MANAGEMENT ACCOUNTING

Session Objectives:

The Scope of Management Accounting

Comparison between Management Accounting and Financial Accounting

Comparison between Management Accounting and Cost Accounting

The Role of Management Accountant

What is Management Accounting?

Management accounting is the accounting for management. Management and accountancy are two close but separate disciplines. The former is basically concerned with policy-formulation and decision making, while the latter is concerned with measuring and reporting financial activities. The Anglo–American committee defines management accounting as the presentation of accounting information in such a way as to assist management in the creation of policy in the day-to-day operations of an undertaking”. The credit of introducing this concept in the corporate level can be traced back to Dupont Corporation and the General Motors in the early part of the last century.

Evolution of management Accounting

Management Accounting dates back to 1740 when the accountant of Melincryddan Smelting Works provided information to management to assess the profitability of two possible locations.

In 1850s Lyman Mills, a USA textile company used sophisticated overheads apportionment techniques and also used efficiency reports.

Between 1880-1914, the scientific management, a method of analyzing factory productivity, through time and motion studies, was used to establish standards.

The development of ‘Management Accounting System’ in the twentieth century can be attributed to the rise of Du Pont in USA.

It was only in 1950, that the term ‘Management Accounting’ came into practice following an Anglo American Productivity Council Meeting.

In India, Management Accounting has emerged more recently as a discipline.

Definition

The professional society, Institute of Management Accountant defines ‘Management Accounting’ as  “a value adding continuous improvement process of planning, designing, measuring and operating non-financial and financial information systems that guides management action, motivates behavior, and supports and creates, the cultural value necessary to achieve an organization’s strategic, tactical and operating objectives”.

According to CT Horngren, “Management Accounting is the identification, measurement, accumulation, analysis, preparation, interpretation and communication of information that assists the executive in fulfilling organizational objectives”.

Role of Management Accounting:

• • Management Accounting plays a significant role in the following areas

• • Operational control:

• • Provides feedback about the efficiency and the quality of the tasks performed.  

• • Product and customer costing:

• • Measures the costs of resources used to manufacture a product or service, and market and deliver the product to the customer.

• • Management control:

• • Provides information about the performance of Managers and operating units.

Strategic control:

• • Provides information about the enterprise’s financial and long run competitive performance, market conditions, customer preferences, and technological innovations.

• • The scope of management Accounting can be analyzed based on the type of decisions taken using the management accounting information.

• • Financial Accounting:  Financial Accounting deals with recorded facts which  are useful for planning the future course of action. The performance appraisal is based on recorded facts and figures.

• • Cost Accounting: The systems of standard costing, marginal costing, differential costing and opportunity costing are all helpful to the management for planning various business activities.

Budgeting and Forecasting:

Both budgeting and forecasting are useful for management accountant in planning various activities.

Inventory Control:  The control of inventory ultimately will help in controlling stocks. Management will need effective inventory control-to-control stocks.

Management Reporting: Keeping the management informed of various activities of the concern is one of the important functions of the management accountant.

Interpretation of Data: The management accountant interprets various financial statements to the management. These statements give an idea about the financial and earning position of the concern

Internal Audit: To judge the performance of every department internal audit system is necessary. Internal audit helps management in fixing responsibility of different individuals.

Tax Accounting: Tax planning is an important part of management accounting. Income statements are prepared and tax liabilities are calculated. The management is informed about the tax burden from Central Government, State Government and local authorities.

The major difference lies in the fact that financial accounting is mandatory for an organization where as management accounting is meant solely for the purpose of management decision making and control.

• • Both forms of accounting differ mainly in areas like

• • The purpose of the accounting statements

• • The facts/matters in which emphasis is laid

• • The preparation of the statements

• • The nature of data required for the preparation of statements

• • The extent of precision provided by both methods

• • The extent of focus on the organization as a whole

• • Usage of other disciplines in the preparation of statements; and

• • The freedom of choice involved.

