UNIT I

INTRODUCTION TO MANAGEMENT ACCOUNTING

CONCEPT OF MANAGEMENT ACCOUNTING
Management Accounting is a new approach to accounting. The term Management Accounting is
composed of two words Management and Accounting. It refers to Accounting for the
Management. Management Accounting is a modern tool to management. Management
Accounting provides the techniques for interpretation of accounting data. Here, accounting
should serve the needs of management. Management is concerned with decision-making. So, the
role of management accounting is to facilitate the process of decision-making by the
management. Managers in all types of organizations need information about business activities to
plan, accurately, for the future and make decisions for achieving the goals of the enterprise.
Uncertainty is the characteristic of the decision-making process. Uncertainty cannot be
eliminated, altogether, but can be reduced. The function of Management Accounting is to reduce
the uncertainty and help the management in the decision making process. Management
accounting is that field of accounting, which deals with providing information including
financial accounting information to managers for their use in planning, decision-making,
performance evaluation, control, management of costs and cost determination for financial
reporting. Managerial accounting contains reports prepared to fulfill the needs of managements.
MANAGEMENT ACCOUNTING-DEFINITION
Different authorities have provided different definitions for the term Management Accounting.
Some of them are as under:
Management Accounting is concerned with accounting information, which is useful to the
management. Robert N. Anthony
Management Accounting is concerned with the efficient management of a business through the
presentation to management of such information that will facilitate efficient planning and
control. Brown and Howard
Any form of Accounting which enables a business to be conducted more efficiently can be
regarded as Management Accounting The Institute of Chartered Accountants of England and
Wales
The Certified Institute of Management Accountants (CIMA) of UK defines the term
Management Accounting in the following manner: Management Accounting is an integral part
of management concerned with identifying, presenting and interpreting information for:
(1) Formulating strategy
(2) Planning and controlling activities
(3) Decision taking

(4) Optimizing the use of resources

(5) Disclosure to shareholders and others, external to the entity
(6) Disclosure to employees
(7) Safeguarding assets
From the above definitions, it is clear that the management accounting is concerned with that
accounting information, which is useful to the management. The accounting information is
rearranged in such a manner and provided to the top management for effective control to achieve
the goals of business.
Thus, management accounting is concerned with data collection from internal and external
sources, analyzing, processing, interpreting and communicating information for use, within the
organization, so that management can more effectively plan, make decisions and control
operations. The information to be collected and analyzed has been extended to its competitors in
the industry. This provides more meaningful clues for proper decision-making in the right
direction.
The information in the management accounting system is used for three different purposes:
(A) Measurement (B) Control and (C) Decision-making
Situation specific: The reports in managerial accounting are situation specific. Information in the
accounting statements is to be culled out to meet the requirements of the relevant situation and
presented to the management for specific problem, situation or decision.
SCOPE OF MANAGEMENT ACCOUNTING:
The scope of Management Accounting is broader than the scope of cost accounting and Financial
Accounting. In cost accounting, as we have seen, the primary emphasis is on cost and it deals
with collection, analysis, relevance, interpretation and presentation for various problems of
management. Management Accounting is an accounting system which will help the Management
to improve its efficiency. The main thrust of Management Accounting is towards determining
policy and formulating plans to achieve desired objectives of management. It helps the
Management in planning, controlling and analyzing the performance of the organization in order
to follow the path of continuous improvement. Management Accounting utilizes the principle
and practices of nancial accounting and cost accounting in addition to other modern
management techniques for effective operation of a company. In fact there is an overlapping in
various areas of cost accounting and management accounting. However, the distinguishing
features of Management Accounting are given below.
Features of Management Accounting
The features of Management Accounting are given below.
1. The Management Accounting data are derived from both, the nancial accounting and cost
accounting.
2. The main thrust in management accounting is towards determining policy and formulating
plans to achieve desired objectives of management.
3. Management Accounting makes corporate planning and strategy effective and meaningful.

