Introduction to Management Accounting

Transcription

1 Unit - 1 MODULE - 1 Introduction to Management Accounting Introduction and Meaning of Management Accounting Definition Relation of Management Accounting with Cost Accounting and Financial Accounting Role of Management Accounting Nature of Management Accounting Scope of Management Accounting Tools and Techniques Difference between Management Accounting and Cost Accounting Difference between Management Accounting and Financial Accounting Functions of Management Accounting Concepts of Management Accounting Limitations of Management Accounting

2 Introduction & Meaning: The term management accounting has its base in accounting for managers, through which managers get necessary information on executing their functions. In other words, it helps a manager in planning, organizing, directing and controlling the business operations in an orderly manner. Accounting, generally, is referred to as the process of recording and classifying the monetary transactions of a business concern for the purpose of analyzing and reporting the result to various parties. Financial accounting does this work effectively. It meets the aims and objectives of various persons, say, shareholders, creditors, bankers, etc, outside the organization. Thus, it is the primary duty of an accountant to record and analyze the transactions of the business and prepare the final accounts in order to take certain decisions. Financial accounting does convey meaningful information to the outsiders, but it at times fails to communicate the valuable information to the management. Owing the rise of joint stock companies and large scale enterprises, the complexities of operating a business firm has also increased. A manager requires organized information, not just raw data, so as to take important decisions. Decision making in any business enterprise is a primary function of management. Financial accounting does provide various sets of accounts and statements to assess the working of a concern, but it does not provide enough information and in appropriate form which can help a manager to arrive at a particular decision. Financial accounting gives an overall picture of an enterprise, while the mangers are interested in minute details to correct the deviations. Again, managers require information continuously. They cannot wait for a year to end and

3 then receive the final accounts. They must get information on a weekly or monthly basis. These growing requirements have changed the picture of the basic traditional accounting of recording in to a powerful tool of forecasting, budgeting, budgetary control, etc. This has led to the formation of the management accounting, whereby; an organization plans, organizes, directs and controls the resources of the organization through above mentioned tools. When accounting is considered in the form of functions of management providing adequate and appropriate information for management requirements, it is referred to as Management Accounting. Meaning and Definitions: In simple terms, any accounting system which aids management in carrying out its managerial functions effectively may be termed as Management Accounting. It is generally referred to as Accounting for Managers. It is an accounting system designed to provide adequate and appropriate information/details to the management in order to carry out its functions. It helps in the creation of various policies to conduct the day to day activities. It is also known as Management Oriented Accounting or Accounting for Management. Management Accounting is the term used to describe the accounting methods, systems and techniques which, coupled with special knowledge and ability assist management in its task of maximizing profits or minimizing losses. - Rober N. Anthony

4 Management Accounting is accounting for effective management. - Bose Management Accounting is the application of appropriate techniques and concepts in processing historical and projected economic data of an entity to assist management in establishing plans for reasonable economic objectives in the making of rational decisions with a view towards achieving these objectives. - American Accounting Association The following definition is given by the Management Accounting Team of the Anglo-American Council of Productivity. 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 operations of an undertaking. "Management Accounting is the term used to describe the accounting methods, systems and techniques which, coupled with special knowledge and ability, assist management in its task of maximizing profits or minimizing losses." - J. Batty

5 "Any form of accounting which enables a business to be conducted more efficiently can be regarded as management accounting." - Institute of Chartered Accountants of England and Wales "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 Institute of Chartered Accountants of India "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. Disclosure to shareholders and other external to the entity 6. Disclosure to employees 7. Safeguarding assets - The CIMA (UK) Thus, the above mentioned definitions clearly state that management accounting is concerned with accounting information which is useful to the management. Management covers all rearrangements, combinations and adjustment of the traditional accounting figures which may be required to provide the managers with the information from which they can control the business. It encompasses accounting methods, system and techniques which are employed with knowledge, skills and ability, to aid management in its task of maximizing profits of the concern.

