Accounting for Managers 20MBA13

Module -4 Management Accounting 9 hours

Scope, Purpose of Management Accounting Cost Volume Profit Analysis: Meaning-Methods
of determination-Applications. Managerial Decision-MakingMake /Buy etc: Short-run
Decision Analysis-Decision situations: Sales-volume related, Sell or further process, Make or
Buy, Operate or shut-down.

Management Accounting

Today accounting is used as a tool in analysis of business and its activities. Accounting
information is presented in different ways in order to help in analysis by the different users of
the information. The two widely used types of accounting are:

• Financial accounting
• Management accounting.

Management accounting also is known as managerial accounting and can be defined as a

process of providing financial information and resources to the managers in decision making.
Management accounting is only used by the internal team of the organization, and this is the
only thing which makes it different from financial accounting. In this process, financial
information and reports such as invoice, financial balance statement is shared by finance
administration with the management team of the company.

Definition of Management accounting

The Institute of Cost and Management Accountants, London, has defined Management
Accounting as: “The application of professional knowledge and skill in the preparation of
accounting information in such a way as to assist management in the formulation of policies
and in the planning and control of the operation of the undertakings.

Nature of Management Accounting

Provides Accounting Information

Management accounting primarily serves the purpose of supplying accounting information to

the management team. It provides all relevant and true information from different sources like
cost and financial accounting which helps managers in framing policies.

Technique of Selective Nature

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Management accounting records and communicates only the most relevant information to
managers. It selects that data and information from various sources which is more useful to
management for their decision making.

Concerned With Future

It is a type of accounting that helps in deciding the future course of action. Management
accounting enables managers in the forecasting of future events by providing all relevant
information that is used for analysis purposes.

Cause And Effect Analysis

Management accounting properly analyses every element of balance sheet and profit and loss
account. It studies the cause and effect of various facts and figures. In case there are losses then
the reasons for incurring such losses are found. Management accounting studies and compares
different variables influencing the amount of profit like sales, capital employed and
expenditure.

No Fixed Conventions

There are no fixed norms and rules for management accounting, unlike financial accounting.
Management accounting tools or techniques differ from organization to organization. It does
not have any prescribed format for providing information. Management accounting supplies
information to managers in a way in which it is more beneficial for them to take decisions.

Provides Data And Not Decisions

Management accounting only provide information to managers but not a decision. It informs
the management about various facts and figures by supplying all relevant data to them. Such
data is analysed by managers for taking various decisions.

Objectives or functions of Management Accounting

The main objective of management accounting is to help the management to take quality
decision for controlling the business activities effectively.

Presentation of Data

Both profit and loss account and balance sheet are not useful for taking a decision in
accounting. Hence, the contents of profit and loss account and balance sheet are modified and

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rearranged in such a manner that helps the management for taking decision through various
techniques.

Forecasting

The management can forecast the achievement of objectives for short term and long term. The
accountant provides necessary information and data for forecasting.

Planning

The fund flow statement, cash flow statement, budgeting, standard costing, capital budgeting
and marginal costing are used for planning purpose. These are important tools of management
accounting.

Facilitates Control

Management accounting translates the objectives into achievements within a specified time.
This is possible through budgetary control and standard costing which are an integral part of
management accounting. In this way, management accounting facilitates control. Managerial
control is one of another important objective of management accounting. Whole organisation
is divided into different responsibility centres and each responsibility centre is allotted some
goals to be achieved. Management accountant monitors and evaluates the performance of these
responsibility centres from time to time. He is responsible to check whether operations are
going as per plans and standards. In case of any deviations, he will inform management thereby
helping in taking corrective measures timely.

Better Decision Making

Assisting in better decision making is the primary objective of Management accounting. It

supports the decision-making process of the management team by informing them about all
affairs of business from time to time. Right decisions taken at the right time can improve the
efficiency of the business. Management accounting helps in understanding the business
problems in a better way using techniques from different fields like costing, statistics,
economics etc. Therefore, proper understanding helps to take better decisions timely.

