SPBA 104 MASTER OF BUSINESS ADMINISTRATION FIRST YEAR FIRST SEMESTER PAPER - IV MANAGEMENT ACCOUNTING INSTITUTE OF DISTANCE EDUCATION UNIVERSITY OF MADRAS CHEPAUK, CHENNAI - 600 005 TAMILNADU, INDIAMBA. PAPER «|v FIRST YEAR MANAGEMENT ACCOUNTING WELCOME Dear Student, We welcome you as a student of the First Year Postgraduate Degree Course in Master of Business Administration - Executive. The complete set of leaming materials for Paper- “Management Accounting” has been prepared inthe self earning format, You will receive seltleamning materials forall the papers. This is a significant step taken by the University of Madras towards realising the Inission to “develop citizens with knowledge. skill and character leading to societal transformation and national development." We invite you to make the fullest possible se of thesé learning materials. They are Gesigned so that the teacher-in-print of the materials is of constant help to you in your Progress as a learner. So, stay with teacher-in-print'and carry out the tasks, exercises ete. \wth care and cligence. In addition to these materials we also conduct Personal Contact Programmes for your benefit. Learning through the distance education mode involves self-learning and self- assessment and in this regard you are expected to put in disciplined and dedicated effort ‘On our part, we assure you of our help in guiding you throughout the course. Wish you all the success. DIRECTOR i)paar feng PAPER -IV MANAGEMENT ACCOUNTING COURSE WRITER Dr. D. AYUB KHAN DAWOOD, Ph.D., ~ Associate Professor in Commerce P.G. Department of Commerce Quaid - Milleth College, Medavakkam, Chennai - 601 302. Dr. R. PANCHALAM, Ph.D. Associate Professor in Commerce Institute of Distance Education University of Madras Chennai - 600 005. @UNIVERSITY OF MADRAS, CHENNAI 600.005, ti)MASTER OF BUSINESS ADMINISTRATION FIRST YEAR PAPER -1V MANAGEMENT ACCOUNTING SYLLABUS Management Accounting - Meaning and Purpose Financial Accounting - Preparation of income statement and Balance Sheet - Interpretation and use of these statements by management. hl! Ratio Analysis and Funds Statement. 2. Capita! Expenditure Evaluation - Capital budgetary concept - Methods - Limitations - Capital Expenditure Control. 3. Budgetary Control - Nature and objective of budgetary control - Limitations. 4. Cost Accounting - Elements of cost- Cost ‘of goods manufactured - Pricing of elements ~ Basis of allocation - Standard costing and variance analysis - Job and process costing, 5. Marginal Costing - Cost Volume - Profit relationship - Break - Even Andysis - Direct Costing vs Absorption costing, 6. _ Reporting to Management - Uses of. ‘Accounting information in Managerial decision - making, References 1. JR. Batliboi, Double entry Book - Keeping - The Standard Accounting Publication Pvt. Ltd., India. 2. — Homgren. Sundem Sratton, Introduction to Management Accounting, New Delhi, Prentice Hall of India Pvt. Ltd., 1999. 3. Man Mohan & S.N. Goyal, Principat of Management Accounting - Sahityabhavan, 2000. 4. ILM. Pandey, Management Accounting, 3rd edition New: Delhi, Vikas Publication, 2000. 5. Robert N.Antony, Management Accounting Principles - D.B, Tareporevata Sons & Co, Ltd. 6 — Ronald N. Hilton, Managerial Accounting, Sth edition New Delhi, Tata McGraw Hill, 2002. 7 Srinivasan N.P. Management Accounting Sterling Publication, 1996.MASTER OF BUSINESS ADMINISTRATIQN FIRST YEAR PAPER -IV MANAGEMENT ACCOUNTING SCHEME OF LESSONS 8. No. TITLE | Page wo. | 1. | Nature and Scope of Mariagement Accounting oot 2. | Financial Accounting 022 3. | Final Accounts 075 4, | Financial Statement Analysis, ee , 108 5. | Ratio Analysis 125 6. _ | Funds Flow Statement 169 7. | Cash Flow’Statement 207 8 | Capifal Budgeting 240 9. | Budgeting and Budgetary Control 270 10. Cost Accounting : 302 11. | Process Costing 334 12. | Marginaf Costing and Break Ever Analysis _ 365 13. | Application of Marginal Costing and Differeritial Costing 395 14. | Standard Costing 414 15. | Reporting to Management 450 (iv)UNIT 4 NATURE AND SCOPE OF MANAGEMENT ACCOUNTING Learning Objectives After: . . . reading this unit, you should be able to: ; define management accounting and describe its role in the management process list and describe the objectives of managerial accounting explain the major differences between management and financial accounting describe the role of management accountant in the organization discuss how managerial accounting constantly changes in dynamic business world. Structure 44 12 13 14 45 16 47 18 1.9 1.40 411 442 1.43 1.14 AAS. 116 147 Introduction Definition of Management Accounting Objectives of Management Accounting Scope of Management Accounting Characteristic Foatures of Management Accounting Functions of Management Accounting Methods and Techniques Financial Accounting Vs Management Accounting Cost Accounting Vo Management Accounting Management Accountant - Position and Status Limitations of Management Accounting Evaluation of Management Accounting Summary Key Words Review Questions Answers to Activities ‘Suggested Readings1.1 Introduction Managers working for the IBM Corporation, indian Airlines, a local hospital, the Coca- Cola Company, a campus pizza parlor, have an important common objective. They must make good decisions to obtain and use their organisation's resources-including people, money, inventory, real