MANAGEMENT ACCOUNTING

Chanderprabhu Jain College of Higher Studies & School of Law
Plot No. OCF, Sector A-8, Narela, New Delhi – 110040
(Affiliated to Guru Gobind Singh Indraprastha University and Approved by Govt of NCT of Delhi & Bar Council of India)
BBA (G)
Semester: THIRD Semester
Name of the Subject:
MANAGEMENT ACCOUNTING
UNIT-1
INTRODUCTION

❑Meaning
•Management accounting, also called managerial accounting or cost accounting,
is the process of analyzing business costs and operations to prepare internal
financial report, records, and account to aid managers’ decision making process
in achieving business goals.
•In other words, it is the act of making sense of financial and costing data and
translating that data into useful information for management and officers within
an organization.

•According to J. Batty:
“Management Accountancy is the term used to describe the accounting methods,
systems and techniques which, with special knowledge and ability, assist management
in its task of maximizing profit or minimizing losses.”
•According to the Institute of Cost and Management Accountants, London,
Management Accounting is defined 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.”

❑OBJECTIVES OF MANAGEMENT ACCOUNTING
1. To Assist in Planning
2. To Assist in Organising
3. To Assist in Motivating
4. To Coordinate
5. To Control
6. To Communicate
7. To Interpret Financial Information
8. Miscellaneous

❑ NATURE OR CHARACTERISTICS OF MANAGEMENT
ACCOUNTING
1. Future Prediction
2. Selective Technique
3. Analytical Approach
4. Provides the information in a useful manner
5. Helps management in taking decisions by supplying necessary information
and data
6. Studies Cause and Effect Analysis
7. Increases Efficiency
8. Achievement of desired objectives
9. Controls Forecasting
10. Helps in Decision Making

❑SCOPE OF MANAGEMENT ACCOUNTING
1. Financial Accounting
2. Cost Accounting
3. Financial Management
4. Budgeting and Forecasting
5. Inventory Control
6. Reporting to Management
7. Interpretation of Data
8. Control Procedures and Method
9. Internal Audit
10. Tax Accounting

❑ ADVANTAGES OF MANAGEMENT ACCOUNTING
1. Increases Efficiency
2. Helps in Price Fixing and Target Fixing
3. Helps in Forecasting and Budgeting
4. Useful in controlling Wastage
5. Helps in Communicating Information
6. Controls Cost of Production
7. Proactive Analysis can be done

❑ DISADVANTAGES OF MANAGEMENT ACOUNTING
1. Based on Financial and Cost Accounting
2. Its Expensive
3. Decisions given by Management Accountant may not be implemented
4. Provides only data and not decisions
5. Its only a tool to management and not an alternative to management
6. New Rules and Regulations have to framed which leads to opposition from the
employees

❑DIFFERENCE BETWEEN FINANCIAL ACCOUNTING AND
MANAGEMENT ACCOUNTING
BASIS FINANCIAL
ACCOUNTING
MANAGEMENT
ACCOUNTING
User Types Outside (External) Inside (Internal)
Level of Aggregation Global (Entire Company) Detailed or subunits
Regulation FASB; GAAP; SEC Value-Added
Characteristics Objective, reliable,
consistent, historical
Estimates and projections
Time Horizon Historical Present & Future
Reporting Frequency Periodic; Years, etc Continuous

❑DIFFERENCE BETWEEN COST ACCOUNTING AND MANAGEMENT
ACCOUNTING
BASIS COST ACCOUNTING MANAGEMENT ACCOUNTING
Meaning The recording, classifying and
summarizing of cost data of an
organization is known as cost
accounting.
The accounting in which the both financial
and non-financial information are provided
to managers is known as Management
Accounting.
Information Type Quantitative. Quantitative and Qualitative.
Objective Ascertainment of cost of production. Providing information to managers to set
goals and forecast strategies.
Scope Concerned with ascertainment,
allocation, distribution and accounting
aspects of cost.
Impart and effect aspect of costs.
Recording Records past and present data It gives more stress on the analysis of future
projections.
Planning Short range planning Short range and long range planning

❑ Who is a Management Accountant?
• The officer who is concerned with management accounting function in
an organization is known as management accountant.
❑ Functions of a Management Accountant
• To assure physical protection for the business through internal control
& proper insurance coverage.
• To consult with all segments of management.
• To administer the tax policies & procedures.
• To supervise & coordinate preparation of reports to govt. agencies.
• To compare performance with operating plan & standards & to report
and interpret its results.