4. It is concerned with short and long range planning and uses highly sophisticated techniques
like sensitivity analysis, probability techniques, decision tree, ratio analysis etc for planning,
control and evaluation.
5. It is futuristic in approach and predictive in nature.
6. Management accounting system cannot be installed without proper cost accounting system.
7. Management Accounting systems generate various reports which are extremely useful from
the Management point of view.
ROLE OF MANAGEMENT ACCOUNTANCY
The role of management accounting and nancial accounting is quite different from each other
as they have different goals altogether. Management Accounting measures, analyzes and reports
nancial and non nancial information that helps managers to take decisions to ful ll the goals
of an organization. Managers use management accounting information to choose, communicate
and implement strategy. They also use management accounting information to coordinate
product design, production and marketing decisions. Management accounting focuses on internal
reporting. The following points highlight the role played by Management Accounting in the
business organization.
I. Implementing Strategy: Managers implement strategies by translating them into actions.
Creating value for customers is an important part of planning and implementation of strategies.
Strategic planning and implementation will include decisions regarding the design of products,
services or processes, research and development, production, marketing, distribution and
customer services.
Each of this area is important for satisfying customers and keeping them satised. Management
accounting will help to track the costs of each of the activity mentioned above. The ultimate
target is to reduce costs in each category and to improve efficiency. Cost information also helps
managers make cost benet analysis. For example, managers can nd out that is it cheaper to buy
products from outside vendors or to do manufacturing in-house? Is it worthwhile to invest more
resources in design and manufacturing if it reduces costs in marketing and customer service?
II. Supply Chain Analysis: Companies can also implement strategy, cut costs and create value
by enhancing their supply chain. The term Supply Chain describes the ow of goods, services
and information from the initial sources of materials and services to the delivery of products to
customers regardless of whether those activities occur in the same organization or in other
organization.
Customers expect improved performance from companies through the supply chain. They expect
that the companies should perform all these activities in an ef cient manner so as to reduce costs
and also maintain quality of the products and the products be available easily for them. This is no
doubt a daunting task and the management accounting plays a vital role in ensuring value for
money for the customers. Tools like standard costing and target costing can be used effectively
for cost control and cost reduction and thus ensure reasonable prices for customers. A system of
budgets and budgetary control will ensure continuous planning and monitoring various functions
and thus provide for introspection. Continuous improvement in these activities will help in
creating value for customers.

III. Decision Making: One of the important functions of management is decision making.
Management
Accounting helps in this crucial area by providing relevant information to the management.
Techniques like marginal costing helps to generate information, which will be useful for taking
decisions. Decisions include make or buy decisions, adding or dropping a product line, working
of additional shift, shut down or continue operations, capital expenditure decisions and so on.
Decisions based on information are expected to be more rational and objective rather than
subjective.
IV. Performance Measurement: Management accounting helps immensely for the measurement
of performance of the organization. The main aspect of performance measurement is comparison
between the targets and actual. There are several tools and techniques like budgets and budgetary
control, standard costing and marginal costing, which are used in measuring the actual
performance against the target performance. This will facilitate introspection and corrective
action can be taken for further improving the performance.
OBJECTIVES/FUNCTIONS OF MANAGEMENT ACCOUNTING
The primary objective of Management Accounting is to maximize profits or minimize losses.
This is done through the presentation of statements in such a way that the management is able to
take corrective policy or decision. The manner in which the Management Accountant satisfies
the various needs of management is described as follows:
(1) Storehouse of Reliable Data: Management wants reliable data for Planning, Forecasting and
Decision-making. Management accounting collects the data from various sources and stores the
information for appropriate use, as and when needed. Though the main source of data is financial
statements, Management Accounting is not restricted to the use of monetary data only. While
preparing a sales budget, the management accountant uses the past data of the products sold from
the financial records and makes projections based on the consumer surveys, population figures
and other reliable information to estimate the sales budget. So, management accounting uses
qualitative information, unlike financial accounting, for preparing its reports, collecting and
modifying the data for the specific purpose.
(2) Modification and Presentation of Data: Data collected from financial statements and other
sources is not readily understandable to the management. The data is modified and presented to
the management in such a way that it is useful to the management. If sales data is required, it can
be classified according to product, geographical area, season-wise, type of customers and time
taken by them for making payments. Similarly, if production figures are needed, these can be
classified according to product, quality, and time taken for manufacturing process. Management
Accountant modifies the data according to the requirements of the management for each specific
issue to be resolved.
(3) Communication and Coordination: Targets are communicated to the different departments
for their achievement. Coordination among the different departments is essential for the success
of the organisation. The targets and performances of different departments are communicated to
the concerned departments to increase the efficiency of the various sections, thereby increasing

