An Ultimate Introduction To management accounting
A business enterprise must keep a systematic record of what happens from day to-day
events so that it can know its position clearly. Most of the business
enterprises are run by the corporate sector. These business houses are required
by law to prepare periodical statements in proper form showing the state of
financial affairs. The systematic record of the daily events of a business leading
to presentation of a complete financial picture is known as accounting. Thus,
Accounting is the language of business. A business enterprise speaks through
accounting. It reveals the position, especially the financial position through the
language called accounting.
MEANING OF ACCOUNTING:
Accounting is the process of recording, classifying, summarizing, analyzing and
interpreting the financial transactions of the business for the benefit of
management and those parties who are interested in business such as
shareholders, creditors, bankers, customers, employees and government. Thus, it
is concerned with financial reporting and decision making aspects of the
business.
The American Institute of Certified Public Accountants Committee on
Terminology proposed in 1941 that accounting may be defined as, “The art of
recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events which are, in part at least, of a financial
character and interpreting the results thereof”.
BRANCHES OF ACCOUNTING:
Accounting can be classified into three categories:
1. Financial Accounting
2. Cost Accounting, and
3. Management Accounting
FINANCIAL ACCOUNTING:
The term „Accounting‟ unless otherwise specifically stated always refers to
„Financial Accounting‟. Financial Accounting is commonly carries on in the
general offices of a business. It is concerned with revenues, expenses, assets and
liabilities of a business house. Financial Accounting has two-fold objective, viz,
1. To ascertain the profitability of the business, and
2. To know the financial position of the concern.
NATURE AND SCOPE OF FINANCIAL ACCOUNTING:
Financial accounting is a useful tool to management and to external users such
as shareholders, potential owners, creditors, customers, employees and
government. It provides information regarding the results of its operations and
the financial status of the business. The following are the functional areas of
financial accounting:-
1. Dealing with financial transactions:
Accounting as a process deals only with those transactions which are measurable
in terms of money. Anything which cannot be expressed in monetary terms does
not form part of financial accounting however significant it is.
2. Recording of information:
Accounting is an art of recording financial transactions of a business concern.
There is a limitation for human memory. It is not possible to remember all
transactions of the business. Therefore, the information is recorded in a set of
books called Journal and other subsidiary books and it is useful for management
in its decision making process.
3. Classification of Data:
The recorded data is arranged in a manner so as to group the transactions of
similar nature at one place so that full information of these items may be
collected under different heads. This is done in the book called „Ledger‟. For
example, we may have accounts called „Salaries‟, „Rent‟, „Interest‟,
Advertisement‟, etc. To verify the arithmetical accuracy of such accounts, trial
balance is prepared.
4. Making Summaries:
The classified information of the trial balance is used to prepare profit and loss
account and balance sheet in a manner useful to the users of accounting
information. The final accounts are prepared to find out operational efficiency
and financial strength of the business.
5. Analyzing:
It is the process of establishing the relationship between the items of the profit
and loss account and the balance sheet. The purpose is to identify the financial
strength and weakness of the business. It also provides a basis for interpretation.
6. Interpreting the financial information:It is concerned with explaining the
meaning and significance of the relationship established by the analysis. It
should be useful to the users, so as to enable them to take correct decisions.
7. Communicating the results:
The profitability and financial position of the business as interpreted above are
communicated to the interested parties at regular intervals so as to assist them to
make their own conclusions.
LIMITATIONS OF FINANCIAL ACCOUNTING:
Financial accounting is concerned with the preparation of final accounts. The
business has become so complex that mere final accounts are not sufficient in
meeting financial needs. Financial accounting is like a post-mortem report. At
the most it can reveal what has happened so far, but it can not exercise any
control over the past happenings. The limitations of financial accounting are as
follows:-
1. It records only quantitative information.
2. It records only the historical cost. The impact of future uncertainties has
no place in financial accounting.
3. It does not take into account price level changes.
4. It provides information about the whole concern. Product-wise, processwise,
department-wise or information of any other line of activity cannot
be obtained separately from the financial accounting.
