management By Objectives
It is also known as Management By Results.
MBO is defined as a process whereby superiors and
subordinate managers of an enterprise jointly
i. identify its common objectives,
ii. Define each individual’s major areas of responsibility in
terms of results expected of him, and
iii. Use these measures as guides for operating the unit or
enterprise and assessing the contribution of each of its
members.

It’s an approach to management planning and appraisal in

which specific targets of performance are established
for each individual and the actual results are measured
against the original targets.
 Steps in MBO Process

Setting
Objectives

Appraising Developing
Annual Action Plans
performance

Conducting
Periodic
Reviews
 Steps in MBO Process

1. Setting the Objectives: verifiable & measurable objectives for

the overall orgn for all the positions.
1st – Top management sets the goals for the total
enterprise in certain key areas considering
environmental opportunities, resources and
constraints of the orgn and forecasts
2nd – Objectives for each dept are laid down in
consultation with the deptl heads.

This process of goal-setting is repeated at lower

levels of management until goals for each and every
individual are established.
2. Developing Action Plans: Responsibility for the
achievement of each goal is specified. Job descriptions for
various positions must define the goals to be attained.
Resources required for goal attainment are identified and
allocated. The means for the implementation of plans are
decided. Goals and resources must be matched together.
3. Conducting periodic Reviews: At frequent intervals actual
performance is reviewed jointly by the superior and the
subordinate in order to know the progress.
If necessary, the goals are modified. Ways and means
are identified to overcome problems and to improve
performance in future.
4. Appraising Annual Performance: A thorough
evaluation of individual performance is done at the
end of the year. At annual review, achievements are
carefully analysed against the given objectives.
Rewards are decided on the basis of annual
appraisal.
 Advantages of MBO

1. Result – oriented planning

2. Co-operation and coordination
3. Motivation
4. Effective Communication
5. Training and Development
6. Performance Appraisal
 Limitations of MBO

1. It’s difficult to set verifiable goals in several cases

2. It involves lot of paper work
3. Time consuming and too pressure-oriented
4. It may prevent co-operation and teamwork
5. May lead to inflexibility
6. May be resented by subordinates
 COST ACCOUNTANCY

Cost:
It refers to the resources that have sacrificed to attain a particular
objective.
It is defined as a total of all expenses incurred in the manufacture and
sale of a product.
Costing:
It refers to cost finding using any method like arithmetic process
memorandum statements, etc
Cost Accounting:
Cost Accounting is the technique and process of ascertaining cost.
It is the process of “classifying, recording and appropriate allocation of
expenditure for the determination of costs of products or
services.”
It consists of principles and rules which govern the procedure of
ascertaining costs of a product or service.
Cost Accountancy:
It is the application of costing and cost accounting principles,
methods and techniques to the science, art and practice of
cost control and the ascertainment of profitability. It
includes the presentation of information derived there
from for the purposes of managerial decision making.
Objectives of Cost Accounting:
 Ascertainment of cost
 Fixation of selling price
 Cost control
 Matching cost with Revenue
 Special cost studies and investigations
 Preparation of Financial Statement.
 Differences between Financial Accounting
& Cost Accounting
• Transactions are recorded for a • Transactions are identified with cost
definite period units.
• It covers transactions of the whole • It covers only a part of the
firm pertaining to business transactions viz., manufacturing, sales,
• It’s prepared to show the final results services, etc. partial
during a particular period to owners, • Guides the management for proper
outsiders, etc
planning, control and decision making
• It analyses the expenditure under
• It analyses the expenditure under
different types of expenses eg.
different heads of performance eg.,
Wages, salaries, depn., etc
direct labour, indirect labour, Materials,
• The overall business result is etc
revealed by P&L A/c, but results of
each dept. can’t be known. • It analyses the profitability and
unprofitability of each
• It can work independently. department/product.
• Reconciliation of results is not • It depends upon Financial Accounting
required
• Reconciliation is required
• It deals with external transactions
• It deals with internal transactions
• Stock is valued at cost price or
market price which ever is less • Stock is valued at cost
• To be maintained as the • To be maintained to meet the
requirements of Companies Act, requirements of the management
Income Tax Act.
 Differences between Cost Accounting and Management Accounting
• It deals with ascertainment, • It deals with the effect and impact of
allocation, apportionment and costs on the business
accounting aspect of costs
• It is derived from both cost
• It provides a base for management accounting and financial accounting
accounting
• It has greater degree of relevance
• It helps in collecting costing data for and objectivity
the management
• Management accountant is senior in
• The status of cost accountant comes position to cost accountant
after the management accountant
• He reports the effect of cost on the
• He refers to economic and statistical business along with cost analysis
data for analysing cost effects
• Along with these, Management
• It has standard costing, variable Accountant has funds and cash flow
costing, BEA, etc., as the basic tools statements, Ratio Analysis, etc as his
and techniques accounting tools and techniques
• It does not include financial • It includes all these
accounting, tax planning and tax
• It needs financial and cost
accounting
accounting as its base for its
• It can be installed without installation.
management accounting
Methods of Costing
1. Job costing
a. Batch Costing
b. Contract Costing
c. Multiple Costing
2. Process costing
a. Unit or Single output costing
b. Operating (Service) Costing
c. Operation costing
Techniques of Costing
1. Historical Costing
2. Standard costing
3. Absorption or Full costing
4. Variable or Marginal costing
5. Uniform costing
Responsibility Centres
It is defined as an area of responsibility which is controlled by an
individual. The following types of responsibility centres are found;

