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Subject COMMERCE

Paper No and Title Paper No.6: Accounting for Managerial Decisions

Module No and Module No. 1: Introduction to Management

Title Accounting
Module Tag COM_P6_M1

COMMERCE Paper No.6: Accounting for Managerial Decisions

Module No. 1: Introduction to Management Accounting
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TABLE OF CONTENTS

1-Learning outcomes
2-Introduction
3-Management accounting as an area of accounting
4-Objectives nature and scope of financial accounting
4.1 objectives of Financial Accounting
4.2 nature of Financial Accounting
4.3 scope of Financial Accounting
4.4 Limitations of Financial Accounting
5-Objective, nature and scope of cost accounting
5.1 Objectives
5.2 Nature of Cost Accounting
5.3 Scope of Cost Accounting
5.4 Limitations of Cost Accounting
6-Objective, nature and scope of Management accounting
6.1 Objectives of Management Accounting
6.2 Nature of Management Accounting
6.3 Scope of Management Accounting
6.4 Limitations of Management Accounting
6.5 Change Management Accounting
7- Summary

COMMERCE Paper No.6: Accounting for Managerial Decisions

Module No. 1: Introduction to Management Accounting
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1. Learning Outcomes
After having studied the first module, the student will be acquainted with the
fundamentals and will be able to:

 Explain basic concept of Management accounting

 Understand various objectives of Management Accounting
 Appreciate how management accounting information can assist
management in planning, monitoring performance, controlling and making
decisions in, their area of responsibility
 Learn the nature and scope of Financial Accounting
 Elaborate the nature and scope of Cost Accounting
 Understand different managerial decisions in relation to Management
Accounting
 Identify the information needs and produce financial analyses for a range of
decisions

2. Introduction
In simple terms, ‘’Management Accounting is meant for the consumption of
managers’’. It begins from where the role of Financial Accounting ends. Management
Accounting assists the managerial functions at all the levels by providing managers with
the required information so as to enable them to run the business efficiently, in policy
creation, controlling and decision making. It is also viewed as that field of Accounting
which assists managers in performance evaluation, management of costs and cost
determination for financial reporting. In short, Management Accounting is concerned
with data collection from internal and external sources, analyzing, processing,
interpreting and communicating the information for use within the organization so that
management can more efficiently plan, take decisions and control the organization .to
understand the concept more clearly, a definition can be the best tool. The CIMA [UK]
defines Management accounting as:

‘’management Accounting is an integral part of management which is concerned with

identifying, presenting, and interpreting information used for the purpose of

[1] formulating strategy,[2] planning and controlling activities,[3] decision making [4]
optimizing the use of resource ,[5] disclosure to shareholders and other external entity;[6]
disclosure to employees,[7] safeguarding ‘assets’.’’

A short and pertinent definition by Robert Anthony can be considered for understanding
the concept of Management Accounting which explains it’’ as being concerned with
accounting of information which is useful to management’’.

COMMERCE Paper No.6: Accounting for Managerial Decisions

Module No. 1: Introduction to Management Accounting
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3. Management accounting as an area of

Accounting
Management accounting is concerned with data, which is collected from both internal
and external sources, thereby creating a data pool. This data pool has all the desired
information that the management would need to plan, control and take decisions.
Therefore management accounting helps management in total situation. To achieve this
goal, Management accounting uses information collected from various sources such as
financial accounting, economics, statistics, operational research etc. With the use of all
the information, desired decision/conclusions can be drawn. For example, if the business
is producing two products and the management wishes to expand one product, then, all
the information received from financial accounting is analyzed by management
accountant to take the right decision as to which product to expand, or both to be equally
expanded or one of the products is to be discontinued etc.

4. Objectives, Nature and scope of Financial Accounting

Accounting serves the purpose of providing financial information relating to a business.

Financial accounting is concerned with providing information to external users such as
shareholders, bankers, creditors, debenture holders, government and tax authorities.
Financial accounting is defined as ‘’the art of recording, classifying and summarizing
in a significant manner and in terms of money, transactions and results thereof’’.