6 Relation of Management Accounting with Cost Accounting and Financial Accounting: Three types of Accounting such as Financial Accounting, Cost Accounting and Management Accounting are strongly interconnected. The Management Accounting uses the principles and practices not only of cost accounting but also of financial accounting. Cost accounting is a more detailed application of financial accounting and management accounting goes a step further. The following chart explains that relation of Management Accounting with Cost Accounting and Financial Accounting. Preparing Revenue statement and Position Statement FIANANCIAL ACCOUNTING Evaluating Cost for Control and optimum competence COST ACCOUNTING Help Management for Planning, Control and Decision Making MANAGEMENT ACCOUNTING

7 ROLE OF MANAGEMENT ACCOUNTING: Management Accounting, as a key input, provides valuable services to management in all the functional areas. It plays a major role in various managerial functions and thereby helping them to take effective decisions which are discussed below: 1. Planning: Planning basically involves deciding future course of actions based on the current status of the given resources. It involves formulation of policies, setting up goals and objectives and deciding a sequence of activities. Management accounting makes an important contribution by supplying valuable information and data for analyzing the problem and taking the accurate decision. Information is the important factor required to plan anything. 2. Organizing: It basically involves grouping of activities in such a way that they operate in a coordinated way in order to achieve the common objective. It identifies the relation between authority and responsibility. Management accounting contributes here by creating various centres which carry various tasks to be performed in order to obtain the pre-determined objective. This gives a sound organization structure with a clear-cut distinction of authority and responsibility. 3. Coordinating: This includes interlinking of different divisions of the business enterprise in a way so as to achieve the objectives of the organization

8 as a whole. There is a requirement of a kind of coordination between various departments such as production, purchase, finance, human resource, sales, etc. An effective way to achieve coordination between the departments is to allot them respective budgets which are inter-connected. Thus, management accounting is used in designing budgets for an efficient allocation and coordination of resources. 4. Controlling: Controlling means, establishing standards or standard performance, measuring actual performance, comparing the actual performance with the established standards and then at the end taking corrective actions for the deviations. The techniques such as budgetary control, standard costing and departmental operating statements greatly help in performing this function. Thus, as a matter of fact, the entire system of controlling is designed and operated by the management accounting practices. 5. Motivating: Motivation means channelizing strong motives or urges of an individual into action so as to obtain goal directed behavior. It involves maintenance of a high degree of morale in the organization. The supervisor should know whom to motivate, to what extent to motivate, which tools to be used to motivate, etc. These burning questions can only be answered if the decision making authority has certain reports to find out the functionality of the resources. Periodical

9 departmental profit and loss accounts, budgets and reports go a long way in achieving this objective. 6. Communicating: Communication involves transmission of ideas, symbols, facts, information, etc from one person to another through a channel. The orders of the supervisors should be communicated to the subordinates while the results achieved by the subordinates should be reported to the supervisors. Moreover, the management also owes a responsibility to supply information to various other parties such as creditors, bankers, investors, shareholders, etc. Management Accounting helps the management in performance of this function by developing a suitable system of reporting which emphasizes and highlights the relevant facts. TOOLS and TECHNIQUES: 1. Financial planning: Financial planning involves determining financial structure of an enterprise. It includes determining financial objectives, both, long term as well as short term, formulating various policies relating to finance and developing various procedures to achieve the objectives. Here, the concern is to take a decision about raising finance. That is, the sources of finance should be precisely decided along with the cost at which they are procured. The firm should minimize the cost of the capital and should define the usage of the capital at a proper place so as to generate the desired revenue. Thus, the financial

10 planning is a technique used by management accounting so as to assist the management in taking important decisions. 2. Analysis of financial statements: The analysis part of financial statements and its interpretation are one of the most important things that are made use of by management accounting. Management accounting uses various techniques such as ratio analysis, fund flow statement, trend analysis, etc to analyze the statements and bring out conclusion so as to take wise decision. 3. Historical cost accounting: Entering the actual costs after they have incurred is called historical cost accounting. Although, management accounting does not use past data, but in case of standard costing though, these data prove to be very useful and hence it is useful to management accounting. 4. Standard costing: Standard costing is a crucial tool to control cost which is the basic aim of management accounting. This basically involves preparation of standard costs of various activities, measuring the actual performance, comparing it with standard costs and correcting the deviations, if any found.