❑ DUTIES OF A MANAGEMENT ACCOUNTANT
• To maintenance of adequate records of all contracts and leases.
• The preparation as a budget director, in conjunction with other
officers of an annual budget, covering all activities of the
corporation for submit to board of directors prior to the fiscal year.
• The preparation & interpretation of all statistical records &
reports of the corporation.
• The costing of all physical inventories.
• The compilation of production costs.
• Continuous audit of all accounts & records of the corporation
wherever located.

❖ FINANCIAL STATEMENTS
• MEANING
➢ A financial statement is an authorized document of the company, which
explores the whole financial information of the company. The aim of the
financial statement is to deliver information and understand the financial aspects
of the company. Hence, preparation of the financial statement is very important
as much as the financial decisions.
➢ Financial statements are the summary of the accounting process, which,
delivers useful information to both internal and external parties.

❖ FINANCIAL STATEMENTS ANALYSIS
Financial statement analysis involves analyzing the information provided in the
financial statements to:
➢ Provide information about the organization's:
• Past performance
• Present condition
• Future performance
➢ Assess the organization's:
• Earnings in terms of power, persistence, quality and growth
• Solvency

➢ Financial statements consist of two important statements:
• Income Statement or Profit and Loss Account
➢ Income statement is also known as profit and loss account, which mirrors the
operational position of the company during a period. Usually it consists of one
accounting year. It determines the whole operational performance of the concern
like total revenue produced and expenses suffered for earning that revenue.
• Balance Sheet or the Position Statement
➢ Position statement is also known as balance sheet, which mirrors the financial
position of the company at the end of the financial year. Position statement helps
to ascertain and understand the total assets, liabilities and capital of the
company. One can understand the strength and weakness of the concern with the
assistance of the position statement.

❖ PURPOSE OF FINANCIAL STATEMENTS
❖ To use financial statements to evaluate an organization's
– Financial performance
– Financial position
– Prediction of future performance
❖ To have a means of comparative analysis across time in terms of:
– Intercompany basis (within the company itself)
– Intercompany basis (between companies)
– Industry Averages (against that particular industry’s averages)
❖ To apply analytical tools and techniques to financial statements
to obtain useful information to aid decision making

❖ LIMITATIONS OF FINANCIAL STATEMENTS
❖ Dependence on historical costs
❖ Inflationary effects
❖ Intangible assets not recorded
❖ Based on specific time period
❖ No discussion of non-financial issues
❖ Not verified

❖ FINANCIAL ANALYSIS
•MEANING
➢ A financial statement is an authorized document of the company, which
explores the whole financial information of the company. The aim of the
financial statement is to deliver information and understand the financial aspects
of the company. Hence, preparation of the financial statement is very important
as much as the financial decisions.
➢ Financial statements are the summary of the accounting process, which,
delivers useful information to both internal and external parties.

❖ TOOLS OF FINANCIAL ANALYSIS
The following are the important tools of Financial Analysis:
➢ Comparative Financial Statements
➢ Common Size Financial Statements
➢ Trend Percentages
➢ Ratio Analysis
➢ Fund Flow Statements
➢ Cash Flow Statements

1. Comparative Financial Statements
➢ Comparative Financial Statements are the complete set of financial statements
that an entity issues, revealing information for more than one reporting period.
➢ The Financial Statements that may be included in this package are:
(i) The Income Statement (showing results for multiple periods)
(ii) The Balance Sheet (showing the financial position of the entity as of
more than one balance sheet date)
(iii) The Statement of Cash Flows (showing the cash flows for more
than one period)

▪ Comparative Financial Statements are quite useful for the following
reasons:
• Provides a comparison of an entity's financial performance over multiple
periods, so that you can determine trends. The statements may also reveal unusual
spikes in the reported information that can indicate the presence of accounting
errors.
• Provides a comparison of expenses to revenues and the proportions of various
items on the balance sheet over multiple periods. This information can be useful
for cost management purposes.
• May be useful for predicting future performance, though you should rely more
on operational indicators and leading indicators than on historical performance for
this type of analysis.