4.1 objectives

The main objective of Financial Accounting is to provide information for ascertaining

the profitability and financial position of the business. It also aims at determining the
profit/loss earned by the business. The aim in recording, summarizing, and classifying the
transactions is to:

[a] prepare a profit/loss account or and income and expenditure account

[b] a balance sheet at the end of the period

4.2 nature of financial accounting

The nature of financial accounting is that it is based on a double entry system and is
governed by generally accepted accounting principles and rules. It is expressed in
monetary units such as dollar; rupee etc. financial accounting is capable of giving, only
monetary information. It is precise in nature and deals with historical data. It is usually on
annual basis and is independent in nature.

COMMERCE Paper No.6: Accounting for Managerial Decisions

Module No. 1: Introduction to Management Accounting
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4.3 Scope of financial accounting

Financial Accounting has got a very wide scope and area of application. Its use is not
confined to the business world alone, but spread over in all the spheres of the society and in
all professions. In the modern world, accounting system is practiced not only in all the
business institutions but also in many non-trading institutions like Schools, Colleges,
Hospitals, and Charitable Trust etc. The professional persons like Medical practitioners,
practicing Lawyers and Chartered Accountants also adopt some suitable types of accounting
methods. As a matter of fact, accounting methods are used by all who are involved in a series
of financial transactions. The scope of financial accounting, as it was in earlier days, has
undergone lots of changes in recent times. As accounting is a dynamic subject, its scope and
area of operation have been always increasing keeping pace with the changes in socio-
economic changes. As a result of continuous research in this field the new areas of
application of accounting principles and policies are emerged. National accounting, human
resources accounting and social Accounting are examples of the new areas of application of
accounting systems.

4.4 Limitations of financial accounting

Financial accounting is not devoid of weaknesses. Some of the limitations are of:

 It does not provide detailed cost information

 Financial accounting does not have a system of system of controlling
materials and supplies
 Performance appraisal of departments and employees is not possible in this
system.
 Financial records are based on historical costs and do not take inflation into
consideration
 Necessary cost data is not provided under financial records for ascertaining
the price of a product
 It does not provide a basis for analyzing causes of losses

In spite of all the limitations of financial accounting, the financial accounting system
includes various techniques and procedures in order to measure, describe and communicate
financial data to the users. Journals, ledgers, cash book and other books of account are kept on a
double entry system. This technique of double entry system includes generally accepted
accounting principles [GAAP] ,the AAS issued by the ICAI and the IFRS[international financial
reporting standards]. All of these include not only broad guidelines of general application but also
detailed practices and procedures.

5. Objectives, nature and scope of Cost Accounting

The term ‘costing’ and; cost accounting’ are often used interchangeably. Cost
accounting is a branch of accounting which specializes in providing information about
COMMERCE Paper No.6: Accounting for Managerial Decisions
Module No. 1: Introduction to Management Accounting
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detailed cost of products or services being supplied by

the entity. The CIMA [UK] has defined it as ‘’the
technique and process of ascertaining costs’’.

5.1 Objectives
the main objectives of cost accounting are:

 To determine the cost of a product, process or service

 To analyze, classify and record all expenditures with respect to the cost of product,
process or service in order to determine its cost
 To provide necessary information to the management in time
 To provide data needed for periodical preparation of profit and loss account and balance
sheets
 To serve as a guide by providing actual data for comparison
 To facilitate price fixation and offering quotations
 To assist budgetary control
 To assist cost control and cost reduction
 To record the relative production results in each unit of plant to examine efficiency
 To provide the basis for production planning and for avoiding wastages of materials and
stores
 To provide data for different periods and various volumes of output for effective planning
and future expansion of business
 To provide the basis for making decisions such as:
[i]To shut down or operate
[ii]To make or buy
[iii]To continue with existing plant/machinery or to replace it
 To determine cost–volume–profit relationship
 To assist the management in devising suitable policy decisions in other key areas

5.2 Nature of cost accounting

The nature of cost accounting is that, it is concerned with ascertaining the cost of
product, process,, division, department or service. Cost accounting uses only quantitative
data which is expressed in monetary terms.. It uses various techniques like standard
costing, marginal costing, budgetary control etc. cost accounting is a mandatory
requirement for the industries specified by the government. Cost accounting system can
be installed independently. It provides a base for accounting.
5.3 Scope of cost accounting

