Unit I - Management Accounting

1. Management Accounting: Management Accounting: Meaning, Nature, Characteristics, Objectives, Advantages and Limitations

 Meaning of Management Accounting:

The term Management Accounting consists of two words “Management” and “Accounting”. It is the study of managerial aspects of accounting. It is a tool in the hands of management to exercise decision making. The emphasis of management accounting is to redesign accounting in a manner which is helpful to the management in framing the policies and control of their execution.

Management accounting is of recent origin. The term was first used in 1950 by a team of accountants visiting the U.S.A. under the auspices of Anglo-American Council on productivity. The terminology of cost accounting had no reference to the word ‘management accountancy’ before the visit by this study group. Intensive competitions, large scale production, dynamic developments in technology, and complexities of modern business have led to the development of management accounting-to solve many of the problems.

 Nature of Management Accounting:

Though Management Accounting is the latest branch in the accounting arena, it may be regarded partly as a Science and partly as an Art. It is the science of ‘Quantifying and summarising’ and Art of ‘Interpreting’ accounting data.

Management Accounts derives its conclusions through the collection, processing and objective analysis of data Quantified in figures. Thus it depends upon “Objectification and Quantification of progress and problems”. From this point of view Management accounting may be regarded as a Science.

However, Management Accounting also involves human judgement, impulses, whims and prejudices as evidenced in the interpretation of data, deductions and conclusions drawn from the analysis. ‘Subjectivity’ is inevitable in ‘deriving the meaning of data’. Deductions cannot be scientific with precision. Personal judgement of Management accountant may influence the interpretations and deductions significantly. From this point of view, Management Accounting may be regarded as an Art.

Characteristics /Features of Management Accounting:

The objective of Management accounting is to record, analyse and present financial data to the Management in such a way that it becomes useful and helpful in planning and running business operations systematically and effectively.

The following are the main characteristics of management accounting:

(1) Providing Financial Information:

The main emphasis of management accounting is to provide financial information to management. The information is provided in a manner suitable to various levels of management for reviewing policies and decision making.

(2) Cause and Effect Analysis:

Financial accounting confines itself to the presentation of P&L account and Balance Sheet. Management accounting analyses the cause and effect of the facts and figures thereon. If there is loss causes for the losses are investigated. If there is profit the variable affecting the profit is also analysed. The amount of profit is compared with expenditure, sales, capital employed, etc., to draw appropriate conclusions relating to the effect of those items on profit.

(3) Use of Special Techniques and Concepts:

Management accounting employs special techniques like standard costing, budgetary control, marginal costing, fund flow, cash flow, ratio analysis, responsibility accounting, etc. to make accounting data more useful and helpful to the management. Each of these techniques or concepts is a a useful tool for a specific purpose in analysis and interpretation of data, establishing control over operations, etc.

(4) Decision Making:

The main objective of management accounting is to provide relevant information-to management to take various important decisions. Historical information provides a base on which the future impact is predicted, alternatives are developed and decisions are made to select the most beneficial course of action.

(5) No Fixed Conventions:

Financial accounting has various established principles and rules in preparing financial accounts. Management accounting has no such fixed rules. The tools or techniques applied by the management accounting are the same but the application of these techniques vary from concern to concern and situation to situation.

 Objectives and Functions of Management Accounting:

The main objective of management accounting is to help the management in performing its functions efficiently. The major functions of management are planning, organising, directing and controlling. Management accounting helps management in performing these functions effectively.

(1) Presentation of Data:

Traditional Profit and Loss Account and the Balance The sheet are not analytical for decision making. Management accounting modifies and rearranges data as per the requirements for decision making through various techniques.

(2) The aid of Planning and Forecasting:

Management accounting is helpful to the management in the process of planning through the techniques of budgetary control and standard costing. Forecasting is extensively used in preparing budgets and setting standards.

(3) Help in Organising:

Organising is concerned with the establishment of relationships among different individuals in the firm. It includes delegation of authority and fixing responsibility. Management Accounting aims at aiding the Management in organising through the establishment of cost centres, profit centres, responsibility centres, Budget preparation etc. AH, these activities are helpful in setting up an effective organisational frame work.

(4) Decision Making:

Management accounting provides comparative data for analysis and interpretation for effective decision making and policy formulation.

(5) Reporting to Management of Different levels:

One of the Major objectives of Management accounting is to keep the Management informed about the performance, adherence to plans and progress of various sections of the organisation.

Top Management needs feed-back about the implementation of its plans policies and programmes. Middle-level Management and even junior executives need data for day to day operating decisions. Periodical and frequent reports are prepared and sent in time by Management Accountant to cater to the needs of all the levels of Management.

Tools and Techniques of Management Accounting:

The tools and techniques used in management accounting are explained below:

(1) Financial Policy and Accounting:

Every business concern ha sot plan for its sources of funds. The fund can be raised out of different sources. Utilising a particular source depends on the cost of servicing the source, terms of repayment in case of borrowings, etc. The amount of share capital raised, the statutory obligations for repayment are to be considered. The capital mix, i.e., the proportion of share capital and borrowing has to be decided to have an optimum capital structure. Management accounting provides capital budgeting techniques for financial planning.

(2) Analysis of Financial Statement:

Analysis of financial statements is meant to classify and present the data in a manner useful to the management. The significance of the information provided is explained in a nontechnical language in the form of ratio analysis, funds flow and cash flow techniques.

(3) Historical Cost Accounting:

Costs are recorded after being incurred for comparison with predetermined targets to evaluate performance.

