INTRODUCTION TO

MANAGEMENT
ACCOUNTING
 1-2

What is Management Accounting

 The Accounting System which is prepared for the help of
Management to plan the activity, evaluate performance,
ensure integrity of the financial information to the
Organization can be considered as “MANAGEMENT
ACCOUNTING”.
MANAGEMENT
ACCOUNTANT

FINANCIAL
ACCOUNTANT

COST
ACCOUNTANT
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Objectives of Management Accounting

 Relevant To Making Decisions

 Types Of Decisions
 Investing

 Financing

 Operating
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Investment Decisions

 Determining the total amount of assets needed to be

held by the firm. (Assets side of the b/s)
 Investment can be:
1. INVESTMENT IN FIXED ASSETS
2. INVESTMENT IN WORKING CAPITAL
 DECISIONS RULE:
Investment in a particular asset can be accepted only if
the return on investment is more than the minimum
acceptable rate
 1-5

Investment Decisions

The main types of investment decisions can be:

1. Fixed assets to be acquired.
2. Investment in current assets.
3. Buy or lease decisions.
4. Asset replacement decisions.
5. Restructuring, merger and acquisition decisions
 1-6

Finance Decisions

 Related to the procurement of funds.

(Liability side of the b/s).
 Decisions about debt and equity mix.
 The long term assets should be financed
with long term funds and short term
assets should be financed with short term
funds.
 1-7

Finance Decisions

The main types of finance decisions can be:

1. Determining the degree of leverage
2. Determining the financing pattern of long,
medium and short term funds.
3. Arranging finance for working capital.
4. Decision about the interest burden on the firm.
 1-8

Dividend Decision

 Concerned with how much profits to be

distributed as dividend and how much to
be retained in the business.
 If profit is paid as dividend it influence
the share price.
 If profit is not paid as dividend it
maximizes the wealth of the shareholder.
 1-9

Function of Management Accounting

Validating Help in Help in

the DATA Planning Controlling.

Recording of Help in Help in

DATA Organising. Communicating

Help in
Communicating Help in
Decision
the DATA Controlling.
Making
 1-10

Functions of Management Accounting

Management accountants perform these functions

 Planning & Forecasting
 Financial analysis & interpretation
 Communication
 Facilitates managerial controls
 Helpful in taking strategic decisions
 Use of qualitative information
 Co-ordinating
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Scope of Management Accounting

 Financial Accounting
 Cost Accounting

 Budgeting & Forecasting

 Inventory control

 Reporting to management

 Internal audit

 Tax accounting
 1-12

Tools & Techniques of Management Accounting

 Financial Management Analysis

 Comparative financial statements
 Ratio analysis
 Fund flow statement
 Trend analysis
 CVP analysis
 Cash Flow Analysis
 1-13

Tools & Techniques of Management Accounting

 Budgetary Control
 Standard costing

 Marginal costing

 Responsibility accounting

 Price level accounting

 Human resource accounting

 Social cost benefit analysis

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Importance of Management Accounting

 Increases efficiency
 Proper planning

 Measurement of performance

 Maximizing profitability

 Improve service to customers

 Effective management control

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Limitations of Management Accounting

 Based on accounting information

 Lack of knowledge

 Intuitive decisions

 Not an alternative to the administration

 Top heavy structure

 Evolutionary stage

 Personal biasness

 Psychological resistance
Comparison of Cost,
Management and Financial
accounting
 1-17

Meanings

 Financial Accounting
 Cost Accounting

 Management Accounting
 1-18

Financial Accounting
 Provides information to users who are
external to the business

 It reports on past transactions to draw up

financial statements

 The format are governed by law and

accounting standards established by the
professional accounting policies
 1-19

Cost Accounting
 Is concerned with internal users of
accounting information, such as operation
managers

 The generated reports are specific to the

requirement of the management

 The reporting can be in any format which

suits the user
 1-20

Management Accounting

 Comprises all cost accounting functions

 The accounting for product and service

costs, management accounting extends to
use various internal accounting reports for
planning, control and decision making
 1-21

Features of Management Accounting

The features of Management Accounting are given
below:

 The Management Accounting data are derived from

both, the financial accounting and cost accounting.

 The main thrust in management accounting is towards

determining policy and formulating plans to achieve
desired objectives of management.

 Management Accounting makes corporate planning

and strategy effective and meaningful.
 1-22

Features contd…..
 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.

 It is futuristic in approach and predictive in nature.

 Management Accounting system cannot be installed

without proper cost accounting system.