5. Cost figures are not known in advance. Therefore, it is not possible to fix
the price in advance. It does not provide information to increase or
reduce the selling price.
6. As there is no technique for comparing the actual performance with that
of the budgeted targets, it is not possible to evaluate performance of the
business.
7. It does not tell about the optimum or otherwise of the quantum of profit
made and does not provide the ways and means to increase the profits.
8. In case of loss, whether loss can be reduced or converted into profit by
means of cost control and cost reduction? Financial accounting does not
answer this question.
9. It does not reveal which departments are performing well? Which ones
are incurring losses and how much is the loss in each case?
10. It does not provide the cost of products manufactured
11. There is no means provided by financial accounting to reduce the
wastage.
12. Can the expenses be reduced which results in the reduction of product
cost and if so, to what extent and how? No answer to these questions.
13. It is not helpful to the management in taking strategic decisions like
replacement of assets, introduction of new products, discontinuation of
an existing line, expansion of capacity, etc.
14. It provides ample scope for manipulation like overvaluation or
undervaluation. This possibility of manipulation reduces the reliability.
15. It is technical in nature. A person not conversant with accounting has
little utility of the financial accounts.
COST ACCOUNTING:(note it in mind it used in making difference between cost and management accounting)
An accounting system is to make available necessary and accurate information
for all those who are interested in the welfare of the organization. The
requirements of majority of them are satisfied by means of financial accounting.
However, the management requires far more detailed information than what the
conventional financial accounting can offer. The focus of the management lies
not in the past but on the future.
For a businessman who manufactures goods or renders services, cost accounting
is a useful tool. It was developed on account of limitations of financial
accounting and is the extension of financial accounting.
The advent of factory
system gave an impetus to the development of cost accounting.
It is a method of accounting for cost. The process of recording and
accounting for all the elements of cost is called cost accounting.
The Institute of Cost and Works Accountants, London defines costing as, “the
process of accounting for cost from the point at which expenditure is incurred or
committed to the establishment of its ultimate relationship with cost centres and
cost units. In its wider usage it embraces the preparation of statistical data, the
application of cost control methods and the ascertainment of the profitability of
activities carried out or planned”.
The Institute of Cost and Works Accountants, India defines cost accounting as,
“the technique and process of ascertainment of costs. Cost accounting is the
process of accounting for costs, which begins with recording of expenses or the
bases on which they are calculated and ends with preparation of statistical data”.
To put it simply, when the accounting process is applied for the elements of
costs (i.e., Materials, Labour and Other expenses), it becomes Cost Accounting.
OBJECTIVES OF COST ACCOUNTING:
Cost accounting was born to fulfill the needs of manufacturing companies. It is a
mechanism of accounting through which costs of goods or services are
ascertained and controlled for different purposes. It helps to ascertain the true
cost of every operation, through a close watch, say, cost analysis and allocation.
The main objectives of cost accounting are as follows:-
1. Cost Ascertainment
2. Cost Control
3. Cost Reduction
4. Fixation of Selling Price
5. Providing information for framing business policy.
1. Cost Ascertainment:
The main objective of cost accounting is to find out the cost of product, process,
job, contract, service or any unit of production. It is done through various
methods and techniques.
2. Cost Control:
The very basic function of cost accounting is to control costs. Comparison of
actual cost with standards reveals the discrepancies (Variances). The variances
reveal whether cost is within control or not. Remedial actions are suggested to
control the costs which are not within control.
3. Cost Reduction:
Cost reduction refers to the real and permanent reduction in the unit cost of
goods manufactured or services rendered without affecting the use intended. It
can be done with the help of techniques called budgetary control, standard
costing, material control, labour control and overheads control.
4. Fixation of Selling Price:
The price of any product consists of total cost and the margin required. Cost data
are useful in the determination of selling price or quotations. It provides detailed
information regarding various components of cost. It also provides information
in terms of fixed cost and variable costs, so that the extent of price reduction can
be decided.