The scope of cost accounting is not as wide as management accounting. There are
plenty of techniques, tools, procedures, processes, programs used in cost accounting for
calculating cost and its control. But basically, we divide its scope within three major parts
namely:

1. Cost Ascertainment
2. Cost Records
3. Cost Control.

COMMERCE Paper No.6: Accounting for Managerial Decisions

Module No. 1: Introduction to Management Accounting
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5.4 Limitations of cost accounting

Cost accounting suffers from several limitations, some of which are:

Limitations of Cost Accounting

• 1. More complex and complicated system of cost accounting is one of
the limitation faced by cost accounting.
• 2. Many companies do not adopt cost accounting owing to the fact,
that it is more expensive and not economical.
• 3. Uniform Inapplicability of costing method and technique is one of
the main limitations of cost accounting.
• 4. It is not suitable for small scale units
• 5. Cost accounting lacks the accuracy of its results.
• 6. Cost accounting fails to take into account the social obligation of the
business.
• 7. Many industrial units function effectively and control the cost
effectively with the financial accounting. Preparing cost accounting is
unnecessary for them and it involves duplication of accounting work.
• 8. Cost accounting depends on financial statements for a lot of
information. Any errors or short coming in the information will affect
the results.
• 9. Cost accounting will not control the cost by itself. It needs an
effective and efficient management to use it.
• 10. It only brings out the cost of goods or services. To find out the
operational results, we need to depend on financial accounting. Cost
accounting will not bring forth the financial status of the company.
• 11. We cannot treat cost accounting as a basis for determining the tax
liabilities of the business. Financial accounting is required for the
determination of tax liabilities.

6. Objectives, nature and scope of management accounting

6.1 Objectives

Objectives are often termed as ‘functions’ of management accounting. Main

functions/objectives of management accounting are being explained as under:

1 Planning: data and information provided by management accounting, helps

management/managers to forecast and prepare all kinds of plans ,namely long term

COMMERCE Paper No.6: Accounting for Managerial Decisions

Module No. 1: Introduction to Management Accounting
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plans, medium term plans and short term plans, basis

on which appropriate strategies can be formulated.

2 Controlling: we all know the importance of control in not only corporations but even
in our lives. Management accounting helps in building good control through its versatile
techniques such as standard costing, budgetary control, control ratios and internal audit.

3 Coordinating: without coordination, nothing can succeed. With the use of carefully
designed MIS system of management accounting, desired coordination can be brought
about in various business activities and amongst all departments and units.

4 Qualitative information: management accounting provides qualitative information

which helps in taking better decisions. Quality of goods, customers and employees, legal
judgments, opinion polls, logics are some of the examples of qualitative information
supplied and used by the management accounting system for better management.

5 Financial analysis and interpretations: Management Accounting has several

techniques such as ratio analysis, cash flow statements, trends analysis etc. are some of
the examples of qualitative information supplied and used by the management accounting
system for better management.

6 Communication: MIS is a very important aspect of management accounting which

prepares reports for presentation to all levels of management. This keeps the management
abreast of all developments in key areas of the organization and also helps in taking right
decisions for successfully running the business.

7 Decision making: a decision can make /mar an organization. Good, correct and timely
decisions are critical to the success of an organization. Management accounting
techniques of decision making such as marginal costing, differential costing, discounted
cash flows, capital expenditure decisions etc. help in taking very significant decisions
such as pricing of product, make/buy decision, continue/discontinue a product,
repair/replace decision.

8 tax policies: good tax policies can be made only when long term goals of an
organization are clear. Tax management experts rely on management reports for
indulging in formulation of tax policies.

Besides the objectives explained, there are three other functions of management
which have been stated by ‘’Horngreen,Foster and Datar’’ which are :1-problem
solving, 2-score keeping, 3-attention directing

6.2 Nature of management accounting

Nature or characteristics of any concept arise out of its meaning and definitions.
Therefore the nature of management accounting can be drawn from the meaning and
objectives as well.

COMMERCE Paper No.6: Accounting for Managerial Decisions

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1Future oriented: although he historical information is

provided by financial accounting but that information
is used to make future plans and for taking critical decisions.