 Management Accounting systems generate various

reports which are extremely useful from the
Management point of view.
Cost and Management
Accounting
Vs.
Financial Accounting
 Relationship of Financial,
1-24

Management, and Cost Accounting

Product Costs

FINANCIAL COST MANAGEMENT

ACCOUNTING ACCOUNTING ACCOUNTING
 1-25
Difference between Cost Accounting and
Financial Accounting

1. Meaning

Cost Accounting : Cost accounting is that part of

accounting which is helpful to calculate the cost and
control the cost. In cost accounting, we deeply study the
variable cost, fixed cost, overheads and capital cost.

Financial Accounting : Financial Accounting is that part

of accounting in which we record the transactions and
we make the financial statements. Through making the
financial statement, it provide information of
profitability and financial position to the interested
parties.
 1-26
Difference between Cost Accounting and
Financial Accounting

2. Objective

Cost Accounting : We can not take all decisions on

the basis of information which have been provided
by financial accounting. After making the financial
statements under financial accounting, we calculate
the cost of each unit and use the techniques of cost
accounting for better decision making.

Financial Accounting : Main objective of financial

accounting is to show the financial statement
correctly.
 1-27
Difference between Cost Accounting and
Financial Accounting

3. Law

Cost Accounting : There is not any restriction on the

cost accounts. It can be made according to the need of
company but some company must audit their cost
accounts under cost audit.

Financial Accounting : In financial accounting, there

are lots of law restrictions. For example, company
accounts and financial statements must be according to
the format of company law. It should also follow the
rules of IFRS and income tax law.
 1-28
Difference between Cost Accounting and
Financial Accounting

4. Controlling

Cost Accounting : In cost accounting, we study the

techniques of controlling the cost. All the costs are
calculated for the purpose of controlling the cost.
For example, Company produces product A, B and C. If
product C is generating 30% but product A and B is
generating just 5%. We will try to control the cost of A and
B product through different techniques of cost control.

Financial Accounting : In financial accounting, we just

record the transactions correctly. We do not care to control
the cost.
 1-29
Difference between Cost Accounting and
Financial Accounting

5. Record

Cost Accounting : In cost accounting, both actual

transactions record and estimations are used. For
example budgetary control and variance analysis, we set
the standard cost which is based on the estimations.
These estimations may be differ from actual cost.

Financial Accounting : In financial accounting, we use

actual transaction for recording purpose. We do not use
the estimation for preparing income statements and
balance sheet.
 1-30
Difference between Cost Accounting and
Financial Accounting

6. Profit Analysis
Cost Accounting : In cost accounting, to find the profit per job
or per batch or per service unit is possible.
Financial Accounting : In financial accounting. we make the
income statement which shows the net profit or loss or whole
organization not one job or batch.

7. Valuation of Inventory
Cost Accounting : In cost accounting, inventory's valuation will
be on cost.
Financial Accounting : In financial accounting, inventory's
valuation will be on the cost or market value which will be low.
 1-31
Difference between Cost Accounting and
Financial Accounting

8. Cycle

Cost Accounting : In cost accounting, we first calculate the

raw material cost. Then, we calculate the labour cost. Then,
we calculate the direct material cost. After this, we calculate
the overhead cost. All these cost are added. A profit margin is
added. An estimated sale price is calculated. Its whole
controlling cycle will be relating to control the cost of raw
material, labour cost and overheads.

Financial Accounting : In financial accounting, we pass the

journal entries. Then, we make the ledger accounts. Then, we
prepare the trial balance. Then, we make the final accounts.
 1-32

Management Financial accounting

(cost)accounting
Nature Records material, Records company

labour and overhead transaction events

costs in product or job External financial
Reports produced are statements are produced

for internal
management and
contol
Accounting Not based on the Follows the double entry

system double entry system system

 1-33

Management Financial accounting

(cost)accounting
Accounting No need to use Use Generally Accepted
principles accounting principles Accounting Principles for
Adopt any accounting recording transactions
techniques that
generates useful
accounting information
Users of Used by different Used by external parties:

information levels of management or shareholders, creditors,

departments responsible government, etc
for respective activities
 1-34

Management Financial accounting

(cost)accounting
Operation Based on management Conforms to company

guidelines instructions and Ordinances, stock

or standards requirements exchange rules

Time span Reports are prepared Reports are prepared

whenever needed for a definite period,
They may be prepared usually yearly and half

on a weekly or daily yearly

basis
 1-35

Management Financial accounting

(cost)accounting
Time focus Future orientation: Past orientation: use of
forecasts, estimates historic data for reporting
and historic data for and evaluation
management
actions