(4) Budgetary Control:

Budgets are used as a tool for planning and control. Expenditure and revenue are predetermined. The actuals are compared with budgets to reveal deviations and individuals responsible for the same. Corrective actions are initiated to eliminate the negative deviations in future.

(5) Standard Costing:

Standard costing is an important technique of cost control. In Standard costing the costs are determined in advance by systematic analysis. The actual costs are compared with standards. The variances are analysed to find the causes and action is taken for removal of the same to increase efficiency.

Generally, standard costing is used along with budgetary control for effective control of operations.

Advantages/ Merits/ Uses of Management Accounting:

Management Accounting is of immense value and utility for the management of any firm and it has been considered as indispensable, particularly in large organisations where the task of Management is complex.

The following can be listed as the benefits or uses of Management Accounting:

(1) Increase in Efficiency:

Management accounting contributes significantly towards increasing efficiency in operations of a firm. Budgets, standards, reports etc., usually elevate the level of performance.

(2) Effective Planning:

Policy formulation and planning of operations become more effective through the ‘decision data’ provided by Management Accounting.

(3) Performance Evaluation:

Evaluating the performance of employees, departments, etc. is facilitated by Management accounting through Variance Analysis, control ratios etc.

(4) Profit Maximisation:

Management accounting is helpful in profit planning to pursue decisions which can optimise profits.

(5) Reliability:

The Tools used by Management accounting usually make the data supplied to Management accurate and reliable.

(6) Elimination of Wastages:

Standard costs, Budgets, cost control techniques, etc., contribute towards the elimination of wastages, production of defectives etc.

(7) Effective Communication:

Regular and systematic reporting ensures a constant flow of information about operations to various levels of Management.

(8) Employee Morale:

The morale of employees can be created and sustained through attainable standards, practical budgets and incentive schemes.

(9) Control and Co-ordination:

Control on costs and coordination in the efforts of different segments of an organisation can be achieved through performance reporting, variance analysis and follow up action etc.

The greatest benefit of Management accounting is its advisory role in making the Management take the best possible decisions on a day-to-day basis on routine matters and also vital policy matters.

 Limitations of Management Accounting:

Like any other discipline Management Accounting has its own Limitations. Though it is considered as an indispensable tool for Managerial decision making, its recent origin and several external factors limit its effectiveness.

These factors are explained below:

(1) Dependence for Basic Records:

Management Accounting rarely maintains basic and primary records of operations, expenses and revenues. It derives all of its Primary data from Financial Accounting Cost Accounting and other relevant records. So, the accuracy .and reliability of the conclusions derived by Management Accounting is limited to the reliability of its sources of data, so, it suffers from several of the limitations of Finance Accounts and cost Accounts.

(2) Personal Bias:

Analysis and interpretation of financial information depend upon the capability of the analyst and interpreter. Personal Judgement and usage of discretion become necessary in several areas of Management accounting. Personal ‘Prejudices’ and ‘Bias’ of individuals can affect the objectivity and effectiveness of the conclusions and recommendations.

(3) Management Accounting is only a Tool:

Management accounting cannot be considered as an alternative or substitute for Management. Management accountant acts as an adviser and facilitator for decision making by management. The actual decisions, their implementation and follow up action are the prerogative of the Management.

(4) Management Accounting provides only Data:

The Main function of Management Accounting is to provide data in the form of ‘Alternatives’ to the Management. It is for Management to make a suitable choice among the alternatives or even discard all of them. So, Management Accounting can ‘only Inform and not prescribe’.

(5) Broad-Based Scope:

The scope of Management accounting is very wide and broad-based. It uses information from varied disciplines like Financial Accounting, economics, Statistics, Cost Accounts, engineering etc. It considers Monetary and Non-Monetary Transaction of the firm. Limitations of the knowledge and experience of the Management Accountant in such diverse fields can make the data unreliable and undependable.

(6) Resistance to Change:

Installation of Management accounting involves basic changes in the organisational setup and Traditional accounting practices. The personnel concerned may resist such change unless they are taken into confidence and convinced of the need for such changes.

(7) Costly to Install:

Installation of Management Accounting involves huge expenditure because of the elaborate organisation needed and a large number of changes in procedures, forms and rules. So, small firms may not be able to afford the cost. Only big organisations can afford to Maintain Management accounting as a department or aid to management.

Cost Accounting vs. Management Accounting

1. The main objective of cost accounting is to assist the management in cost control and decision-making. The primary objective of management accounting is to provide necessary information to the management in the process of its planning, controlling, and performance evaluation, and decision-making.

2. Cost accounting system uses quantitative cost data that can be measured in monitory terms. Management accounting uses both quantitative and qualitative data. It also uses those data that cannot be measured in terms of money.

3. Determination of cost and cost control are the primary roles of cost accounting. Efficient and effective performance of concern is the primary role of management accounting.

4. The success of cost accounting does not depend upon the management accounting system. The success of management accounting depends on sound financial accounting system and cost accounting systems of concern.

5. Cost-related data, as obtained from financial accounting, is the base of cost accounting. Management accounting is based on the data as received from financial accounting and cost accounting.

6. Provides future cost-related decisions based on the historical cost information. Provides historical and predictive information for future decision-making.

7. Cost accounting reports are useful to the management as well as the shareholders and creditors of a concern. Management accounting prepares reports exclusively meant for the management.

8. Only cost accounting principles are used in it. Principals of cost accounting and financial accounting are used in management accounting. 9 Statutory audit of cost accounting reports is necessary in some cases, especially big business houses. No statutory requirement of audit for reports. 10 Cost accounting is restricted to cost-related data. Management accounting uses financial accounting data as well as cost accounting data.