2. Common Size Financial Statements
A common size financial statement shows each line item on a financial statement
as a percentage of a base figure. Most commonly, this means the following:
• Income statement. Each revenue, expense, and profit line item is presented as a
percentage of net sales.
• Balance sheet. Each asset, liability, and shareholders' equity line item is
expressed as a percentage of total assets.
The concept has two uses, which are:
• Time series analysis. The percentages for each line item are compared over a
period of time, to discern trends that management can act upon. For example, an
increase in the cost of goods sold percentage might call for changes in price
points or more attention to supplier costs.
• Industry comparison. The financial statements of competitors can be converted
into the common size format, which makes them comparable to a company's own
financial statements. One can then determine how the cost structure or asset base
of a competitor varies from the company's.

3. Trend Percentages
• Method of analyzing information obtained over an extended
period by choosing a baseline period (usually the earliest year) and
stating the data associated with subsequent periods as a percentage
of that period.

4. Ratio Analysis
• A ratio analysis is a quantitative analysis of information contained
in a company’s financial statements.
• Ratio analysis is used to evaluate various aspects of a company’s
operating and financial performance such as its efficiency, liquidity,
profitability and solvency.

5. Funds Flow Statements
• Fund flow is the net of all cash inflows and outflows in and out of
various financial assets.
• Fund flow is usually measured on a monthly or quarterly basis; the
performance of an asset or fund is not taken into account, only
share redemptions, or outflows, and share purchases, or inflows.
• Net inflows create excess cash for managers to invest, which
theoretically creates demand for securities such as stocks and bonds.

6. Cash Flow Statements
• An examination of a company's cash inflows and outflows during
a specific period.
• The analysis begins with a starting balance and generates an
ending balance after accounting for all cash receipts and paid
expenses during the period.
• The cash flow analysis is often used for financial reporting
purposes. See also cash flow projection, cash flow forecast.

❖ RATIO ANALYSIS
•MEANING
➢ Ratio analysis is the process of determining and interpreting numerical
relationships based on financial statements. A ratio is a statistical yardstick that
provides a measure of the relationship between two variables or figures.
➢ This relationship can be expressed as a percent or as a quotient. Ratios are
simple to calculate and easy to understand. The persons interested in the analysis
of financial statements can be grouped under three heads,
i) owners or investors
ii) creditors and
iii) financial executives.

❑ Classification of Ratios:
Financial ratios can be classified under the following five
groups:
1) Structural
2) Liquidity
3) Profitability
4) Turnover
5) Miscellaneous.

1) STRUCTURAL GROUP:
The following are the ratios in structural group:
i) Funded debt to total capitalisation:
The term ‘total’ capitalisation comprises loan term debt, capital stock and
reserves and surplus.
Total capitalisation (Share capital + Reserves and surplus + long term loans)
ii) Debt to Equity:
Long term loans + short term credit + Total debt to equity = Current liabilities and
provisions Equity share capital + reserves and surplus (or)
Long-term debt to equity =
Long – term debt / Equity share capital + Reserves and surplus

iii) Net fixed assets to funded debt:
This ratio acts as a supplementary measure to determine security for the lenders.
A ratio of 2:1 would mean that for every rupee of long-term indebtedness.
iv) Funded (long-term) debt to net working capital:
The ratio is calculated by dividing the long-term debt by the amount of the net
working capital. It helps in examining creditors’ contribution to the liquid assets
of the firm.
Long term loans Net working capital
2) LIQUIDITY GROUP:
I) CURRENT RATIO:
• It is computed by dividing current assets by current liabilities.
• Current assets / Current liabilities and provisions + short-term credit against
inventory

II) ACID TEST RATIO:
• It is also termed as quick ratio. It is determined by dividing “quick assets”, i.e.,
cash, marketable investments and sundry debtors, by current liabilities.
• It is also termed as quick ratio. It is determined by dividing “quick assets”, i.e.,
cash, marketable investments and sundry debtors, by current liabilities.
•

3) PROFITABILITY GROUP:
It has five ratio, and they are calculated as follows:

4) TURNOVER GROUP:
It has four ratios, and they are calculated as follows:

