1. What is Management accounting and its importance?

Management Accounting:- Management accounting is the process of preparing management

reports and accounts that provide accurate and timely financial and statistical information
to managers to make short-term and long-term decisions. It identifies, measures,
analyzes, interprets, and communicates information to enable an organization to pursue its
goals.
Management accounting differs from financial accounting. While financial accounting
provides information to people inside and, more importantly, people outside the
organization, management accounting is mostly aimed at aiding managers inside the
organization with decision making.
Importance of management accounting
Determine of Aim: Management accounting on the basis of the information available
determines its goal and tries to find out the route through which it can reach the goal.
Helps in the Preparation of Plan: Present age is the age of planning. That producer is
considered as most successful producer who produces articles according to the plan and
needs of the consumers. Before taking any plan the manager must study and analyze the
present and future of the business.
Better Services to Customers: The cost control device is management accounting
enables the reduction in prices of the Product. All employees in the concern are made cost
Conious. The quality of the Product become good because quality standards ate pre-
determined. The Customers are supplied goods and goods quality at reasonable price.
Easy to take judgment: Before taking any plan or to determine policy. There are several
plans or policies before the management on the basis of the study he decides which plan
and policy was to be adapted so that it may be more useful and helpful.
Measurements of performance: The techniques of budgetary control standard costing
enables the measurement of performance In standard costing, standards are determined
1st and then actual cost of compared with standard cost. It enables the management to
find out deviations between standard cost and actual cost. The performance will be good it
actual cost does not exceed the standard cost. Budgetary control system too helps in
measuring efficiency of all employees.
Its Increase Efficiency of the business: Management accounting increases efficiency of
the business concern. The targets of different departments of the enterprise are
determined in advance and the achievement of these goals is taken as a tool for measuring
their efficiency.
Its Provide effective management control : The Tools and techniques of the
management accounting are helpful to the management in planning controlling and
coordinating activities of the business, the getting of standard and assessing actual
performance regularly enables the management to have ‘management by exception’.
Everybody assesses his own work and immediate actions are taken as a tool for measuring
their efficiency.
Maximum profits of can be obtained: in this process every possible effort are made to
control unnecessary expenses. The incapability or inefficiency is removed. New systems or
techniques are found out to achieve the goal, so that there may be maximum profits out if
the capital invested in the Business.
Safety and security from trade cycle: The Information received form the management
accounting gives more or throws enough light over the past trade cycle. The management
tries to ascertain the Causes of trade cycle and its affect. Thus, management accounting
tries to safeguard the organization from the affect of trade cycle.

2. Scope Of Management Accounting

The scope or field of management accounting is very wide and broad based and it includes
a variety of aspects of business operations. The main aim of management accounting is to
help management in its functions of planning, directing, controlling and areas of
specialization included within the admit of management accounting. The scope of
management accounting can be studied as follows:

1. Financial Accounting :- Financial accounting forms the basis for analysis and
interpretation for furnishing meaningful data to the management. The control aspect is
based on financial data and performance evaluation, on recorded facts and figures. So,
management accounting is closely related to financial accounting in many respects.

2. Cost Accounting:- Cost accounting is the process and techniques of ascertaining cost.
Planning, decision making and control are the basic managerial functions. The cost
accounting system provides the necessary tool for carrying out such functions efficiently.
The tools includes standard costing, inventory management, variable costing etc.

3. Budgeting And Forecasting Budgeting means expressing the plans, policies and goals
of the firm for a definite period in future. Forecasting on the other hand, is a prediction of
what will happen as a result of a given set of circumstances. Forecasting is a judgement
whereas the budgeting is an organizational object. These are useful for management
accounting in planning.

4. Inventory Control Inventory is necessary to control from the time it is acquire till its
final disposal as it involves large sum. For controlling inventory, management should
determine different level of stock. The inventory control technique will be helpful for taking
managerial decisions.

5. Statistical Method Statistical tools not only make the information more impressive,
comprehensive and intelligible but also are highly useful for planning and forecasting.
6. Interpretation Of Data Analysis and interpretation of financial statements are
important part of management accounting. After analyzing the financial statements, the
interpretation is made and the reports drawn from this analysis are presented to the
management. Interpreting the accounting data to the authorities in the management is the
principal task of management accounting.