estate, investments, technology, and equipment in the best possible way. This is the most fundamental business principle in use today. Every organisation's resources are in limited supply, but the demand for them is unlimited. This is true for a merchandising business, a manufacturer, a service firm, a governmental agency, a ullliy, or 2 not-for-profit organization. The resource decisions of most businesses are made with the primary goal of eaming satisfactory profitas an important measure of financial success. Even not-for-profit groups such as a fraternal organisastion must be certain that their expenditures do not exceed their revenues for an extended period Management decisions concerning the acquisition and use of resources provide answers to such questions as © What products or services should be sold? + Where should they be sold? ‘+ What are the responsibilities of each management position? * Who should be hired to fill these positions? * How much does it cost to produce a product or offer a service? © Whatis the most profitable combination of products or services? ‘* What will happen to profits if selling prices are increased or decreased? * How much operating capacity is needed in the form of people, funds, inventory, and fixed assets? * How should the organization finance its various activities? Good management decision making is highly dependent on good information, Where does this information come from in a typical organization? Think back to your first course infinancial accounting. You learned that a great deal of information is made available to the managers of a business in the genera purpose financial statements prepared for the firm. But, general purpose financial statements have limited usefulness to managers, as we will see later. Managerial accounting is an important branch of accounting that provides the information needed by managers to determine how resources should be obtained and used in any type of business, large or small. Managerial accounting builds on the principlesyou learned in financial accounting to satisfy the internal reporting needs of managers Because itis manager ontented, any study of managerial accounting must be preceded by Some understanding of what managers do, the information managers need, and the general business environment. 1.2. Definitions of Management Accounting The term Management Accounting has become popular in recent years, Various authors have defined it in different ways. Some of the popular definitions are given below. The Institute of Chartered Accountants of England and Wales has defined Management Accounting as “any form of accounting which enables a business to be conducted more efficiently can be regarded as Management Accounting’ According to J. Batty: "Management Accounting is the term used to described the accounting methods, systems and techniques which, coupled with special knowledge and ability, assist management in its task of maximizing profits or minimizing losses" Robert Anthony: "Management Accounting is concerned with accounting information which is useful to management’. 1. Rose: "Management Accounting is the adaptation and analysis of accounting information and its diagnosis and explanation in such a way as to assist management’. Management Accounting Team of Anglo-American Council on Productivity: “Management Accounting is the presentation of accounting information in such a way as to assist management in the creation of policy and the day to day operation of an undertaking’. The Institute of Chartered Accounts of India: “Such of its techniques and procedures by which accounting mainly seeks to aid the management collectively have come to be known as management accounting’. The Institute of costs & works Accounts India defines Management Accounting as, “a system of collection and presentation of relevant economic information relating to an enterprise for planning, controlling and decision making’. The National Association of Accountants in the United States has given a wider definition of Management Accounting, According to it, itis “the process of identification, measurement, ‘accumulation, analysis, preparation, interpretation, and communication of financial4 information used by management to plan, evaluate, and exercise contro! within an organization and to assure the appropriate use ‘of and accountability for its resources. Management Accounting also comprises the preparation of financial reports for non- management groups, such as shareholders, creditors, regulatory agencies, and tax authorities”. 1.3 Objectives of Management Accounting ‘Management Accounting seeks to provide relevant accounting information for use in planning, decision-making and control for the different levels of management at the right time. {ts main objectives may be summarized as follows: © formulating strategy, ©, planning and controling activities; decision taking; ‘optimizing the use of resources: disclosure to shareholders and others external to the entity; disclosure to employees; * “safeguarding assets. ‘The above involves participation in management to ensure that there is effective, + Formulation of plans to meet objectives (strategic planning): © Formulating of short-term operation plans (budgeting / profit planning); . Acquisition and use of finance (financial management) and recording of transactions (financial accounting and cost accounting); © Communication of financial and operating information, Corrective action to bring plans and results into line (financial control); Reviewing and reporting on systems and operations (internal audit, management audit). 