The purpose of the accounting statements

The purpose of the financial statements is generally for internal or external uses. While management accounting focuses solely on the internal users, financial accounting focuses mainly on the external users. Internal users don’t require the same type of information sought by the external users like share holders, creditors etc. The information provided by management accounting is sued by managers to solve internal problems of the company and also in making vital decisions, which are not given much attention by the external users.

The facts/matters in which emphasis is laid : The emphasis of management accounting is on the future plans of the organization. As a large part of the overall responsibilities of a manager has something to do with planning, a manager’s information need has a strong orientation towards the future. The importance of future plans lies in the fact that the critical factors like economic conditions, customer demands, competitive conditions etc. are so dynamic and thus proper planning is considered as the need of the hour.

The preparation of the statements: The preparation of financial statements in accordance with the generally accepted accounting principles is mandatory as per the financial accounting requirements. This information projects the performance of the company to the outsiders. The users of management accounting however are not required to follow the rules prescribed by any of the accounting standards.

The nature of data required for the preparation of statements: The nature and importance of data is different for both forms of accounting. While the financial accounting data is to be objectively determined and verifiable, management accounting data is more concerned about receiving information that is relevant to a particular decision being taken and also should be flexible enough to be used in a variety of decision making situations.

The extent of precision provided by both methods: Precision is a more common term used in financial accounting. The financial statements prepared under financial accounting,  is audited to check the accuracy of the statements. In case of data required for management accountants, speed is more important than precision.

Financial accounting focuses on the business activities of the organization as a whole where as management accounting focuses on the whole and more on the parts or segments of a company.

Usage of other disciplines in the preparation of statements: Management accounting uses other disciplines for the preparation of reports for managers for future planning. It extends beyond the boundaries of traditional accounting systems and practices and draws heavily from other disciplines.

The freedom of choice involved: Financial accounting is mandatory for any organization where as management accounting is not. Any organization should compulsorily maintain financial records as per the legal stipulations. On the other side, there are no regulatory bodies that provide statutes for the preparation of management accounting reports.  

Streams of Accounting

• • Financial Accounting

• • Cost Accounting

• • Management Accounting

1) Financial Accounting: is the process in which business transactions are recorded systematically in the various books of accounts maintained by the organization in order to prepare financial statements. Theses financial statements are basically of two types: First is Profitability Statement or Profit and Loss Account and second is Balance Sheet.

2) Cost Accounting: is the process of classifying and recording of expenditure incurred during the operations of the organization in a systematic way, in order to ascertain the cost of a cost center with the intention to control the cost.

3) Management Accounting: is the process of analysis, interpretation and presentation of accounting information collected with the help of financial accounting and cost accounting, in order to assist management in the process of decision-making, creation of policy and day to day operation of an organization. Thus, it is clear from the above that the management accounting is based on financial accounting and cost accounting.

Management accounting is a field of accounting that analyzes and provides cost information to the internal management for the purposes of planning, controlling and decision-making.

Management accounting refers to accounting information developed for managers within an organization. CIMA (Chartered Institute of Management Accountants) defines Management accounting as “Management Accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of information that used by management to plan, evaluate, and control within an entity and to assure appropriate use of an accountability for its resources”. This is the phase of accounting concerned with providing information to managers for use in planning and controlling operations and in decision making.

Managerial accounting is concerned with providing information to managers i.e. people inside an organization who direct and control its operations. In contrast, financial accounting is concerned with providing information to stockholders, creditors, and others who are outside an organization. Managerial accounting provides the essential data with which organizations are actually run. Financial accounting provides the scorecard by which a company’s past performance is judged.

Because it is manager oriented, any study of managerial accounting must be preceded by some understanding of what managers do, the information managers need, and the general business environment.