5. Framing business policy:
Cost accounting helps management in formulating business policy and decision
making. Break even analysis, cost volume profit relationships, differential
costing, etc are helpful in taking decisions regarding key areas of the business
like.
Continuation or discontinuation of production
b. Utilization of capacity
c. The most profitable sales mix
d. Key factor
e. Export decision
f. Make or buy
g. Activity planning, etc.
NATURE AND SCOPE OF COST ACCOUNTING:
Cost accounting is concerned with ascertainment and control of costs. The
information provided by cost accounting to the management is helpful for cost
control and cost reduction through functions of planning, decision making and
control. Initially, cost accounting confined itself to cost ascertainment and
presentation of the same mainly to find out product cost. With the introduction
of large scale production, the scope of cost accounting was widened and
providing information for cost control and cost reduction has assumed equal
significance along with finding out cost of production. To start with cost
accounting was applied in manufacturing activities but now it is applied in
service organizations, government organizations, local authorities, agricultural
farms, extractive industries and so on.
Cost accounting guides for ascertainment of cost of production. Cost accounting
discloses profitable and unprofitable activities. It helps management to eliminate
the unprofitable activities. It provides information for estimate and tenders. It
discloses the losses occurring in the form of idle time spoilage or scrap etc. It
also provides a perpetual inventory system. It helps to make effective control
over inventory and for preparation of interim financial statements. It helps in
controlling the cost of production with the help of budgetary control and
standard costing. Cost accounting provides data for future production policies. It
discloses the relative efficiencies of different workers and for fixation of wages
to workers.
LIMITATIONS OF COST ACCOUNTING:
i) It is based on estimation: as cost accounting relies heavily on
predetermined data, it is not reliable.
ii) No uniform procedure in cost accounting: as there is no
uniform procedure, with the same information different results
may be arrived by different cost accounts.
iii) Large number of conventions and estimate: There are number
of conventions and estimates in preparing cost records such as
materials are issued on an average (or) standard price, overheads
are charged on percentage basis, Therefore, the profits arrived
from the cost records are not true.
iv) Formalities are more: Many formalities are to be observed to
obtain the benefit of cost accounting. Therefore, it is not
applicable to small and medium firms.
v) Expensive: Cost accounting is expensive and requires
reconciliation with financial records.
vi) It is unnecessary: Cost accounting is of recent origin and an
enterprise can survive even without cost accounting.
vii) Secondary data: Cost accounting depends on financial
statements for a lot of information. Any errors or short comings
in that information creep into cost accounts also.
MANAGEMENT ACCOUNTING:
Management accounting is not a specific system of accounting. It could be any
form of accounting which enables a business to be conducted more effectively
and efficiently. It is largely concerned with providing economic information to
mangers for achieving organizational goals. It is an extension of the horizon of
cost accounting towards newer areas of management. Much management
accounting information is financial in nature but has been organized in a manner
relating directly to the decision on hand.
Management Accounting is comprised of two words „Management‟ and
„Accounting‟. It means the study of managerial aspect of accounting. The
emphasis of management accounting is to redesign accounting in such a way
that it is helpful to the management in formation of policy, control of execution
and appreciation of effectiveness.
Management accounting is of recent origin. This was first used in 1950 by a
team of accountants visiting U. S. A under the auspices of Anglo-American
Council on Productivity
Definition:
Anglo-American Council on Productivity defines Management Accounting as,
“the presentation of accounting information in such a way as to assist
management to the creation of policy and the day to day operation of an
undertaking”
The American Accounting Association defines Management Accounting as “the
methods and concepts necessary for effective planning for choosing among
alternative business actions and for control through the evaluation and
interpretation of performances”.
The Institute of Chartered Accountants of India defines Management
Accounting as follows: “Such of its techniques and procedures by which
accounting mainly seeks to aid the management collectively has come to be
known as management accounting”
From these definitions, it is very clear that financial data is recorded, analyzed
and presented to the management in such a way that it becomes useful and
helpful in planning and running business operations more systematically.