11 5. Budgetary control Budgetary control is an instrument used for planning and controlling the operations of the business enterprise. This activity basically calls for comparing the actual performance with the set standards and thus, correcting deviation. The major aim of budgetary control is to ensure that the funds are utilized optimally, and thus, a firm can produce goods at the minimum cost and sell them at a price which will help them achieve a desired level of profit. Thus it is used under management accounting. 6. Marginal costing: This method helps the management to measure changes in the costs with the changes in the output level or volume of production. This is one of the costing methods which is used to measure costs and profitability of a concerned product at different lines of production. 7. Decision accounting: More often than not, management encounters problems related to various alternative solutions. From the available solutions, the purpose is to select the best decision which proves beneficial for the company. Decisions are generally made after studying the data of costs, prices and submitted by management accounting and then the best one is chosen for implementation.

12 8. Revaluation accounting: Revaluation accounting is basically meant for replacement of fixed assets in the times of rising prices. It ensures the maintenance and preservation of the capital for the purpose of replacing the fixed asset after its life gets over. 9. Ratio accounting: Ratio analysis is basically a technique through which a firm s performance is analyzed and interpreted by means of accounting ratios so as to take certain decisions. It helps the management to get a clear picture of firm s performance at various levels and time periods and also allows the management to have a comparative analysis. Based on these, the firm can take a proper decision. 10. Internal auditing: Auditing is an independent appraisal system designed within the organization in order to review the performance of accounting, finance and other operations as a basis for protective and constructive service to the management. It primarily deals with the matters relating to accounts and brings about effectiveness in the organization by putting a mandatory regular check on the activities. 11. Management information system: Today s world is an informative world. No firm could survive without adequate information. Management accounting with this regard provides adequate and appropriate information to the management so as to take various decisions. It provides necessary

13 information to all the levels of management according as their requirements. 12. Statistical techniques: Management accounting, in order to operate more effectively, also calls for certain statistical tools such as time series, regression analysis, sampling, correlation, etc which are highly useful for planning and forecasting. Through these tools, one can prepare graphs, charts, diagrams, etc. to make the information look more impressive and comprehensive. Nature of Management Accounting: As discussed earlier that management accounting is essentially accounting information which facilitates the management in making important decisions that would generate maximum profits out of the business activities. On the basis of the previous discussion and various definitions, following are few characteristics of management accounting: 1. Forecasting: Management accounting is basically concerned with the future. It is not restricted only to the collection and analysis of historical data or facts but also attempts to emphasize on what should have been done. Thus, it is more focused on activities that are going to take place in the future, for decisions that a manager takes is always for the future course of action and not for the past. All the tools and techniques used under management accounting is future oriented.

14 2. Disseminate information: Management accounting, through its techniques, generates data or information which it provides to the management. It does not help in making decision or providing an opinion on it. The task of arriving at a decision remains with the management. Management accounting, however, only supplies information necessary to take any important decision. 3. Increase in efficiency: Management accounting provides information that helps generate various alternatives for the management. Out of various alternatives, the management chooses the best one which gives maximum profit and incurs minimum cost. Thus, by providing efficient and effective data to the management, it helps the management to make an effective decision and thereby helps in increasing efficiency of the firm. 4. Usage of techniques and concepts: Information, when available randomly, does not help in making effective decisions. It has to be so organized as to interpret the same. Management accounting through various techniques and concepts makes accounting data more useful. The techniques usually employed include marginal costing, standard costing, break-even analysis, and budgetary control among others.