4) MISCELLANEOUS:
It contains four ratio and they are as follows:

❑ LIMITATIONS OF RATIO ANALYSIS
1) It is always a challenging job to find an adequate standard.
2) When the two companies are of substantially different size, age and
diversified products,, comparison between them will be more difficult.
3) A change in price level can seriously affect the validity of comparisons of
ratios computed for different time periods.
4) Comparisons are also made difficult due to differences of the terms like
gross profit, operating profit, net profit etc.
5) If companies resort to ‘window dressing’, outsiders cannot look into the
facts and affect the validity of comparison.
6) Financial statements are based upon part performance and part events
which can only be guides to the extent they can reasonably be considered as
dues to the future.

❖ FUNDS FLOW STATEMENTS
•MEANING
• Funds flow statement is a statement which discloses the analytical
information about the different sources of a fund and the application
of the same in an accounting cycle.
•It deals with the transactions which change either the amount of
current assets and current liabilities (in the form of decrease or
increase in working capital) or fixed assets, long-term loans
including ownership fund.

• Generally speaking, the Fund Flow analysis requires the
preparation of two statements:-
1. Statement of Changes in Working Capital.
2. Fund Flow Statement.

❖ CASH FLOW ANALYSIS
•MEANING
• An examination of a company's cash inflows and outflows during a specific
period. The analysis begins with a starting balance and generates an ending
balance after accounting for all cash receipts and paid expenses during the period.
The cash flow analysis is often used for financial reporting purposes. See also
cash flow projection, cash flow forecast.

▪ Cash Flow Statement Components:
The cash flow statement components provide a detailed view of
cash flow from the following components:
1) Cash Flow from Operating Activities
2) Cash Flow From Investing Activities
3) Cash Flow From Finance Activities

Cash Flow Statement Format
Operating Activities:
Net Income
+ Depreciation and Amortization
+/- One Time Adjustments (i.e. investment gains or losses not related to operations, deferred
taxes, stock compensation)
+/- Changes in Working Capital
= Cash Flow From Operations
Investing Activities:
+/- Net Capital Expenditures
+/- Net Investments
= Cash Flow from Investing Activities
Financing Activities
– dividends
+/- sale or purchase of company stock
+/- net borrowings
= Cash Flow from Financing Activities
Summary of Cash Flow Activities:
+/- Cash Flow From Operating Activities
+/- Cash Flow From Investing Activities
+/- Cash Flow From Financing Activities
= Net Change in Cash
+ Beginning Cash Balance
= Ending Cash Balance

❑ BUDGETORY CONTROL
▪ Meaning:
• Budgetary control is the process of determining various actual results with
budgeted figures for the enterprise for the future period and standards set then
comparing the budgeted figures with the actual performance for calculating
variances, if any.
• “According to Brown and Howard, “Budgetary control is a system of
controlling costs which includes the preparation of budgets, coordinating the
departments and establishing responsibilities, comparing actual performance
with the budgeted and acting upon results to achieve maximum profitability.”

❑ OBJECTIVES OF BUDGETORY CONTROL:
The main objectives of budgetary control are the follows:
1. To ensure planning for future by setting up various budgets, the requirements
and expected performance of the enterprise are anticipated.
3. To operate various cost centres and departments with efficiency and economy.
4. Elimination of wastes and increase in profitability
5. To anticipate capital expenditure for future.
6. To centralize the control system.
7. Correction of deviations from the established standards.
8. Fixation of responsibility of various individuals in the organization.

❑ ADVANTAGES OF BUDGETORY CONTROL:
Some of the advantages of budgetary control are:
1. Maximization of Profits
2. Co-ordination
3. Specific Aims
4. Tool for Measuring Performance
5. Economy
6. Determining Weaknesses
7. Corrective Action
8. Consciousness
9. Reduces Costs
10. Introduction of Incentive Schemes

❑ DISADVANTAGES OF BUDGETORY CONTROL:
Some of the disadvantages of budgetary control are:
1. Uncertain Future
2. Budgetary Revision Required
3. Discourage Efficient Persons
4. Problem of Co-ordination
5. Conflict Among Different Departments
6. Depends Upon Support of Top Management

❑ TYPES OF BUDGETS
Some of types of Budgets are:
(i) Sales Budget
(ii) Production budget
(iii) Financial budget
(iv) Overheads budget
(v) Personnel budget and
(vi) Master budget

❑ ZERO BASED BUDGETING
Zero-based budgeting (ZBB) is a method of budgeting in which
all expenses must be justified for each new period. The process of zero-based
budgeting starts from a "zero base," and every function within an organization is
analyzed for its needs and costs. Budgets are then built around what is needed for
the upcoming period, regardless of whether each budget is higher or lower than
the previous one.