Proper Planning And Formulation Of Policies

Management accounting helps the managers in making better plan and policies for the
organisation. It provides management for the financial reports containing all financial and
statistical data about the organisation. Information from various financial sources like cash

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flow statement, fund flow statement, capital budgeting, marginal and standard costing is
presented in these financial reports. This all collectively helps managers in proper analysis and
formulating of appropriate policies.

Scope of Management Accounting

Helps In Decision Making

Assisting in better decision making is an important role in Management accounting. It supports

the decision-making process of the management team by informing them about all affairs of
business from time to time. The right decisions taken at the right time can improve the
efficiency of the business. Management accounting helps in understanding business problems
in a better way using techniques from different fields like costing, statistics, economics, etc.

Controls Management Performance

Managerial control is another important objective of management accounting. The whole

organization is divided into different responsibility centers and each responsibility center is
allotted some goals to be achieved. Management accountant monitors and evaluates the
performance of these responsibility centers from time to time. He is responsible to check
whether operations are going as per plans and standards. In case of any deviations, he will
inform management thereby helping in taking corrective measures timely.

Proper Planning And Formulation Of Policies

Management accounting assists managers in making better plans and policies for the
organization. It provides management of the financial reports containing all financial and
statistical data about organization. Information from various financial sources like cash flow
statement, fund flow statement, capital budgeting, marginal and standard costing is presented
in these financial reports. This all collectively helps managers in proper analysis and
formulating of appropriate policies.

Interprets Financial Information

Management accounting interprets the financial information in a way that is well understood
by management. Information collected through accounting is somehow technical and cannot
be well understood easily until you have proper knowledge of accounting subjects.
Management accounting derives information from various financial statements and presents it
in the form of reports which contain information in non-technical and intelligible manner.

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Motivates Employees

Motivation of employees is a must for the achievement of organizational goals timely.

Management accountant sets goals and policies to be followed by each employee and
department in an organization. It keeps a full check on the activities of employees and measures
their effectiveness from time to time. In addition to measuring their performance, he also guides
and supports them in improving their efficiency.

Evaluates Policies Effectiveness

Management accounting measures the overall efficiency of various policies taken by the
management team. It assists and lay emphasis on Management audit. Management accounting
reviews the performance and effectiveness of management policies in various departments. It
finds out the deviations and communicates the same to management team.

Advantages of Management Accounting

Better Decision Making

Management accounting helps in effective decision making for an organization. It supplies all
required information in the form of charts, tables, and forecasts to the management team. All
this information enables managers in performing detailed analysis and taking correct decisions.

Increase Business Efficiency

It aims at increasing the overall efficiency of the business. Management accounting using
scientific techniques evaluates the performance of the business and detects deviations and
problems. It takes corrective measures accordingly to remove defects that enhance business
productivity.

Simplify Financial Statements

This accounting branch simplifies the information contained in financial statements.

Management accountant properly studies financial statements and presents all data to managers
in the forms of simplified tables or charts for better understanding.

Raises Profitability

Management accounting assists in increasing business profitability. It enables in cutting the

extra expenditure involved in business activities using capital budgeting and budgetary control.
Companies are able to reduce the cost of their products and earn better profits on them.

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Motivates Employees

Management accounting serves as a tool for motivating employees. It prepares and presents
periodic reports regarding operations of the business to the management team. Managers are
easily able to evaluate the performance of employees and takes decision regarding promoting
or demoting them accordingly.

Cost Transparency

Transparency of cost is another important role played by management accounting. It properly

monitors all cash inflows and outflows of business and ensures that there is no misuse of
money. Management accounting works closely with the IT department to ensure that all
expenses are within budget.

Reliability

The information provides by management accounting is reliable as it uses proper scientific

tools for analysis purposes. Accurate and genuine information available to managers enables
them to the effective management of business affairs.