the profitability of the firm. Variance analysis is an important tool to bring the necessary matters
to the attention of the concerned to exercise control and achieve the desired results.
(4) Financial Analysis and Interpretation: Management accounting helps in strategic decision
making. Top managerial executives may lack technical knowledge. For example, there are
various alternatives to produce. There is always a choice for the sales mix. Management
Accountant gives facts and figures about various policies and evaluates them in monetary terms.
He interprets the data and gives his opinion about various alternative courses of action so that it
becomes easier to the management to take a decision.
(5) Control: It is absolutely essential that there should be a system of monitoring the
performance of all divisions and departments so that deviations from the desired path are brought
to light, without delay and are corrected then and there. This process is termed as control. The
aim of this function control is to facilitate accomplishment of the goals in an efficient manner.
For the discharge of this important function, management accounting provides meaningful
information in a systematic and effective manner. However, the role of accountant is
misunderstood. Many consider the accountant as a controller of their performance. Many
accountants themselves misunderstand their own role as controllers. The real role of control is
effective communication and assists the managers in achieving their goals, as efficiently as
possible.
(6) Supplying Information to Various Levels of Management: Every level of management
requires information for decision-making and policy execution. Top-level management takes
broad policy decisions, leaving day-to-day decisions to lower management for execution. Supply
of right information, at proper time, increases efficiency at all levels.
(7) Reporting to Management: Reporting is an important function of management accounting
to achieve the targets. The reports are presented in the form of graphs, diagrams and other
statistical techniques so as to make them easily understandable. These reports may be monthly,
quarterly, and half-yearly. These reports are helpful in giving constant review of the working of
the business.
(8) Helpful in taking Strategic Decisions: There are complicated decisions in respect of make
or buy, discontinuance of a product line, exploring new market areas etc. In the absence of
systematic accounting information, it is difficult to take decisions on such vital areas.

DIFFERENCES BETWEEN FINANCIAL ACCOUNTING AND MANAGEMENT

ACCOUNTING
The points of difference between Financial Accounting and Management Accounting are set out
as below:
Financial Accounting

Management Accounting

Financial accounting produces

information that is used by external
Audience
parties, such as shareholders and
lenders.

Managerial accounting produces

information that is used within an
organization, by managers and employees.

The main objectives of financial

accounting are to disclose the end
Objectives results of the business, and the
financial condition of the business on
a particular date.

The main objective of managerial

accounting is to help management by
providing information that is used to plan,
set goals and evaluate these goals.

It is legally required to prepare

Managerial accounting reports are not
Optional financial accounting reports and share legally required.
them with investors.
Pertains to the entire organization.
Segment
Certain figures may be broken out for
reporting
materially significant business units.

Pertains to individual departments in

addition to the entire organization.

Financial accounting focuses on

Managerial accounting focuses on the
Focus history; reports on the prior quarter or present and forecasts for the future.
year.
Financial accounts are reported in a
Format is informal and is on a per
Format specific format, so that different
department/company basis as needed.
organizations can be easily compared.
Rules in financial accounting are
prescribed by standards such asGAAP
Rules or IFRS. There are legal requirements
for companies to follow financial
accounting standards.

Managerial accounting reports are only

used internally within the organization; so
they are not subject to the legal
requirements that financial accounts are.

Financial Accounting
Reporting Defined - annually, semi-annually,
frequency and quarterly, yearly.
duration
Information

Monetary, verifiable information.

Management Accounting
As needed - daily, weekly, monthly.

Monetary and company goal driven

information.

LIMITATIONS OF MANAGEMENT ACCOUNTING

Despite the development of Management Accounting as an effective discipline to improve the
managerial performance, some of the limitations are as under:
1. Accuracy is not Ensured: Management Accounting is largely based on estimates. It does not
deal with actuals, alone, and thus total accuracy is not ensured under Management Accounting.
2. A Tool in the Hands of Management: Management Accounting is definitely a tool in the
hands of management, but cannot replace management.
3. Strength and Weakness: Management Accounting derives information from Financial
Accounting, Cost Accounting and other records. The strength and weakness of these basic
information providers become the strength and weakness of Management Accounting too.
4. Costly Affair: The installation of Management Accounting is a costly affair so all the
organizations, in particular, small firms cannot afford.
5. Lack of Knowledge and Understanding: The emergence of Management Accounting is the
fusion of a number of subjects like statistics, economics, engineering and management theory.
Any inadequate grounding in any one or more of the subjects is bound to have an unfavorable
effect on the consideration and solution of the problems, relating to management performance.
6. Persistence on Intuitive Decision-making: Though the main contribution of Management
Accounting is elimination of intuitive approach, there is always a temptation to take an easy
course of arriving at decisions, by intuition, rather than taking the tortuous path of scientific
decision-making.
7. Psychological Resistance: Adoption of a system of Management Accounting brings about a
radical change in the established pattern of the activity of the management personnel. It calls for
rearrangement of personnel as well as their activities. This is bound to encounter opposition from
some quarter or other.