Cost Centre:
The Institute of Cost and Management Accountants, London:
It is defined as a “location, person, or an item of equipment (or a group
of these) for which costs may be ascertained and used for the
purposes of cost control”.
It is an organisational segment or area of activity considered to
accumulate costs. Its managers are held responsible for the costs
incurred in that segment.
Performance evaluation of a cost centre is guided by a cost variance
equal to the difference between the actual and budgeted costs for
a given period.
Types of Cost Centres:
1. Impersonal Cost centre: It consists of a location or item of
equipment (or a group of these).
2. Personal cost centre: It consists of a person or group of
persons.
3. Operation cost centre: It consists of the machines and / or
persons carrying out similar operations
4. Process cost centre: It consists of a specific process or a
continuous sequence or operations.
Revenue Centre:
It is a segment of the orgn which is primarily responsible for
generating sales revenue. A revenue centre manager has
control over some of the expenses of the marketing
department. The performance of a revenue centre is
evaluated by comparing the actual revenue with budgeted
revenue.
Eg. Marketing Manager of a product line, sales representative.

Profit Centre:
A profit centre is a segment of the orgn for which both revenue
and costs are accumulated. The main purpose of profit centre
is to earn profit. Profit centre managers aim at both the
production and marketing of a product.
Its performance is evaluated in terms of whether the centre has
achieved its budgeted profit.
Eg. A division of the company which produces and markets the
products may be called a profit centre.
Investment Centre:
It is responsible for both profits and investments. The
investment centre manager has control over revenues,
expenses and the amounts invested in the center's
assets. He also formulates the credit policy which has a
direct influence on debt collection, and the inventory
policy which determines the investment in inventory.
Cost Units:
The Institute of Cost and Management Accountants, London:
A cost unit is defined as “a unit of quantity of product, service or time (or
a combination of these), in relation to which cost may be ascertained
or expressed”.

In the job costing method, cost unit is a single specific order; in batch
costing it consists of a group of similar articles and in contract costing,
it consists of a single contract.

Eg: Building – Sq. foot of area / House

Cement, Steel – Tonne
Automobile – Number
Power – Kilowatt hour
paper – Ream etc
Cost Concepts:
Cost:
It is the amount of expenditure, actual (incurred) or notional
(attributable), relating to a specific thing or activity. The
specific thing or activity may be a product, job , service,
process or any other activity.
Cost is the amount of resources given up in exchange for some
goods or services. The resources given up are generally in
terms of money.

