Cost Management

CHAPTER 1: MANAGEMENT ACCOUNTING

Introduction:

            Accounting may be broadly classified into two categories – accounting which is meant to serve all parties external to the operating responsibility of the firms and the accounting which is designed to serve internal parties who take care of the operational needs of the firm. The first category which is conventionally referred to as financial accounting, looks to the interest of those who have primarily a financial stake in the organization’s affairs – creditors, investors, employees etc. On the other hand the second category of accounting is primarily concerned with providing information relating to the conduct of the various aspects of a business like cost or profit associated with some portions of business operations to the internal parties viz., management. This category of accounting is called as Management accounting.

            In order to perform the primary task of decision making managers of business enterprises need information about the past, present and future in the functional areas of management such as personnel, finance, marketing and production. Right decision making has to be based on quantitative and qualitative information. The management thus constantly needs accounting information to base its decisions upon. Thus management accounting provides the information needed by management personnel.

Definition:

            The Institute of Chartered Accountants of England has defined management accounting as: “Any form of accounting which enables a business to be conducted more efficiently can be regarded as Management Accounting”.

            As per American Accounting Association, “Management Accounting includes the methods and concepts necessary for effective planning, for choosing among alternative business actions and for control through the evaluation and interpretation of performances.

            As per Institute of Chartered Accountants 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 Chartered Institute of Management Accounts (UK) defines management accounting as under:

“Management accounting is an integral part of management concerned with identifying, presenting and interpreting information used for:

1.      Formulating strategy

2.      Planning and controlling activities

3.      Decision making

4.      Optimizing the use of resources

5.      Disclosures to shareholders and others external to the entity

6.      Disclosure to employees

7.      Safeguarding assets.”

Nature of management accounting:

Managerial personnel are entrusted with authority and responsibility of operating business activities. Management accounting provides information to the personnel are entrusted with authority and responsibility of operating business activities. Management accounting provides information to the managerial personnel at three levels of management viz., top, middle and lower levels of management. It provides the management with the tools for an analysis of its administrative action that can lay suitable emphasis on the possible alternatives in terms of costs, prices and profits. The decisions made by management are based on quantitative information and common sense, foresight, knowledge and experience. Management accounting includes financial accounting information and raw material from several other disciplines such as costing, statistics, mathematics, political science, sociology, psychology, management economics, law etc. With all these data he can ensure optimum utilization of all the resources including employees by maintaining sound morale of the employees, maximization of output and minimization of inputs, analyze the managerial questions in terms of costs, revenues, profits and growth. It is thus a highly personalized service with the help of which management can explore and exploit business opportunities and take sound and correct decisions. It is not a precise science as it uses its own conventions rather than standardized principles. Therefore the inferences drawn from the facts provided, depends on the skill, judgment and common sense of different management accountants. Thus it is said that management accounting serves as a management information system which enables the effective management of an enterprise.

Scope of management accounting:

Management accounting is a wide and diverse subject. As stated earlier it includes various branches of knowledge such as psychology, sociology, economics, laws, political science, mathematics, statistics, finanacial accounting, cost accounting etc.  It is thus very difficult to define its scope, as it is a dynamic and ever growing discipline of knowledge. The important techniques and systems used by management accounting are briefly stated below.

a.       Historical cost accounting: Maintenance of books of cost accounting enables to know the actual costs incurred by the firm.

b.      Standard costing: The standard costs laid down by experts are compared with the natural costs in order to know the deviations

c.       Marginal costing: The costs are divided into fixed and variable costs which help is making vital decisions.

d.      Decision accounting: Decisions are made after studying the impact of decisions in terms of costs, resource, profits, growth etc.

e.       Budgetary control: It is a system of controlling the cost with the help of budgets.

f.       Control accounting: It includes the techniques such as standard costing, budgetary control, control reports, internal check, internal audit and reports.

g.      Revaluation accounting: It is based on current costs to ensure that the investment is intact and profits from investment are kept in mind.

h.      Financial planning & policies: It consists of raising the long term and short term finance and invest it on optimum basis and enhance the profitability of the firm.

i.        Capital expenditure: The large amounts of future capital expenditure and future profits are analysed to take important decisions.

j.        Break even analysis: This is an important technique which is used to analyse the behavior of costs viz., fixed and marginal costs, indicating the level of activity at which the total costs would equal the total revenue and also the margin of safety.

k.      Inter-period comparison: It is a technique of comparing the present performance with the past performance.

l.        Techniques of forecasting: Some techniques like decision tree, probability and sensitivity analysis are used by management accountants for forecasting which forms a base for planning.

m.    Operations research: It consists of statistical and mathematical techniques that are increasingly used in decision making process.

n.      Statistics: The statistical techniques used by management accountant are correlation, regression, probability, time series, standard deviation, linear programming, control charts etc.

o.      Other techniques: Other techniques employed are: Financial reporting, data processing, project management and appraisal, management audit, efficiency audit, cost audit, performance budgeting, tax planning, social accounting & audit, human resource accounting, responsibility accounting and divisional performance.

Functions of management accounting:

1. Modification of data: The management accounting system modifies the data furnished by financial accounting to serve the managerial needs in such a way that the process of classification and combination which enables to retain similarities without eliminating dissimilarities.
2. Validating the data: To make reliable decisions valid data should be made available to managers. The effectiveness of managerial function depends too much upon the accuracy and adequacy of the data. It is the function of management accounting to present before the management the required data with some sort of reasonable accuracy and it need not be with perfect accuracy.
3. Analysis and interpretation of data: Though management accounting is concerned with recording of business transactions, the analysis and interpretation of such data, in analyzing and interpreting the data lies the essence of management accounting. To discharge this function management accounting uses a number of tools like Marginal costing, budgeting, standard costing etc.
4. Communicating the data: The collected and interpreted data must be communicated to those who are interested in it or to whom it has some meaning. Otherwise these data may not yield any meaningful result and the whole process of collecting, validating and interpreting would amount to be a futile exercise. The communication of the data should be done within a reasonable time. Data delayed is decision delayed and a delayed decision may delay the prosperity of its concern. To accomplish this function of management accounting several reports and statements are being used.