Perspective Detailed analysis Financial summary of

of parts of the the whole orgainisation
entity, products,
regions, etc
 Cost Accounting
vs.
Management Accounting
 1-37

Cost and Management Accounting

 Provides management with costs for
products, inventories, operations or
functions and compares actual to
predetermined data

 It also provides a variety of data for many

day-to-day decision as well as essential
information for long-range decisions
 1-38

Management Cost accounting

accounting
Objective To provide To ascertain and control

information for cost

planning and decision
making by the
management

Basic of  Concerned with Based on both present

recording transactions related to and future transactions for

the future cost ascertainment
 1-39

Management Cost accounting

accounting
Coverage Covers a wider area: Covers matters relating

financial accounts, cost to ascertainment and

accounts, taxation, etc. control of cost of product
or service

Utility Only the needs of The needs of both

internal management internal and external
interested groups

Approach  Futuristic in approach  Historical in approach

 1-40

Management Cost accounting

accounting
Types of Deals with both Deals only with

transactions monetary any non- monetary transactions,

monetary transactions, covering only quantitative
covering both aspect
quantitative and
qualitative aspects
 Types of Cost
&
Elements of Cost
 1-42

Cost- Meaning

"Cost is a measurement, in monetary terms, of the

amount of resources used for the purpose
of production of goods or rendering services”

 Cost means the amount of expenditure

(actual or notional) incurred on, or
attributable to, a given thing.

 Total cost = quantity used * cost per unit

(unit cost)
 1-43

Cost Concepts

 Cost object
 Cost unit
 Cost centre
 Profit centre
 1-44

Cost object
 It is an activity or item or operation for
which a separate measurement of costs is
desired

 E.g. the cost of operating the personnel

department of a company, the cost of a
repair fob, and the cost for control
 1-45

Cost unit
 Cost unit is a form of measurement of volume
of production or service. This unit is generally
adopted on the basis of convenience and
practice in the industry concerned

 Example: cost per table made, cost per metre

of cloth
 1-46

Cost centre
 Any unit of Cost Accounting selected with a view
to accumulating all cost under that unit. The
unit may be a product, a service, division,
department, section, a group of plant and
machinery, a group of employees or a combination
of several units. This may also be a budget centre

 E.g. the rent, rates and maintenance of buildings;

the wages and salaries of strorekeepers
 1-47

Profit centre
 It is location or function where managers
are accountable for sales revenues and
expenses

 E.g. division of a company that is

responsible for the sales of products
 1-48

Cost Terminology
 COST: Cost means the amount of expenditure
incurred on a particular thing.

 COSTING: Costing means the process of

ascertainment of costs.

 COST ACCOUNTING: The application of cost

control methods and the ascertainment of the
profitability of activities carried out or planned”.

 COST CONTROL: Cost control means the control of

costs by management. Following are the aspects or
stages of cost control.
 1-49

Cost Terminology contd…..

 JOB COSTING: It helps in finding out the cost
of production of every order and thus helps in
ascertaining profit or loss made out on its
execution. The management can judge the
profitability of each job and decide its future
courses of action.

 BATCH COSTING: Batch costing production is

done in batches and each batch consists of a
number of units, the determination of optimum
quantity to constitute an economical batch is all
the more important.
 1-50

Elements of Cost

Elements of cost

Materials Labour Expenses

Direct Indirect Direct Indirect Direct Indirect

 1-51

Material
 The substance from which the finished product is made
is known as material.

(a) DIRECT MATERIAL: is one which can be directly

or easily identified in the product
Eg: Timber in furniture, Cloth in dress, etc.

(b) INDIRECT MATERIAL: one which cannot be

easily identified in the product.
Eg: At factory level – lubricants, oil, consumables, etc.
At office level – Printing & stationery, Brooms,
Dusters, etc.
At selling & dist. level – Packing materials,
printing & stationery, etc.
 1-52

Labour
 The human effort required to convert the materials into
finished product is called labour.
a. DIRECT LABOUR: is one which can be conveniently
identified or attributed wholly to a particular job, product
or process.
Eg: wages paid to carpenter, fees paid to tailor, etc.
b. INDIRECT LABOUR: is one which cannot be conveniently
identified or attributed wholly to a particular job, product
or process.
Eg: At factory level – foremen’s salary, works manager’s
salary, gate keeper’s salary,etc
At office level – Accountant’s salary, GM’s salary,
Manager’s salary, etc.
At selling and dist.level – salesmen salaries, Logistics
manager salary, etc.
 1-53