2 Increase in efficiency: dynamic concepts such as responsibility accounting, cost

centers etc. are instrumental in increasing efficiency and control performance of
personnel.

3 Cause and effect relationship: management accounting studies both cause and effect
relationship while analyzing a reason for loss or profit.

4 It is flexible: rigid rules or formats are not followed in management accounting ,

so much so that the method to be followed and the manner in which the result would be
analyzed ,is left to the wisdom of the user of the data.

5 It provides information and not decisions: management accounting provides only

information, which must be analyzed and properly interpreted by the management for
arriving at a decision.
6 Tools and techniques: it uses several tools and techniques of statistics and mathematics
for presenting data.

7 Uses accounting information: it uses the financial information in such a way that suits
the managerial requirements of planning, controlling and decision making.

6.3 Scope of management accounting

It has a very wide scope as it cuts across the boundaries of cost and financial accounting and
covers a number of fields such as:

1 Financial accounting: for a successful and effective management accounting

system, a sound and well designed financial accounting system is a must.
2 Cost accounting: several cost accounting tools such as marginal costing, standard
costing, budgeting etc. are used by management accounting syatem for arriving at
decisions.
3 Cost control and procedures: a system of management accounting is incomplete
without effective cost control procedures.
4 Statistical tools: tables, graphs charts and other statistical tools are used by
management accounting for preparing results and reports.
5 Reporting to management: Management Accounting provides a sound reporting
system to top level management.
6 Tax planning: tax management is possible only when there is a sound management
accounting system.
7 Budgeting and forecasting: budgeting and budgetary control play a very
significant role in decision making.
8 Internal audit: management accountant has to use the internal audit report for
appraising the performance at all levels.
9 Office services: management accountant is expected to maintain and control office
routines such as filing, copying, communicating and other allied services.

COMMERCE Paper No.6: Accounting for Managerial Decisions

Module No. 1: Introduction to Management Accounting
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6.4 Limitations of management accounting

Some of the limitations of management accounting can be listed as:

 It is based on historical data therefore results may not be accurate

 Quality of management accounting depends upon the Level of knowledge of the
management accountant
 Management accounting is relatively a new concept therefore it has not fully evolved
 Installation of management accounting system is a costly affair
 As the methods used by management accounting system are very complex, they lead to
unscientific approach to decision making.

6.5Change management accounting

We all know that is a rapidly changing environment, due to which, there is a need to
adapt and innovate in the management accounting system as well so as to cater to the
needs of the changing scenario. The factors which are causing change in the management
accounting system are:

 Rapid Technological changes and innovations

 Ever increasing global competition
 Fast changing consumer demand, awareness and taste
 Changing governmental regulations and stricter rules
 More uniformity in presentation of financial data

COMMERCE Paper No.6: Accounting for Managerial Decisions

Module No. 1: Introduction to Management Accounting
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7. Summary
Management accounting, financial accounting and costing accounting at a glance

Basis Management Financial Cost accounting

accounting accounting
Definition It is concerned It is concerned with It is the process of
with accounting recording, classifying ascertaining costs from
information and summarizing the the first point of
useful for transactions expenditure to the last
management
Objective It provides It provides It helps in cost
information for information for ascertainment, cost
decision making ascertain profitability control, performance
and financial position evaluation and decision
making.
Nature It is futuristic in It is historical in It uses both past and
nature nature present data
Users of information Management Management as well Mainly management
as third partied
Dependence It depends on It is independent It is independent but takes
both financial figures from financial
accounting and accounting
cost accounting
Units of measurement It can be It is expressed in It is also expressed In
expressed both monetary units both monetary and
in monetary and physical units.
physical units
Accounting system It is not It is based on double It follows few principles
restricted to any entry system and and procedures for
specific follows uniform rules recording costs.
accounting
system
Emphasis Emphasis is on Emphasis is on Emphasis is on cost
planning and profit/loss ascertainment, cost
controlling determination control and cost reduction
Approach Practical Both practical & Normative approach
approach normative approach

COMMERCE Paper No.6: Accounting for Managerial Decisions

Module No. 1: Introduction to Management Accounting