Expenses:
They are expired costs, incurred and totally used up in
generation of revenue. It results from a productive usage of
an asset. It is that portion of the revenue producing potential
of an asset which has been consumed in the generation of
revenue. Eg. Selling & administrative expenses, salary, rent,
commission paid, taxes paid, interest paid, etc
Loss:
It refers to “reduction in firm’s equity, other than from
withdrawals of capital for which no compensating
value has been received”.
It is an expired cost resulting from the decline in the
service potential of an asset that generated no
benefit to the firm.
Eg; obsolescence or destruction of stock
 CLASSIFICATION OF COST
I Natural classification of costs:
1. Direct Material: refers to the cost of materials which are traceable to
specific units of output. Eg. Raw cotton in textiles, crude oil for petrol,
steel to make automobile bodies, etc
2. Direct labour: It is the labour of those workers who are engaged in the
production process. It is the labour expended directly upon the
materials comprising the finished product. Eg. Labour of machine
operators and assemblers.
3. Direct expenses (chargeable expenses): It includes other expenses
other than direct material and direct labour directly incurred on a
specific product or job. Eg. Cost of hiring special machinery or plant,
cost of patents, royalties, licence fees, etc.

Total of the above 3 elements of costs is referred to as Prime Cost.

4. Factory overhead: It is also called manufacturing overhead. It is the
cost of indirect materials, indirect labour and indirect expenses.
Indirect material refers to materials that are needed for the
completion of the product but whose consumption with regard to the
product is small. Eg. Lubricants, cotton waste, hand tools, works
stationery, etc
Indirect labour refers to the labour cost of production-related activities
that cannot be associated the final product. Eg. Labour of foremen,
shop clerks, general helpers, cleaners, etc
Indirect expenses covers all indirect expenditure incurred by the
manufacturing enterprise from the time production has started to its
completion and its transfer to the finished goods store. According to
Institute of Cost and Management Accountants Indirect expenses are
the expenses which cannot be allocated but which can be apportioned
to or absorbed by cost centres or cost units. They are incurred for the
benefit of more than one product, job or activity.
Eg: Heat, Light, Maintenance, factory manager’s salary, etc
5. Selling, distribution and administrative overheads: S & D overheads
are the expenses incurred for the selling the products. It covers the
cost of making sales and delivering / dispatching products. Eg.
Advertising, salesmen salaries, and commissions, packing, storage,
transportation, etc

Administrative overheads includes costs of planning and controlling

the general policies and operations of a business enterprise. Such
costs which cannot be charged either to the production or sales
division.
II on the basis of Cost Behaviour
Fixed cost: It is the cost which does not change in total for a given time
period despite wide fluctuations in output or volume of activity. They
are also called standby costs, capacity costs or period costs. Eg. Rent,
property taxes, salaries, depn, etc

Total
cost Fixed Cost

Volume
Classification of Fixed costs:
a. Committed costs: They are primarily incurred to maintain the
company’s facilities and physical existence, and over which
management has little or no discretion. Eg. Depn, taxes, insurance
premium rate, rent charges, etc
b. Managed costs: They are related to current operations which must
continue to be paid to ensure the continued operating existence of
the company. Eg. Management and staff salaries.
c. Discretionary costs: They are also known as programmed costs.
They result from special policy decisions, management programmes,
new researches, etc. Eg. R&D costs, marketing programmes, new
system dvpt.
d. Step Costs: it is constant for a given amount of output and then
increases in a fixed amount at a higher output level.
Eg. Supervisor’s salary
2. Variable Cost: They are the costs that vary directly and proportionately
with the output. There is a constant ratio between the change in the
cost and change in the level of output. Eg. Direct material cost, direct
labour cost, factory supplies, sales commission, office supplies, etc.