15 5. No fixed model: Management does not have strict rules and system which has to be followed as it is in the case of double entry system. The usage of data differs from organization to organization. It is purely a subjective matter when it comes to development and usage of the bits of information produced through management accounting. 6. Aids management: As discussed earlier, it assists management in carrying out its functions effectively. It provides various customized data which helps in planning, organizing and controlling the activities at various levels and time periods. It provides accurate information and at the right time to the management so as to enable them to make a right decision. 7. Cause and effect analysis: The most distinguishing feature of management accounting is that it portrays cause and effect relation between the variables. If the firm had earned profit, then it displays the reasons for the same and if the firm had incurred loss then, it gives reason for loss as well. Thus, on this ground, management is also at times called as science. 8. Helps in achieving objectives: The ultimate aim of any business concern is to earn profit. All other plans and strategy prepared are directed towards earning a handsome profit. Management accounting, by providing information and assisting management, tries to do the same. It aids management

16 so that managers can take effective decisions which are directed towards the achievement of certain objectives. Thus, management accounting, directly or indirectly, helps in achieving objectives of the concern. Scope of Management Accounting: The management accounting is very wide and broad in its scope. It embraces a variety of aspects of business operations. The ultimate objective of management accounting is to aid management in effective functioning of planning, organizing and controlling. The following are some of the areas included within the scope of management accounting: 1. Financial accounting: It is a general accounting practice which includes recording of transaction taken place in the business, posting it into respective ledger account, balancing them and preparing a trial balance. On the basis of the trail balance, the entry is made in trading, profit and loss and balance sheet. These accounts and statements in turn show the real position of where the business stands. On the basis of these accounts and statement, management can take effective decisions. These accounts and statements help the management to analyze the situation and interpret the data for some meaningful usage to the operations. Management accounting, thus, is incomplete without the availability of data on financial accounting.

17 2. Cost accounting: Cost accounting is one of the branches of accounting. Cost accounting is basically a process or technique to ascertain costs. It provides valuable data for planning, organizing and controlling business operations through various tools, viz. standard costing, marginal costing, budgetary control, etc. 3. Budgeting and forecasting: Budgetary control is an instrument used for planning and controlling the operations of the business enterprise. This activity basically calls for comparing the actual performance with the set standards and thus correcting deviation. The major aim of budgetary control is to ensure that the funds are utilized optimally, and thus, a firm can produce goods at minimum cost and sell them at a price which will help them achieve a desired level of profit. Forecasting, on the other hand, is a prediction made of what is going to happen in future as a result of a given situation. 4. Statistics: Management accounting, in order to operate more effectively, also calls for certain statistical tools such as time series, regression analysis, sampling, correlation, etc. which are highly useful for planning and forecasting. Through these tools, one can prepare graphs, charts, diagrams, etc to make the information look more impressive and comprehensive.

18 5. Inventory control: Management accounting also embraces inventory control as it involves major portion of the total cost. The management should determine accurate levels of different stockpiles, such as minimum stock level, maximum stock level, re-ordering level for stock control. The study of inventory management helps the managers in taking wise decisions. 6. Analysis and interpretation of data: Analyzing the financial data is very important and interpreting them in a correct way is equally significant. Financial accounting provides valuable data which can be used for a comparative study over the years so as to analyze the situation of the company and differences in financial statements, and then, take appropriate actions. 7. Reporting: Once the data has been analyzed and interpreted, the next task before the management is to communicate those valuable data to the interested parties, both inside and outside the organization. For that, the management needs to prepare various reports which make the data presentable in a proper form from the core numerical form. These reports can be sent monthly, quarterly or yearly to the interested parties in order to arrive at a decision.

19 8. Methods and procedures: Management accounting also hold in its arms maintenance of proper data processing and other office management services, reporting on the best use of mechanical and electronic devices. It defines various methods and techniques on how to do a particular work. Difference between Management Accounting and Financial Accounting: Financial and management accounting are closely interrelated since management accounting, to a large extent, is just a mere extension of financial accounting. Most of the data for exercising management accounting comes from financial accounting only. In spite of such a close relation between the two, there are certain fundamental differences between them, which are discussed below: Objectives: The main aim behind practicing financial accounting is to supply data or information in the form of profit and loss account and balance sheet to external parties like shareholders, bankers, investors, government, etc. This information is provided at some definite period of time where the internal management does not share any interest. Management accounting, on the other hand, is mainly responsible for the data for the internal management team so as to operate effectively. Thus, the former is basically meant for external reporting while the latter is for internal reporting process.