4.4 Scope of Management Accounting The scope of Management Accounting includes i. Formation, installation and operation of accounting, tax accounting and information systems. Management Accountant has to construct and re-construct these systems to meet the changing needs of management functions.ti, iv, vi. vii vill The compilation ard preservation of vital data for management planning. The Management Accountant resents the past data in such a way as to reflect the trends of events to the management. 7 Providing means of communicating management plans to the various levels of organization, This, on the one hand, ensures the co-ordination of various segments of the enterprise plans and on the other defines the role of individual segments in the \whole plan and assists the management in directing their activities. Providing and installing an effective system of feedback reports. This would enable the management in its controling function. By pinpointing the significant deviations between actual expected activities, and by adhering to the principles of selectivity and relevance, stich reports help in the installation and operation of the system of ‘Management by Exception’ Analyzing and interpreting accounting and other data to make and understandable and usable to the management. Itis only through such analysis and clarification that the management's enabled to place the various data and figures in proper perspective in the performance ofits functions. Such analysis assists management. the location of responsibilities and to effect necessary changes in the organizational set-up to achieve the objectives of the enterprise in a more efficient manner. Assisting management in decision making by (a) providing relevant accounting and other data and (b) analyzing the effect of alternative proposais on the profits and position of the enterprise Providing methods and techniques for evaluating performance of the management in the light ofthe objectives of the enterprise, thus assisting inthe implementation of the principle ‘Management by Objectives’. Improving, modifying and srarpening the effectiveness of the existing techniques of analysis. The Management Accountant would always think of increasing the practicabilty of existing tech'ques. He should be on the look-out ofthe development of new techniques as weil Thus, Management Accou* "g serves not only as a tool in the hands of management, but also provides for a technique evaiuating the performance of the management itself. It operates as a double-edged sword assisting the management in proper performance of its functions of planning, decision making and control, and at the same time, enabling the ‘owners and other interested parties to evaluate and appraise the management of the enterpriseManagement Accounting Practice Boeing Company's CFO demonstrated an understanding of the importance of assigning decision - making authority, providing information for decision making and evaluating and rewarding decision makers, The CFO gave Boeing company's managerial accounting system a pivotal role in ‘the decision - making process. Starting with accounting basics, such as which planes and rockets make money, the Boeing CFO created a value score card that evaluated and compared the profitability of each unit. These management accounting systems helped improve the efficiency and effectiveness of decision making at Boeing. 1.5. Characteristic Features of Management Accounting Management accounting has certain unique features. The important characteristic features of management accounting are explained below. 1, Accounting information which is useful to the management. 2. Management accounting supplements the financial accounting in order to serve the diverse needs of modern management. 3. Accounting designed for use in the operational needs of the business, i.e. to provide information regarding to the conduct of the various aspects of the business like cost, funds, profits, etc, 4. Efficiency is the key for management accounting system in the implementation. 5. Management accounting comprises accounting methods, system and techniques which coupled with special knowledge and ability, assist management in its task of maximizing profits or minimizing losses. 6. The distinguishing feature of management accounting is its emphasis on the planning and control purposes. 7. Management accounting is an internal accounting. It emphasizes the preparation of reports of an organization for its internal users such as presidents, top management, middle management, lower management, functional managers, etc. 8 Management accounting spreads over into related disciplines, such as economies, the decision sciences, and the behavioural sciences. 9 Management accounting provides a means of communicating management plans upward, downward and outward through the organization. 10. Management accounting supplies feedback reports for both attention getting and score- card keeping purposes which is the most visible contribution within the organization.Activity- I Indicate whether the following statements are true or false 1. Managerial accounting is as concerned with providing information to stockholders as it is with providing information to managers. 