V.C
3. Mixed cost (Semi-variable and semi-fixed cost)
They are a combination of semi-variable costs and semi-fixed costs.
Because of the variable component, they fluctuate with volume;
because of the fixed component, they do not change in direct
proportion to output. Semi-fixed costs are those costs which remain
constant up to a certain level of output after which they become
variable. Eg. Electricity charges, water, supervisors salary, etc
III. On the basis of degree of traceability to the product:
1. Direct Cost
2. Indirect cost

IV. On the basis of association with the product

1. Product cost: They are the costs which are identified with the product
and included in inventory values, i e they are included in the cost of
manufacturing a product. In a manufacturing concern, it is composed
of 4 elements: i) direct materials, ii) direct labour iii) direct expenses iv)
manufacturing overhead
2. Period Cost: They are the costs which are not identified with product or
job and are deducted as expenses during the period in which they are
incurred. Eg. All Selling & administrative expenses.
IV. Functional classification of Costs

Capital cost and Revenue costs:

Costs can also be divided into
a) Capital Expenditure & b) Revenue Expenditure

Capital expenditure provides benefit to future periods and is

classified as an asset; a revenue expenditure is assumed to
benefit the current period and is classified as an expense. A
capital expenditure will flow into the cost stream as an expense
when the asset is used up or written off.
 Costs for Decision Making and Planning

1. Opportunity Cost: It is the cost of opportunity lost. It is the

cost of selecting one course of action in terms of the
opportunities which are given up to carry out that course of
action. It is the benefit lost by rejecting the best competing
alternative to the one chosen.
2. Sunk Cost: It is the cost that has already been incurred. Also
known as unavoidable cost, it refers to all past costs since these
amounts cannot be changed once the cost is incurred.
Eg. Book values of existing assets – Plant and equipment,
inventory, investment in securities, etc
3. Relevant Costs: They are the future costs which differ
between alternative. They are the costs which are
affected and changed by a decision.
Irrelevant costs are the costs which remain the same and
not affected by the decision whatever alternative is
chose.
Features of Relevant Costs:
i. They are only future costs, they are expected to be
incurred in future.
ii. They are only incremental (additional) or avoidable
costs.
Incremental costs refer to an increase in cost between 2
alternatives.
Avoidable costs are those which are not incurred from one
alternative to another.
4. Differential Cost: It is the difference in total costs
between any 2 alternatives. They are equal to the
additional variable expenses incurred in respect of
the additional output, plus the increase in fixed costs.
They are also known as incremental costs.
They are calculated by taking the total cost of
production and comparing it with the total costs
incurred if the extra output is undertaken.
5. Imputed Cost: They are not actually incurred but
are relevant to the decision as pertain to a particular
situation.
Eg. Interests on internally generated funds, rental
value of company owned property and salaries of
owners of a single proprietorship or partnership, etc

6. Out-of-Pocket Cost: It refers to the cash cost

incurred on an activity. It is significant for
management in deciding whether or not a particular
project will at least return the cash expenditures
associated with the project selected by management.
7. Shut Down Cost:
These are the costs which have to be incurred under all
situations in the case of stopping manufacture of a product
or closing down a department or a division.They are always
fixed costs. If the manufacture of a product is stopped,
variable costs like direct materials, direct labour, direct
expenses, variable factory overhead will not be incurred.
However, a part of fixed costs associated with the product
will be incurred.
Costs for Control:
1. Controllable and Uncontrollable cost
The ICMA (UK) defines Controllable cost as “a cost
which can be influenced by the action of a specified
member of an undertaking” and a non-controllable
cost as “a cost which cannot be influenced by the
action of a specified member of an undertaking.
Controllable costs can be controlled (reduced) by a
manager at a given organisation level.
Eg. Indirect labour, lubricants, cutting tools, etc
2. Standard costs:
They are the costs which are planned or
predetermined cost estimates for a unit of output in
order to provide a basis for comparison with actual
costs. They are used to prepare budgets. Standard
cost is a unit concept and indicates standard cost per
unit of output, per labour hour, etc.

3. Fixed cost
4. Variable cost
5. Mixed costs
Other costs:
1. Joint cost: They arise where the processing of a single
raw material or production resources results in two or
more different products simultaneously. Joint costs
relate to two or more products produced from a
common production process. They are apportioned to
different products using suitable bases of
apportionment.
Eg. Kerosene, fuel oil, gasoline & other oil products are
derived from crude oil.
2. Common Costs:
They are those which are incurred for more than one product,
job, territory or any other specific costing object. They
cannot be easily identifiable with individual products and
therefore, are generally apportioned.
Eg. Salary of a manager of a production dept which is
manufacturing 3 products