20 Performance: Financial accounting measures an overall performance of the business concern by portraying the information through profit and loss account and balance sheet. It displays the financial position of the firm at a particular date. In case of management accounting, it provides the data of all relative departments and their function performed in the business. Thus, it measures the performance of each individual activity rather than giving the overall picture. Thus, financial accounting cannot reveal what part of the business is going wrong and why. While management accounting provide a detailed analysis of the adverse impacts generated by individual section of a business. Data usage: Financial accounting is historical in nature and thus uses past data to record the transaction and thereby displays the result. It analyzes the past data and then provides the report in the present. Management accounting, on the other hand, is based on future and therefore supplies the data for present and future duly analyzed and in a detailed structure. Monetary management: Under financial accounting, those transactions which involve monetary effect are taken into consideration. Non-monetary transactions are not taken into account in financial accounting practices. However, in case of management accounting, non-

21 monetary events also find their way to enter into the books. For example: new technology, human resource, etc. These all affect the business to a large extent and thus cannot be avoided. Reporting: The period of reporting, in case of financial accounting, is longer than management accounting. Usually, profit and loss account and balance sheet are prepared at the end of the financial year or probably half-yearly. This goes well as the data is to be provided to the outside parties generally. But the management needs a continuous availability of the data and report in order to improve on the current lines of conducting business. This is fulfilled by management accounting. Management accounting provides information at frequent intervals which financial accounting fails to provide. Nature: Financial accounting has been said to be more objective than management accounting. Financial accounting is generally counted as a positive science while management accounting is subjective in nature as it is highly based on judgments rather than measurements. Legality: With reference to legality of the concept, financial accounting is more or less a mandatory practice for every business unit while management accounting, on the other hand, is voluntary. There is no compulsion as to whether or not a firm should practice management.

22 Coverage: Financial accounting is broad in nature covering all the aspects of the concern while management accounting is limited in this case focusing mainly on the needs of the management. It covers those aspects which are important from the managerial perspective of decision making. Publication and audit: Financial accounts like Profit and loss account and balance sheet are to be published for the use of general public and are also subject to audit by a chartered accountant. In case of management accounting, there are no such provisions made. All the details and reports are generally meant for the internal use for the management only. Methodology: Financial accounting and management accounting also differ in respect of their methodology. In financial accounting, the information is recorded or maintained in the form of various accounts and statements while in case of management accounting, costs and revenues are mostly reported by various responsibility centres.

23 Difference between Management Accounting and Cost Accounting: Basis Management Accounting Cost Accounting Objective The purpose of management accounting is to provide information to the management for planning and coordinating the activities of the business Scope The scope of management accounting is very wide. It includes financial accounting, cost accounting, budgeting, tax planning, reporting to the management, interpretation of financial data, etc. Nature Management accounting is generally concerned with the projection of figures for future Data used Management accounting uses both quantitative and qualitative information Development The management accounting has been developed only in the last 30 years The objective of cost accounting is to record the cost of producing a product or providing a service. The cost is recorded product-wise or unitwise Cost accounting deals primarily with cost ascertainment Cost accounting uses both past and present figures Only quantitative aspects are used in cost accounting The development of cost accounting is related to industrial revolution. Cost accounting was able to provide information not only about cost structure but also for planning and decision-making Principle Followed No specific rules and procedures are followed in reporting management accounting Certain principles and procedures are followed for recording costs of different products. The same rules are applicable at different times too.