2. Managerial accounting focuses more on the Segments of an organization than on the organization as a whole, 3. Managerial accounting need not follow Generally Accepted Accounting Principles, 4. Inmanagement accounting no emphasis is given to actual figures, 5. Intuitive decisions limit the usefulness of management accounting 1.6 Functions of Management Accounti ing Management accounting is assigned the functions of classifying presenting and " interpreting data in such a way that it helps ‘management in controlling and running the enterprise in an efficient and economical manner. Some of the functions of management accounting are given as follows 1. 2 Planning and Forecasting: One of the important functions of the management ‘counting is to help management in planning for short-term and long term periods and also in making forecasts for the future. Management accountants use various techniques such as budgeting, standard costing, marginal costing, fund flow statements, probability and trend ratios, etc. for fixing targets. These techniques are Useful in planning various activities. So management accounting tools are useful in planning and forecasting Modification of Data: Management accounting helps in mocitying accounting data. ‘The information is modified in such a way that it becomes useful forthe management, If sales datais required, itcan be classified according to product, area, season-wise, type of customers and time taken for getting payments, etc Financial Analysis and Interpretation: Management accountant undertakes the {eb af presenting financial data n a simplified way. Financial data is generally collected and presented in a technical way. Top managerial executives may lack technical knowledge. Management accountant analyses and interprets nancial dataina simple way and presents it in a non-technical language. He gives facts and figures aboutvarious policies and devaluates them in monetary terms. He gives his opinion about various alternative courses of action so that it becomes easy for the management to take a decision. Facilitates Managerial Control: Management accounting is very useful in controtting performance. All accounting efforts are directed towards control of the enterprise. Performance evaluation is possible through standard costing and budgetary control which are an integral part of management accounting, Communication: Management accounting establishes communication within the organization and with the outside world. The management accountant prepares reports for the benefit of different levels of management and employees. The activities of the concern, are communicated to outsiders such as bankers, investors, creditors, government agencies, ete. The filing of various tax returns is also entrusted to the accountant Use of Qualitative Information: The field of management accounting is not restricted to the use of monetary data only. It collects and uses qualitative information also. While preparing a production budget, management accountant may not only use past production figures, but he may rely on the assessment of persons dealing with production, productivity reports, consumer surveys and many other business documents. The use of qualitative information is as helpful as monetary information. Management can assess various aspects of a plan before finalizing it. Coordinating: The coordination among different departments is essential for smooth running of the concern. Management accountant acts as a coordinator among different financial departments through budgeting and financial reports. Helpful in taking Strategic Decisions: Management accounting helps in taking strategic decisions. !t supplies analytical information regarding various alternatives and the choice of management is made easy. These decisions may be regarding ‘seasonal or temporary stoppage of production, replacement decisions, expansion or diversification of works and a correct decision is taken. ‘Supplying Information to Various Levels of Management: Every management level needs accounting information for decisions making and policy execution. Top management takes broader decisions and leaves day-to-day decisions for the lower levels of management. Management accountant feeds information to different levels of management so that further decisions are taken. The supply of adequate information at the proper time will increase efficiency of the management. “Thus, the objectives of Management Accounting and the functions of management accountants may be graphically illustrated as follows :Objectives of Management Accounting 1+ Providing Information Participating in the Management Process aS EI Management Accountant's Responsibilities Eee Ree eee eee] Planning Evaluating Controlling Assuring Accountability External Reporting Principal Activities Reporting Interpretation Resource Information Technological Verification Administration Management Systems Implementation Development Process at Identification Measurement Accumulation Analysis Preparation Communication and Interpretation Objectives of Management Accounting and Functions of Management Accountants, 1.7 Methods and Techniques Management Accounting is not a new form of Accounting- it refers to the application of accounting skills to the problems of management. So Management Accounting