❑ RESPONSIBILITY ACCOUNTING
• Responsibility Accounting is a system of control where responsibility is
assigned for the control of costs. The persons are made responsible for the
control of costs.
• Proper authority is given to the persons so that they are able to keep up their
performance. In case the performance is not according to the predetermined
standards then the persons who are assigned this duty will be personally
responsible for it. In responsibility accounting the emphasis is on men rather than
on systems.

❖ STANDARD COSTING
• Standard costing is the practice of substituting an expected cost for an actual
cost in the accounting records, and then periodically recording variances showing
the difference between the expected and actual costs.
• This approach represents a simplified alternative to cost layering systems, such
as the FIFO and LIFO methods, where large amounts of historical cost
information must be maintained for items held in stock

• ADVANTAGES OF STANDARD COSTING:
1) Budgeting
2) Inventory costing
3) Overhead application
4) Price formulation

• Standard Cost Variances :
• A variance is the difference between the actual cost incurred and the standard
cost against which it is measured. A variance can also be used to measure the
difference between actual and expected sales. Thus, variance analysis can be
used to review the performance of both revenue and expenses.
• There are two basic types of variances from a standard that can arise, which are
the
1) RATE VARIANCE AND
2) VOLUME VARIANCE

• VARIANCE ANALYSIS
•Variance Analysis refers to the investigation as to the reasons for deviations in the
financial performance from the standards set by an organization in its budget. It helps
the management to keep a control on its operational performance.
➢ TYPES OF VARIANCE ANALYSIS
Variance Analysis can be broadly classified into the following heads:
1) Material Variance
2) Labour Variance
3) Variable Overhead Variance
4) Fixed Overhead Variance
5) Sales Variance

❖ MARGINAL COSTING
• Marginal Costing is a costing technique wherein the marginal cost,
i.e. variable cost is charged to units of cost, while the fixed cost for the
period is completely written off against the contribution.
• The term marginal cost implies the additional cost involved in
producing an extra unit of output, which can be reckoned by total
variable cost assigned to one unit. It can be calculated as:
Marginal Cost = Direct Material + Direct Labor + Direct Expenses
+ Variable Overheads

❑ CHARACTERISTICS OF MARGINAL COSTING:
1) Classification into Fixed and Variable Cost: Costs are bifurcated, on
the basis of variability into fixed cost and variable costs. In the same
way, semi variable cost is separated.
2) Valuation of Stock: While valuing the finished goods and work in
progress, only variable cost are taken into account. However, the variable
selling and distribution overheads are not included in the valuation of
inventory.
3) Determination of Price: The prices are determined on the basis of
marginal cost and marginal contribution.
4) Profitability: The ascertainment of departmental and product’s
profitability is based on the contribution margin.

❑ MARGINAL COSTING APPROACH

❑ THE CONTRIBUTION CONCEPT
The contribution concept lies at the heart of marginal costing. Contribution can be
calculated as follows.
Contribution = Sales price - Variable costs
The idea of profit is not a particularly useful one as it depends on how many units are
sold. For this reason, the contribution concept is frequently employed by management
accountants.
•Contribution gives an idea of how much 'money' there is available to 'contribute'
towards paying for the overheads of the organisation.
•At varying levels of output and sales, contribution per unit is constant.
•At varying levels of output and sales, profit per unit varies.
•Total contribution = Contribution per unit x Sales volume.
•Profit = Total contribution - Fixed overheads

❑ ABSORPTION COSTING
Absorption costing is a method of building up a full product cost which adds direct
costs and a proportion of production overhead costs by means of one or a number of
overhead absorption rates.
➢ ABSORPTION COSTING STATEMENT