Difference between Financial & Management Accounting

	Financial Accounting	Management Accounting
Audience	Financial accounting produces information that is used by external parties, such as shareholders and lenders.	Managerial accounting produces information that is used within an organization, by managers and employees.
Objectives	The main objectives of financial accounting are to disclose the end 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.
Optional	It is legally required to prepare financial accounting reports and share them with investors.	Managerial accounting reports are not legally required.
Segment reporting	Pertains to the entire organization. Certain figures may be broken out for materially significant business units.	Pertains to individual departments in addition to the entire organization.
Focus	Financial accounting focuses on history; reports on the prior quarter or year.	Managerial accounting focuses on the present and forecasts for the future.
Format	Financial accounts are reported in a specific format, so that different organizations can be easily compared.	Format is informal and is on a per department/company basis as needed.
Rules	Rules in financial accounting are prescribed by standards such as GAAP 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.
Reporting frequency and duration	Defined – annually, semi-annually, quarterly, yearly.	As needed – daily, weekly, monthly.
Information	Monetary, verifiable information.	Monetary and company goal driven information.

     

Cost Accounting and Management Accounting:

Cost accounting is a conscious and rational procedure followed by accountants for accumulating cost and relating such costs to specific products or departments for effective management action. It establishes budgets, standard costs and actual costs. The subject matter of cost accounting is the cost and price data. It is limited to product costing procedures and related information processing. Cost accounting is a management information system that analyzes past, present and future data to provide the basis for managerial decision making.

Management accounting, attempts to fill the information needs of managers with respect to a specific problem or situation. It is not confined to the area of product costing, cost and price data. In order to achieve the management accounting objectives, it makes use of the information derived from financial accounting and various other disciplines.

Tools and Techniques of Management Accounting:

In their functioning the Management Accountants use several tools and techniques such as:

Analysis of Financial Statements: The techniques used for financial analysis includes comparative financial statements, ratios, funds flow statements, trend analysis, etc.

Budgetary Control: Budgetary control technique is used as a tool for planning and control. The management is able to assess the performance of each person in the organization.

Standard Costing: This is one of the important techniques of cost control. It is determined in advance based on a systematic analysis of prevalent conditions. The standard costing technique helps to enhance the efficiency of the concern and also ‘management by exception’.

Marginal Costing: This is a technique of costing which is concerned with changes in costs resulting from changes in the volume of production. The short-term utilization of capacity decisions are also assessed with the help of marginal costing.

Decision Accounting: Decision-taking involves a choice from various alternatives. Management accounting helps to calculate the financial implications of each alternative.

Revaluation Accounting: This is also known as replacement accounting. The preservation of capital in the business is the main object of management.

Management Information Systems: With the development of electronic devices for recording and classifying data, reporting to management has considerably improved. The data pertaining to planning, co-ordination and control is supplied to the management. 

Limitations of Management Accounting:

• • It is based on Accounting Information

• • Management is based on the data supplied by financial accounting and cost accounting. The data used for making the future decisions is historical, which acts as a major limitation in decision-making.

• • Comprehensive Knowledge

• • The management should have thorough knowledge of the accounting principles, statistics, principles of management, economics, etc., to have an effective management accounting.

• • It is not an Alternative to Administration

• • Management accounting does not provide an alternative to administration

Evolutionary Process

• • Management is only in the evolutionary stage; the techniques and tools used by this system give varying results. The conclusions taken from analysis and the interpretations are not the same.

• • Personal Judgment: The interpretation of the financial information depends upon the capability of the interpreter and his personal judgment.

• • Resistance: Installation of management accounting involves basic change in the organizational set-up.

• • Functions of Management Accountant

• • The functions of the management accountant or controller relate to the management and control of the firm’s resources.

• • Planning and controlling function: The management accountant establishes, coordinates and maintains an integrated plan for the control of operations.

• • Reporting and interpreting function: Compares the actual performance with the operating plans and standards, and to report deviations if any to the owners of the business.

• • Tax administration: To establish and administer tax policies and procedures.

• • Preparation of reports to government agencies: To prepare the report to the government agencies as required under different laws.

• • Protect the assets of the business: Performing the function of protecting the assets of the business through internal controls, auditing and ensuring proper insurance coverage.

• • Appraisal of external influences on the business:  Make an appraisal of the influence of economic, social, and governmental influences and their effect on the business.

Summary: In this chapter we have discussed the introductory aspects of Management Accounting, evolution of management accounting, benefits of management accounting to an organization, difference between management accounting and financial accounting and also the distinguishing factor between management accounting and cost accounting. The major functions of a management accountant are also discussed here.