8. Evolutionary Stage: Comparatively, Management Accounting is a new discipline and is still

very much in a stage of evolution. Therefore, it comes across the same difficulties or obstacles,
which a relatively new discipline has to face
TECHNIQUES AND TOOLS OF FINANCIAL STATEMENT ANALYSIS
Financial statements give complete information about assets, liabilities, equity, reserves,
expenses and profit and loss of an enterprise. They are not readily understandable to interested
parties like creditors, shareholders, investors etc. Thus, various techniques are employed for
analysing and interpreting the financial statements. Techniques of analysis of financial
statements are mainly classified into three categories:
(i)

(ii)

(iii)

Cross-sectional analysis: It is also known as inter firm comparison. This analysis

helps in analysing financial characteristics of an enterprise with financial
characteristics of another similar enterprise in that accounting period. For example, if
company A has earned 15% profit on capital invested. This does not say whether it is
adequate or not. If we analyse further and find that a similar company has earned 16%
during the same period, then only we can make a conclusion that company B is better.
Thus, it turns into a meaningful analysis.
Time series analysis It is also called as intra-firm comparison. According to this
method, the relationship between different items of financial statement is established,
comparisons are made and results obtained. The basis of comparison may be :
Comparison of the financial statements of different years of the same business unit.
Comparison of financial statement of a particular year of different business units.
Cross-sectional cum time series analysis This analysis is intended to compare the
financial characteristics of two or more enterprises for a defined accounting period. It
is possible to extend such a comparison over the year. This approach is most effective
in analysing of financial statements.

Other important tools which are commonly used for analysing and interpreting financial
statements are:
1. Comparative Statements: These are the statements showing the profitability and financial
position of a firm for different periods of time in a comparative form to give an idea about the
position of two or more periods. It usually applies to the two important financial statements,
namely, balance sheet and statement of profit and loss prepared in a comparative form. The
financial data will be comparative only when same accounting principles are used in preparing
these statements. If this is not the case, the deviation in the use of accounting principles should
be mentioned as a footnote. Comparative figures indicate the trend and direction of financial
position and operating results. This analysis is also known as horizontal analysis.
2. Common Size Statements: These are the statements which indicate the relationship of different
items of a financial statement with a common item by expressing each item as a percentage of
that common item. The percentage thus calculated can be easily compared with the results of
corresponding percentages of the previous year or of some other firms, as the numbers are
brought to common base. Such statements also allow an analyst to compare the operating and

financing characteristics of two companies of different sizes in the same industry. Thus, common
size statements are useful, both, in intra-firm comparisons over different years and also in
making inter-firm comparisons for the same year or for several years. This analysis is also
known as Vertical analysis.
3. Trend Analysis: It is a technique of studying the operational results and financial position over
a series of years. Using the previous years data of a business enterprise, trend analysis can be
done to observe the percentage changes over time in the selected data. The trend percentage is
the percentage relationship, in which each item of different years bear to the same item in the
base year. Trend analysis is important because, with its long run view, it may point to basic
changes in the nature of the business. By looking at a trend in a particular ratio, one may find
whether the ratio is falling, rising or remaining relatively constant. From this observation, a
problem is detected or the sign of good or poor management is detected.
4. Ratio Analysis: It describes the significant relationship which exists between various items of
a balance sheet and a statement of profit and loss of a firm. As a technique of financial analysis,
accounting ratios measure the comparative significance of the individual items of the income and
position statements. It is possible to assess the profitability, solvency and efficiency of an
enterprise through the technique of ratio analysis.
5. Cash Flow Analysis: It refers to the analysis of actual movement of cash into and out of an
organisation. The flow of cash into the business is called as cash inflow or positive cash flow and
the flow of cash out of the firm is called as cash outflow or a negative cash flow. The difference
between the inflow and outflow of cash is the net cash flow. Cash flow statement is prepared to
project the manner in which the cash has been received and has been utilised during an
accounting year as it shows the sources of cash receipts and also the purposes for which
payments are made. Thus, it summarises the causes for the changes in cash position of a business
enterprise between dates of two balance sheets.