can be said to include the use of all accounting techniques-financial and cost-and also the use of, in appropriate situations, mathematical and statistical techniques. From this standpoint,” the methods and techniques usually applied include:10 ) Analysis of cash and fund flows ii) Analysis and interpretation of financial statements with the help of accounting ratios and statistical measures. ii) Financial planning iv) _ Trend analysis and business forecasting ¥) Capital budgeting vi) Marginal costing vil) Budgetary control and standard costing vil) Operations research ix) Performance and efficiency audit x) Reporting. Exhibit - I Extract from “Standards of Ethical Conduct for Management Accountants” Management accountants have a responsibility to: >» — Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict . > — Refrain from engaging in any activity that would prejudice their ability to carry out their duties ethically > Refuse any gift, favour, or hospitality that would influence or would appear to influence their actions, > Refrain from either actively or passively subverting the attainment of the organization's legitimate and ethical objective > — Recognize and communicate professional limitations other constraints that would preclude responsible judgment or successful performance of an activity. > Communicate unfavorable as well as favorable information and professional judgments or opinions. > Refrain from engaging in or supporting any activity that would discredit the profession. > Courtesy of the Institute of Management Accountants, Montvale, NTa 1.8 Financial Accounting Vs. Management Accounting Financial accounting is concerned mainly with the historical aspects of externat reporting, that is, providing financial information to outside parties such as investors, creditors, and governments. To protect those outside parties from being misled, financial accounting 's governed by what are called generally accepted accounting principles (GAAP). Management accounting, on the other hand, is concemed primarily with providing information to internal mangers who are charged with planning and controlling the operations of the firm and making a variety of management decisions. Because of its internal use, management accounting is not subject to GAAP. More specially, the differences between financial and management accounting are summarized below. inancial Accounting Provides data for external users Management Accounting Provides data for internal users Is required by the law Is not mandatory by law ts subject to GAAP Must generate accurate and timely data Emphasizes the past Looks at the business as a whole Primarily stands by itself Js an endin itself 4s not subject to GAAP Emphasizes relevance and flexibility of data Has more emphasis on the future Focuses on parts as well as on the whole of a business. Draws heavily from other disciplines such as finance, economics, and operations research Is a means to an end 1.9 CostAccounting and Management Accounting Differences “Though a few number of differences can be identified between cost accounting and management accounting, the line of difference is very thin. Because cost accounting, at present, comprises of some of the advanced techniques and systems of costing such as. marginal costing, standard costing, budgetary control, responsibility accounting, etc. and therefare, it (.e., cost accounting) tends to conform to management accounting.12 Consequently, no much difference can be found between the two. Further, both serve the intemal parties (viz., management). However, 2 very few minor differences that exist between the two are explained below. Differences between Cost Accounting and Management Accounting S.No] Cost Accounting Management Accounting 1 Primary Objective: Cost accounting aims at ascertaining the cost of goods and services. It lays emphasis on the stage by stage computation of costs. Time Factor: It lays emphasis on the past but less emphasis on the future, That means, it reports about costs that have been incurred. Information Coverage: Cost reports deal mainly with the costs-incurred or budgeted and standards, variances, savings, etc. Governing Principles, Rules, etc:Cost accounts and reports are tobe prepared as per certain rules, principles, procedures, etc., as specified by the appropriate authority (e.g., ICWAI) to the industry to which the company belongs to. Statutory Verification: Cost accounts and reports, in many cases, are subject to statutory audit (ie., cost audit). Hence, they should be prepared, as far as possible, on objective manner. Management accounting aims at the | presentation of the cost data, to the extent required, wherever and whenever they are required together with other relevant information to the management for taking decisions. It predicts the future on the basis of the past events, present happenings and future estimates. Cost data form a part of managerial reports but not the sole aspects. No such rigidity is there in the case of managerial reports. The procedure, format, etc. Can be modified from time to time depending upon convenience and requirements. Management reports are not subject to any statutory audit. Of course, there is @ management audit. But, tis voluntary and it evaluates the managerial functions, decisions, etc. However, management reports include both the objective and the subjective data