Disadvantages of Management Accounting

Lack Of Specific Procedure

Management accounting does not have any specific rules and principles to follow. In the
absence of any guideline, this branch of accounting may provide inaccurate data.

Costly

The installation of a management accounting system requires huge expenses as they need to
hire a management accountant. Such high costs cannot be bear by small business organizations.

Dependency

Management accounting is dependent upon financial and cost accounting for various data. The
authenticity of the information provided by management accounting completely depends upon
the accuracy of records maintained by cost and financial accounting.

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Personal Bias

This accounting branch is subject to personal bias and prejudices by management. The
effectiveness of management accounting may be affected by the interpretation and analysis
capability of individuals.

Uncertain

Management accounting is related to the future as it provides data for management and
planning of future activities. However, the future is uncertain and management accounting may
not provide effective results.

Provides Only Data

It only supplies data to management but does not provide any plan of action or decision.
Management accounting cannot substitute the role of management and can only help them in
their role by providing the required data.

Difference between Financial Accounting and Management Accounting

Points of
Financial Accounting Management Accounting
Difference

The main aim is to provide Here, the aim is different than

information to outside parties. financial accounting. Generally,
Aim Outside parties include creditors, management accounting
investors, customers, etc. Hence, it is i nform ati on is meant for
mainly aimed at assisting investors in management to make informed
making informed decisions. business decisions.

It is a mandatory requirement for It is at the discretion of management.

Regulatory every public organization by the There is no mandatory requirement
Requirements government. Thus, they are governed but still, institutes like CIMA,
by Accounting Standard Boards, ICWAI, etc provide some framework
companies’ law and government. and formats.

Financial accounting statements are

There is no standard basis for
prepared based on ‘Generally
Governing preparing management accounting
Accepted Account ing
principles statements. Hence, they are prepared
P ri nci pl es (GAAP)’. This GAAP is
based on the requirement of the
different for different countries with
management team.
more or less same features.

The time horizon for financial

Time Horizon It has no specific time horizon but
accounting is ‘past’. Generally, it is
the main focus is on the future.
one accounting year.

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Reports prepared under management

It is prepared for outside or external
Reporting accounting are useful to internal
parties. External parties
beneficiaries parties like CEO, directors,
like sharehol ders , suppliers,
promoters, and higher-level
customer, government, banks, etc.
managers, etc.

Financial accounting reports consist Management accounting reports are

Outputs of profit and loss the monthly, weekly, or yearly
statements, bal ance sheet and cash analysis of products, geographies,
fl ow st at em ent . functions, etc.

Data of management accounting

Relevance and Data of financial accounting are is not necessarily 100%
Precision of 100% verifiable and precise. verifiable. So, the data should be
Data Hence, everything has evidence to relevant, timely and logical. For
support it. instance, nobody can forecast
sales perfectly.

Independent audit of financial There is no specific requirement

accounting reports is mandatory for an independent audit. But
Independent in most countries. For instance, in management at its discretion can
Audit the USA, CPA conducts such take the initiative to conduct an
audits and in India, Chartered independent audit, for the sake of
Accountants (CA) conducts such efficient and effective
audits. management.

Management accounting
Financial accounting statements
statements are meant for
are publicly published statements
Confidentiality management and confidentiality
and are meant for the public only.
of the statements is the key
So, there is no question of
concern. It is because they
confidentiality.
contain business secrets.

It is concerned with the whole On the other hand, it is concerned

business and it is an end in itself. with a specific area or segment
Segment
Thus, some accounting standards for their analysis. Hence,
Reporting
in some countries bind the segments may be a product line,
companies to do segment geography, manufacturing unit,
reporting in defined formats. etc.

Perspective
It has a historical perspective. It has a futuristic perspective.

Nature of Both, financial and non-financial

Information required for financial
Information information is utilized in the
accounting statements is financial
Input preparation of management
in nature.
accounting reports.