Expenses
 These are those expenses other than materials and
labour.
a. DIRECT EXPENSES: are those expenses which can be
directly allocated to particular job, process or product.
Eg : Excise duty, royalty, special hire charges, etc.
b. INDIRECT EXPENSES: are those expenses which
cannot be directly allocated to particular job, process
or product.
Eg: At factory level – factory rent, factory insurance,
lighting, etc.
At office level – office rent, office insurance, office
lighting, etc.
At sales & dist.level – advertising, show room expenses
like rent, insurance, etc.
 1-54

Cost accumulation
•Prime cost = direct materials + direct labour + direct expenses

•Production cost = Prime cost + factory overhead

OR
= Direct materials + Conversion cost
*Conversion cost is the production cost of converting raw materials
into finished product
•Total cost = Prime cost + Overheads (admin, selling, distribution cost)
OR
= Production cost + period cost (administrative, selling,
distribution and finance cost)
*Period cost is treated as expenses and matched against sales for
calculating profit, e.g. office rental
 1-55

COST CLASSIFICATION – ON THE BASIS OF

 Nature / Elements
 Function
 Direct & Indirect
 Variability
 Controllability
 Normality
 Time
 Planning and Control
 Managerial Decision Making
 1-56

ON THE BASIS OF NATURE / ELEMENTS

 Materials:- Cost of materials used for the

manufacture of a product, a particular work order,
or provision of a service. Example: Cloth for
making a dress, stores used for maintaining
machines and buildings such as lubricants, cotton
waste, bricks etc.
 Labour

 Expenses
 1-57

ON THE BASIS OF FUNCTION

 Production Costs :- All costs incurred for production of goods are
known as production costs.
 Administrative Costs :- Costs incurred for administration are
known as administrative costs. Examples of these costs are office
salaries, printing and stationery, office telephone, office rent, office
insurance etc.
 Selling and Distribution Costs :- All costs incurred for procuring an
order are called as selling costs while all costs incurred for
execution of order are distribution costs. Market research expenses,
advertising, sales staff salary, sales promotion expenses are some
of the examples of selling costs. Transportation expenses incurred
on sales, warehouse rent etc are examples of distribution costs.
 Research and Development Costs :- In the modern days, research
and development has become one of the important functions of a
business organization. Expenditure incurred for this function can be
classified as Research and Development Costs.
 1-58

ON THE BASIS OF DIRECT AND INDIRECT

 Direct costs:- Direct costs that can be easily and

conveniently traced to a unit of product or other
cost objective. Examples: direct material and
direct labor

 Indirect costs:- Indirect costs cannot be easily and

conveniently traced to a unit of product or other
cost object. Example: manufacturing overhead
 1-59

ON THE BASIS OF VARIABILITY

 Fixed costs / Period Costs: Out of the total costs, some
costs remain fixed irrespective of changes in the
production volume. The feature of these costs is that the
total costs remain same while per unit fixed cost is
always variable.
Examples of these costs are salaries, insurance, rent, etc.
 Variable costs: These costs are variable in nature, i.e.
they change according to the volume of production.
 Semi variable costs: Certain costs are partly fixed and
partly variable. In other words, they contain the features
of both types of costs. These costs are neither totally
fixed nor totally variable. Maintenance costs,
supervisory costs etc are examples of semi-variable
costs. These costs are also called as ‘stepped costs’.
 1-60

ON THE BASIS OF CONTROLLABILITY

 Controllable costs: These costs are regulated or
controlled by specified member of an organisation.
Most of the variable costs are controllable. Generally
direct material, direct labor and direct expenses are
controlled by the lower level of the management.

 Uncontrollable costs: These are those which can not

be controlled or influenced by a conscious
management action. Most of the fixed costs are
uncontrollable. For example factory rent, managers
salary etc.
 1-61

ON THE BASIS OF NORMALITY

 Normal costs: It is the cost which is normally

incurred at a given level of output. These costs are
part of cost production. Example: repairs,
maintenance, salaries paid to employees.

 Abnormal costs: It is the cost which is not

normally incurred at a given level of output. These
costs are not charged to the cost of production. It
is transferred to the costing profit and loss
account. Example: destruction due to fire, shut
down of machinery, lock outs, etc.
 1-62

ON THE BASIS OF TIME:

 Historical costs: These are the costs which are

incurred in the past, i.e. in the past year, past
month or even in the last week or yesterday. The
historical costs are ascertained after the period is
over. In other words it becomes a post-mortem
analysis of what has happened in the past.