❑ MARGINAL COSTING FORMULAES
1) MARGINAL COSTING EQUATION: SALES – VC = FC + PROFIT
2) Contribution = (Sales – VC) or (Profit + FC)
3) Profit Volume Ratio = Contribution / Sales
Profit Volume Ratio = Change in Profit / Change in Sales
When Profit = EBIT then Profit Volume Ratio = Change in Contribution /
Change in Sales
4) Break Even Point : Total Revenue = Total Cost
Break Even Point(In Rupees) = FC / PV Ratio
Break Even Point(In Rupees) = Break Even Point * Selling Price
Break Even Point(Quantity) = FC / Contribution p.u
Note:At BEP, Total Contribution = Total Fixed Cost
5) Margin Of Safety: Total Sales – Break even Sales
Margin Of Safety(In Rupees) = Profit / PV Ratio
Margin Of Safety(Quantity) = Profit / Contribution p.u

❑ Advantages of Marginal Costing:
The important advantages of Marginal Costing are:
(a) Marginal costing is easy to understand. It can be combined with standard costing
and budgetary control and thereby makes the control mechanism more effective.
(b) Eliminating of fixed overheads from the cost of production prevents the effect of
varying charges per unit, and also prevents the carrying forward of a portion of the
fixed overheads of the current period to the subsequent period.
(c) The problem of over or under absorption of overheads is avoided.
(d) A clear – cut division of costs into fixed and variable elements makes the flexible
budgetary control system easy and effective and thereby facilitates greater practical
cost control.
(e) It helps profit planning through break-even charts and profit graphs. Comparative
profitability can easily be assessed and brought to the notice of the management for
decision-making.
(f) It is an effective tool for determining efficient sales or production policies, or for
taking pricing and tendering decisions, particularly when the business is at low ebb.

❑ Disadvantages of Marginal Costing:
The important disadvantages of Marginal Costing are:
a) Segregation of all costs into fixed and variable costs is very difficult.
b) In marginal costing, greater importance is attached to the sales function thereby
relegating the production function largely to a secondary position.
c) The elimination of fixed costs from the valuation of inventories is illogical since
costs are also incurred in the manufacture of goods.
d) Pricing decision cannot be based on contribution alone.
e) Although the problem of over or under absorption of fixed overheads can be
overcome to a certain extent, the same problems still persists with regard to
variable overheads.
f) The application of the technique is limited in the case of industries in which,
according to the nature of business, large stocks have to be carried by way of work-
in-progress (e.g. contracting firms).

❑ COST VOLUME PROFIT ANALYSIS:
• Cost-volume profit (CVP) analysis is based upon determining
the breakeven point of cost and volume of goods and can be useful for
managers making short-term economic decisions.
• Cost-volume profit analysis makes several assumptions in order to be
relevant including that the sales price, fixed costs and variable cost per
unit are constant. Running this analysis involves using several equations
using price, cost and other variables and plotting them out on an
economic graph.

❖DECISIONS INVOLVING ALTERNATIVE CHOICES
❑ Introduction:
•Managerial decision-making is the process of choosing among
alternative courses of action.
•The manager chooses that course of action which he considers as the
most effective means of achieving goals and solving problems.
•All decisions are futuristic in nature, involving a forecast of what
management thinks is likely to occur.

❑ Steps in Decision Making:
• Defining the Problem
–Perceptive analysis and insight may be required to articulate the problem. The real
problem may have to be distinguished from the apparent one.
• Developing the alternative choices
–In the initial stages of developing alternative solutions several possibilities
may arise. The manager should eliminate those which are clearly unattractive and
narrow his choice down to a few, perhaps two or three.
• Evaluating the alternatives
Each solution may have several advantages and disadvantages. These have to be
weighed and balanced for judging its overall desirability.
• Arriving at a decision
Once the alternative courses of action are evaluated in terms of their measurable
and non-measurable effects, the decision maker will be in a position to select one
of the alternatives.

❑ DIFFERENT DECISIONS INVOLVED ARE:
•Evaluation of performance
•Profit planning
•Fixation of selling price
•Make or buy decisions
•Optimizing product mix
•CVP analysis in multi-product situations
•Decision to accept a special order
•Decision to continue or drop a product line
•Decision regarding equipment replacement

MANAGEMENT ACCOUNTING

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