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Difference between Cost Accounting and Management Accounting

Tools of Management Accounting

1. Based on Financial Accounting Information
▪ Analysis of Financial Statements through Ratio Analysis.
▪ Analysis of Financial Statements through comparative statements, trend, graph,
and diagram.
▪ Fund flow and cash flow analysis.
▪ Return on capital employed techniques.
2. Based on Cost Accounting Information
▪ Marginal costing (including cost volume profit analysis).
▪ Direct or incremental Costing and differential costing.
▪ Standard Costing.
▪ Analysis of Cost Variances.

Important tools and techniques used in management accounting.

Some of the important tools and techniques are briefly explained below.

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1. Financial Planning
The main objective of any business organization is maximization of profits. This objective is
achieved by making proper or sound financial planning. Hence, financial planning is
considered as best tool for achieving business objectives.

2. Financial Statement Analysis

Profit and Loss account and Balance Sheet are important financial statements. These statements
are analysed for different period. This type of analysis helps the management to know the rate
of growth of business concern. This analysis is done through comparative financial statements,
common size statements and ratio analysis.
3. Cost Accounting
Cost accounting presents cost data in product wise, process wise, department wise, branch wise
and the like. These cost data are compared with predetermined one. This comparison of two
costs enables the management to decide the reasons responsible for the difference between
these costs.
4. Fund Flow Analysis
This analysis find out the movement of fund from one period to another. Moreover, this
analysis is very useful to know whether the fund is properly used or not in a year when
compared to the previous year. The working capital changes and funds from operation are also
find out through this analysis.
5. Cash Flow Analysis
The movement of cash from one period to another can be find out through this analysis.
Besides, the reasons for cash balance and changes between two periods are also find out. It
studies the cash from operation and the movement of cash in a period.

6. Standard Costing
Standard costing is predetermined cost. It provides a yard stick for measuring actual
performance. It is used to find the reasons for the deviations if any.
7. Marginal Costing
Marginal costing technique is used to fix the selling price, selection of best sales mix, best use
of scarce raw materials or resources, to take make or buy decision, acceptance or rejection of
bulk order and foreign order and the like. This is based on the fixed cost, variable cost and
contribution.

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8. Budgetary Control
Under Budgetary control techniques, future financial needs are estimated and arranged
according to an orderly basis. It is used to control the financial performances of business
concern. Business operations are directed in a desired direction.

9. Revaluation Accounting
The fixed assets are revalued as per the revaluation accounting method so that the capital is
properly represented with the assets value. It helps to find out the fair return on capital
employed.

10. Decision-making Accounting

A business problem can be solved by choosing any one of the best and most profitable
alternatives. To select such alternative, the relevant costs are compared. Thus, accounting
information are used to solve the business problem which are arising out of increasing
complexity of nature of business.

11. Management Information System

The free flow communication within the organization is essential for effective functioning of
business. Hence, the management can design the system through which every employee of an
organization can assesses the information and used for discharging their duties and taking
quality decisions.

12. Statistical Techniques

There are a lot of statistical techniques used in removing management problems. Methods of
least square, regression and quality control etc. are some examples of statistical techniques.

13. Management Reporting

The management accountant is preparing the report on the basis of the contents of profit and
loss account and balance sheet and submit the same before the top management. Thus, prepared
reports disclose the strength and weakness indifferent areas of operating activities and financial
activities. These identifications are highly useful to management for exercising control and
decision-making.
14. Historical Cost Accounting
It means that costs are recorded after being incurred. This is used for comparing with
predetermined costs to evaluate performance.

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15. Ratio Analysis

It is used to management in the discharge of its basic functions of forecasting, planning,
coordination, communication, and control. It paves the way for effective control of business
operations by undertaking an appraisal of both the physical and monetary targets.

Cost Volume Profit Analysis

C.V.P. analysis is a technique used to study the inter-relationship between costs, sales and net
profit. It shows the net effect that fluctuation in cost, price and volume has on profits. The
higher the volume of output, the lower will be the unit cost of production and vice-versa as the
fixed overhead cost in total cost does not change with changes in the volume of output.