24 Functions of Management Accounting: The basic function of management accounting is to assist the management in performing its functions effectively. The basic functions of manager/management are planning, organizing, directing and controlling. The management accounting assists in the performance of each of these functions in the ways mentioned below: 1. Provides data: Management accounting serves as an important source of data for the planning of management. The accounting information and documents are a repository of a vast quantity of data about the past progress of the enterprise which are a must for making forecasts for the future. 2. Modifies data: In order to facilitate managerial decision making and making it more effective and accurate, accounting data must have to be properly compiled and classified. Thus, modification of data is an important function as it processes the data so as to derive some meaningful conclusion. 3. Analyses and interprets data: The data obtained from the accounting area is analyzed meaningfully for effective planning and decision-making. For this purpose, the data so collected is offered in a comparative form. Ratios are also calculated and likely trends are projected as well.

25 4. Serves as a means of communicating: The management accounting practices provide means for communicating management plans upward, downward and outward through the organization. At an initial stage, it helps in identifying the viability or feasibility of various segments of plans. Later on, it helps all parties to inform about the plans that have been agreed upon and their roles in the given plans. 5. Facilitates control: Management accounting assists in transforming given objectives and tactics into specified goals for attainment by a specified time and secures effective accomplishment of these goals in an efficient manner. All this is made possible through budgets and budgetary control and standard costing which are integral parts of management accounting. 6. Use of qualitative information: The quantitative information does have its vital importance in the case of decision making by a management. Management accounting does not limit itself to accounting data for assisting the management in decision making but also uses such information which may not be capable of being measured in monetary terms. Such information may be collected from special field/in house surveys, statistical accumulation, engineering records, etc.

26 CONCEPT OF MANAGEMENT ACCOUNTING: Concept refers to the rule of the game of Management Accounting that helps and guides an accountant in presenting his responsibility. It is a science but not an exact science. Many of the conclusions drawn on the basis of it depend to a greater extent upon the intelligent interpretation of data and because of which it may be given direction only under exceptional situations. The general practices, which have been adopted by the Management Accountants to deal with an exceptional situation from time to time, have now taken the form of conventions. These concepts may be taken as directions while using management accounting and are listed as follows: 1. At the time of recording transactions, accounting should be made limited to business transactions only. 2. Cost and revenues ought to be matched as far as possible. 3. The methods, procedures and principles should be reliable and consistent. 4. All anticipated profits should be credited on realization basis while losses should be granted in advance. 5. All the accounting revelations whether relating to past, present or future should be intended to meet the special needs of the business. 6. Capital employed should be kept intact at present price. 7. Management accounting information should be integrated and must be futuristic. 8. Direct cost should be allocated to cost centres and it should be recovered from products.

27 9. Reports and statements should not be utilized as a substitute for personal contact with the persons at higher levels of authority. 10. The object of control at source accounting should be followed. Limitation of Management Accounting: Although management accounting is helpful in providing guidelines for planning, directing and controlling functions, its effectiveness is still limited by a number of reasons. Unless these limitations are taken into account, while using the management accounting system, the so called benefits of management accounting cannot be availed. The limitations of management accounting are as follows: Based on accounting records: Management accounting is mainly concerned with the rearrangement or modification of a data. The data used for making the future decisions is historical. The correctness of the managerial decisions will depend upon the quality of data. If the financial data collected is incorrect, then management accounting fails to provide the right direction. Constant efforts: The conclusions and decisions drawn by the management accountant are not executed automatically. Thus, there is need for continuous and coordinated efforts of each management level to execute these decisions. Widespread Knowledge: It requires the knowledge of a number of related subjects. Management should have a thorough knowledge of the accounting

28 principles, statistics, economics, principles of management etc., to have an effective management accounting. Expensive System: It is very expensive. The installation of management accounting system requires a very complicated organization and several rules and regulations. This results in a huge investment which only large scale entities can afford. Resistance: Setting up of management accounting system requires basic changes in the organizational set up. New rules and regulations are also necessitated to be framed which affect a number of workforce and hence there is a possibility of resistance from some quarters or the others. Incommensurability : Management is only in the progressive phase; the techniques and tools used by this system give fluctuating results. Its conventions are not as accurate and established as of other branches of accounting. The conclusions taken from analysis and the interpretations are not the similar.