 Pre determined costs: These costs relating to the

product are computed in advance of production,
on the basis of a specification of all the factors
affecting cost and cost data.
 1-63

ON THE BASIS OF PLANNING AND CONTROL:

 Budgeted costs: Budgeted Costs are costs which

have been estimated, possibly by using Forecasted
Costs.

 Standard costs: It is a predetermined calculation of

how much cost should be under specific working
conditions. It is based on technical studies
regarding material, labor and expenses. The main
purpose of standard cost is to have some kind of
benchmark for comparing the actual performance
with the standards.
 1-64
ON THE BASIS OF MANAGERIAL DECISION
MAKING

 Marginal costs: Marginal cost is the change in the aggregate

costs due to change in the volume of output by one unit. For
example, suppose a manufacturing company produces
10,000 units and the aggregate costs are Rs. 25,000, if
10,001 units are produced the aggregate costs may be Rs.
25,020 which means that the marginal cost is Rs. 20.

 Differential costs: Differential costs are also known as

incremental cost. This cost is the difference in total cost that
will arise from the selection of one alternative to the other. In
other words, it is an added cost of a change in the level of
activity. This type of analysis is useful for taking various
decisions like change in the level of activity, adding or
dropping a product, change in product mix, make or buy
decisions, accepting an export offer and so on.
 1-65
ON THE BASIS OF MANAGERIAL DECISION
MAKING contd….
 Opportunity costs: It is the value of benefit
sacrificed in favor of an alternative course of
action. It is the maximum amount that could be
obtained at any given point of time if a resource
was sold or put to the most valuable alternative
use that would be practicable.

 Replacement cost: This cost is the cost at which

existing items of material or fixed assets can be
replaced. Thus this is the cost of replacing existing
assets at present or at a future date.
 1-66
ON THE BASIS OF MANAGERIAL DECISION
MAKING contd….
Relevant and irrelevant costs: Relevant costs are
those costs which would be changed by the
managerial decision, while irrelevant costs are
those which would not be affected by the decision.
Example: If a manufacturer is considering closing
down of an unprofitable retail sales shop, wages
payable to the workers of the shop are relevant in
this connection since they will disappear on
closing down of the shop. But prepaid rent for the
shop or unrecovered costs of any equipment which
will have to be scrapped, will be irrelevant costs
which must be ignored.
 1-67
ON THE BASIS OF MANAGERIAL DECISION
MAKING contd….
 Sunk costs: These are costs which have been created by a
decision that was made in the past that cannot be changed
by any decision that will be made in the future. Investment
in plant & machinery are prime examples of such costs.
Since sunk costs cannot be altered by later decisions, they
are irrelevant for decision making.
 Shutdown costs: A manufacturer or an organization
rendering service may have to suspend its operations for a
period on account of some temporary difficulties such as
shortage of raw materials, non availability of labour etc.
During this period though no work is done yet certain fixed
costs such as rent and insurance of buildings, depreciation
etc. for the entire plant will have to be incurred. Such costs
of the idle plant are known as shut down costs.
 1-68
ON THE BASIS OF MANAGERIAL DECISION
MAKING contd….
 Avoidable &Unavoidable costs: Avoidable costs
are those which will be eliminated if a segment of
the business with which they are directly related is
discontinued. Unavoidable costs are those which
will not be eliminated with the segment. Such costs
are merely reallocated if the segment is
discontinued.
Example: In case a product is discontinued, salary
of the factory manager or factory rent cannot be
eliminated. It will simply mean that certain other
products will have to absorb a higher amount of
such overheads. However salary of clerks or bad
debts traceable to the product would be eliminated.
 1-69
ON THE BASIS OF MANAGERIAL DECISION
MAKING contd….
Imputed costs: These are costs which do not
involve any cash outlay. They are not included in
cost accounts but are important for taking into
consideration while making management
decisions.
Examples: Interest on internally generated funds,
salaries of the proprietor or partner of a partnership
firm, rented value of company’s own property etc.
 1-70
ON THE BASIS OF MANAGERIAL DECISION
MAKING contd….
 Out of pocket costs: This means the present or
future cash expenditure regarding a certain
decision which varies depending upon the nature
of decision made.
Example: A company has its own trucks for transporting
raw materials and finished products from one place to
another. It seeks to replace these trucks by
employment of public carrier of goods. In making this
decision of course , the depreciation of the trucks is not
to be considered, but the management must take into
account the present expenditure on fuel, salary to
drivers and maintenance. Such costs are termed as out-
of-pocket expenses.
 1-71

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