Objectives of Cost Volume Profit Analysis

• To forecast profit accurately. It aims at measuring variations in cost with volume.

• C.V.P. analysis is used in setting up flexible budgets which show costs at various levels
of activities.
• C.V.P. analysis helps management in the evaluation of performances for control
purposes.
• C.V.P. analysis may be helpful in formulating pricing policies by projecting the effect
that various price structures have on costs and profits.
• C.V.P. analysis helps to ascertain the amount of overhead costs that could be charged
to product costs at different levels of operation.
• It helps in making short-run tactical decisions, e.g., shift working, acceptance of special
order, choice of sales-mix, etc.

Cost Volume Profit Analysis – Purposes

(i) To ascertain the amount of profit (or loss) at any level of activity.

(ii) To determine the selling price/sales volume which will give the desired amount of
profit.

(iii) To ascertain the selling price/sales volume which will yield the desired return on
capacity employed.

(iv) To determine costs and revenues at various levels of activity.

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(v) To ascertain the effect of change (increase or decrease) in fixed costs, variable costs,
selling price, production/sales volume on profit.

(vi) To suggest the change in sales mix for obtaining maximum profits.

(vii) To compare profitability among products and firms.

Assumptions of CVP Analysis:

The CVP analysis is subject to the following assumptions:

(a) It assumes that output is the only factor affecting costs, but there are other variables
which can affect costs, e.g., inflation, efficiency and economic and political factors.

(b) Not all costs can be easily and accurately separated into fixed and variable elements.

(c) Total fixed costs do not remain constant beyond certain ranges of activity levels but
increase in a step-like fashion.

(d) It assumes that where a firm sells more than one product the sales mix is constant.
However, the sales mix will be continually changing owing to changes in demand.

(e) There is an assumption that there are either no stocks, or no changes in stock levels.
Profit is therefore dependent on the sales volume. However, when changes in stock levels
occur and such stocks are valued using absorption costing principles, then profit will vary
with both production and sales.

(f) CVP analysis assumes that costs and sales can be predicted with certainty. However,
these variables are uncertain, and the Finance manager must try to incorporate the effects
of uncertainty into his information.

Applications of Marginal Costing

1. Cost Control:

Marginal costing divides the total cost into fixed and variable cost. Fixed cost can be
controlled by the top management and that to a limited extent. Variable costs can be
controlled by the lower level of management. Marginal costing by concentrating all efforts
on the variable costs can control and thus provides a tool to the management for control of
total cost.

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There may be situations where the profits of the concern are decreasing in-spite of increase
in sales. If the data is presented on the basis of absorption costing basis, the management
may not be able to comprehend the results. Marginal costing analysis will correctly bring
out the reasons as to why the profits are decreasing in-spite of increase in sales.

2. Profit Planning:

Marginal costing helps the profit planning i.e., planning for future operations in such a way
as to maximise the profits or to maintain a specified level of profit. Absorption costing fails
to bring out the correct effect of change in sale price; variable cost or product mix on the
profits of the concern but that is possible with the help of marginal costing. Profits are
increased or decreased as a consequence of fluctuations in selling prices, variable costs and
sales quantities in case there is fixed capacity to produce and sell.

3. Evaluation of Performance:

The different products, departments, markets, and sales divisions have different profit
earning potentialities. Marginal cost analysis is very useful for evaluating the performance
of each sector of a concern. Performance evaluation is better done if distinction is made
between fixed and variable expenses. A product, department, market or sales division
giving higher contribution should be preferred if fixed expenses remain same.

4. Decision Making:

The information provided by the total cost method is not sufficient in solving the
management problems. Marginal costing technique is used for providing assistance to the
management in vital decision-making, especially in dealing with the problems requiring
short-term decisions where fixed costs are excluded.

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