Lesson 1: The role and scope of Cost & Management Accounting

1.1 Introduction:

Cost and Management Accounting plays an important role by providing a vast

range of information necessary for managerial decision-making process. It
provides the necessary accounting information for decision making by the
management. There are differences between financial accounting and cost &
management accounting. To see these differences, one should have a
understanding of financial accounting and cost and management accounting. The
following section gives you a brief account on this aspect.

1.2 Financial accounting

Financial Accounting is prepared for an accounting period covering all the

transactions and events occurred during that period. It is prepared in accordance
with the established accounting concepts, accounting principles, accounting
standards and legal requirements and submitted in a format based on the
statutory requirement. According to the definition, Recording transactions and
measuring economic impact of transactions created on firm’s assets and liabilities
are at the centre of financial accounting. It is mainly concerned with the
preparation of the income statement and the balance sheet.

1.2.1 Limitations of Financial Accounting

Financial accounting is based on historical data. It just keeps records on the

transactions incurred within the financial year. It fails to provide adequate data
related to future to the management to plan for the future years due to the lack of
latest and up to date cost information.

A business organization is consisted with many departments such as purchasing,

production, processing, maintain etc. Financial accounting is not concerned with
on each of these departments. Instead, it focuses on the net results of the overall
business activities.

Financial accounting doesn't provide any information on the cost. Therefore, it is

not an effective way of determining the cost of a product service or a job.

Measuring the usage efficiency of the resources such as labor, material, and other
resources is impossible thorough the financial accounting. This is not an approach
to control the materials and suppliers.

Due to the above inherent limitations of financial accounting, cost and

management accounting emerged long time back to address the above problems.
Major differences between financial accounting and cost & management
accounting are explained in the following section.

1.2.2 A comparison between financial accounting and cost & management

accounting.

Legal requirement:

Preparing the final financial statements (Income statement, balance sheet,

statement of the changes of equity, cash flow statement and the explanatory
notes) is the aim of financial accounting and it is mandatory to prepare these
statements as per the legal requirement in public limited companies. Cost and
management accounting reports are used by the management of the firms and it
is entirely optional.

Precision:

Since external parties depend on the financial statements published by the

companies, financial accounting information should be accurate to a larger extent.
In the meantime, approximate information is sufficient for management
accounting purpose.
Segments of the business:

It covers all the transactions and events occurred within the financial year. In
contrast, management accounting focuses on part of the organization.

Accepted accounting principles:

Financial accounting is based on the generally accepted accounting principles.

There are no generally accepted accounting principles in preparing cost &
management accounting reports. Since management reports are prepared for
internal purposes, they can be of any form in presenting management reports

Time dimension:

Financial accounting reports only the past transactions and events of the entities.
It reports the data related to the past period. In contrast, management accounting
is concerned with the future information as well as past information for effective
decision making.

Report frequency:

Financial statements are published annually whereas management accounting

reports are prepared whenever the need for management accounting reports
arise.

The following section provides the explanation for cost accounting and
management accounting for better understanding of these.

1.3 Cost Accounting

Cost Accounting is the application of cost accounting principles, methods and

techniques to the cost control. It includes the presentation of the information
derived there from for the purpose of managerial decision making. “The process of
accounting starts from the point at which expenditure is incurred or committed to
the establishment of its ultimate relationship with cost centers and cost units. In
its widest 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 Work Accountants, America).

1.3.1 Objectives of Cost Accounting

Cost accounting has been a strong and effective approach in manufacturing firms
in ascertaining and controlling the cost of products and services. The main
purposes of cost accounting are as follows.

Determination of cost:

Determination of the accurate cost for a product, service, department, job or unit
of production is a very important for a manufacturing firm. There are costing
methods and costing techniques in cost accounting such as marginal costing,
standard costing, process costing, batch costing, job costing etc., available for
management to ascertain the cost of a product or a service.

Determination of price of a product or a service:

Pricing of a product is a most complex process in any manufacturing firm. Various
factors such as demand for a product, demand elasticity of it, degree of the
competition, type of the market in which the firm operates should be considered
before making the pricing decisions. Cost accounting plays an important role to
help the management to take pricing decisions.

Controlling the cost:

Management uses the cost accounting as a mode of controlling the cost of
products and services. It is done through comparing the statements of costs of the
current period with the cost of previous period or with the budgeted cost. The core
task of the management is to keep the cost under the control through ensuring
the efficiency of each and every production and service departments of the
organization. Cost accounting is recognized as the most effective approach in
controlling the cost in an effective manner.

Cost estimations and plans:

Cost accounting helps the management to estimate cost and plan its future
activities. Usually the process of planning is based on the past and present cost
information. Management establishes standard costs for a product produced or
service rendered and this becomes the basis for future planning. Cost accounting
is quite important as it provides the vast range of information related to the cost
of a product or a service.

1.3.2 Limitations of Cost Accounting

Cost accounting provides only cost information related to a product or service. It

does not deal with all the accounting information those are quite important for
managerial decision making. Evaluating the alternatives is at the centre of the
managerial works. In evaluating the alternatives, non cost items and information
are quite important. But, cost accounting doesn’t provide any information on these
non cost items. The purpose of cost accounting is just to determine the cost,
profit, through costing systems but it does not focus on formulating strategies,
actions those should be formulated to maximize the profitability of the firm. These
are the inherent limitations of cost accounting. These inherent limitations have
given the birth for Management accounting.

1.4 Management Accounting

Management accounting is a system of accounting that is concerned with internal
reporting of information to management for
a) Planning and controlling operations.
b) Decision making on special matters.
c) Formulating long term plans.
 d) Ensure the effective use of the recourses.

According to J Batty, “Management accounting is the term uses to describe the

accounting methods, systems, and techniques which coupled with special
knowledge and ability, assist the management in the task of maximizing the profit
or minimizing the losses. Management accounting is carried out with the
information obtained through financial accounting and cost accounting and all
other related non-financial information.

The management accounting process starts with collecting, classifying, processing,

and analyzing the financial and non-financial data, and to formulate plans and
strategies for the better functioning of the entity in a effective way. The scope of
the management accounting is wider than the financial accounting and cost
accounting.

1.5 The Cost & Management Accounting and Modern Business

Environment

The business environment is so complex today. All the business firms are required
to maintain a high degree of efficiency in order to survive in the highly competitive
environment. Accounting is said to be the language of business as they
communicate the required information. All businesses are trying to expand their
businesses with the wave of the globalization. Cross border transactions are very
common in the today’s world. All business firms have to face the tough and stiff
competition created by the other firms in this highly competitive business
environment. The competitive business environment forces all firms to increase
the quality of their products and the services by decreasing the cost to achieve the
competitive advantages. Under this kind of environment, management of entities
are forced to evaluate the performances of their firm continuously. In this task,
management keeps the reliance on the accounting information to the most extent.
Cost and management accounting helps the management to cope with this
situation effectively in a comprehensive manner.
1.6 Summary
Though cost accounting and management accounting are used together, the
activities carried out by the accountants are different from each other. Cost
accounting is concerned cost data whereas the management accounting facilitates
the management to take effective decision in order to improve the entity’s
performance. Corrective measures are taken by the management through
management accounting process. The scope of the management accounting is
wider than the financial accounting and cost accounting.