7. Reporting To Management The interpreted information must be communicated to

those who are interested in it. The report may cover Profit and Loss Account, Cash Flow
and Funds Flow statements etc.

8. Internal Audit And Tax Accounting Management accounting studies all the tax
matters to assist the management in investment decisions vis-a-vis tax planning as a
resource to enjoy tax relief.

Internal audit system is necessary to judge the performance of every department.

Management is able to know deviations in performance through internal audit. It also helps
management in fixing responsibility of different individuals.

9. Methods Of Procedures This includes maintenance of proper data processing and

other office management services. It may have to deal with filing, copying, duplicating,
communicating and management information system and also may have to report about
the utility of different office machines.

CHARACTERISTICS AND NATURE OF MANAGEMENT ACCOUNTING

It is matter of fact that management accounting is the backbone for every organization.
Because it assists the management of organization through providing the relevant and
accurate information at the right time for taking rational decisions to short out the business
problems. Thus, it is clear that a management accounting should possess these essential
characteristics:-

 Helpful in Decision Making:- It is an important feature of management accounting.

In fact, it helps the management of organization by providing relevant and accurate
information from various sources (like financial and cost accounting) in order to make
sound decisions to remove business problems.
 Provides Data, Not the Decision:- It only provides required data and information
to the management, not the decision. It is up to the management that how they
utilize the available data and information to resolving the business problems through
taking effective decisions.
 Selective in Nature:- It is also a potent characteristic of this accounting system.
Here selective means, in management accounting a management accountant is only
collect those data and information from a variety of alternatives which may create
 more benefits and easiness to the management in decision making. Hence, it is
selective in nature.
 Assist in Achieving Objectives:- Management Accounting is always assist
organization in achieving its predetermined goals. Because it provides detailed
information in regarding the weakness and the strength of organization in the form of
report, on the basis of that any organization can eliminate recognized weakness
(business problems) and may achieve its goal easily.
 Related to Future:- Management Accounting is an accounting system which is
directly related to future course of events. It means by preparing this account any
organization can forecast its future on the basis available information in relating the
past events (Historical data).
 Increase in Efficiency:- It also plays an essential role in increasing efficiency of
organization. As we know that in this competitive business age it is difficult for every
organization to carry out its entity for ever. Hence to survive for long run it is
important for organization to increase its efficiency by finding the errors and
removing it through management accounting techniques (standard costing, budgetary
control, control accounting),
 Use of Special Techniques:- Management Accounting uses special tools or
techniques (like standard costing, budgetary control, control accounting, marginal
costing etc) for composing the accounting information and data more accurate and
relevant. So that management can easily make their decisions. The type of technique
to be applied will be determined according to the situation and necessity.

Limitations or disadvantages of management accounting

Management accounting is an important tool of management. Hence, it serves the

management in many ways. Even though, the management accounting has some
limitations or disadvantages. They are briefly explained below:

Limitations or disadvantages of management accounting

1. Based on Financial and Cost Records:- Both financial and cost accounting
information are used in the management accounting system. The accuracy and validity of
management account is largely based on the accuracy if financial and cost records
maintained. These records determine the Strength and weakness of management
accounting.

2. Personal Bias The analysis and interpretation of financial statements are fully
depending upon the capability of the analyst and interpreter. Hence, personal prejudices
and bias of an individual can affect the objectivity and effectiveness of the conclusions and
recommendations.

3. Lack of Knowledge and Understanding of the Related Subjects Financial

accounting, cost accounting, statistics, economics, psychology and sociology are the
related subjects of management accounting. The organization can derive more benefits of
management accounting if the management accountant has thorough knowledge over
related subjects. If not so, the success of management accounting system is questionable.

4. Provides only Data Under management accounting system, many alternatives are
developed to solve a problem and submitted before the management. Out of the many
alternatives available, the management can select any one of alternatives or even discard
all of them. Hence, management accounting can only provide data and not prescribe any
course of action.

5. Preference to Intuitive Decision Making Scientific decisions can be taken with the
help of using management accounting techniques. But, majority of the management
accountant and top level executives prefer their past experience and intuition in making
business decisions. The reason is that an intuitive decision making is very simple and easy.

6. Management Accounting is only a Tool The management accountant is using the

management accounting system as a tool to give advice and facilitate the management for
decision making. The actual decisions, their implementation and follow up action are the
prerogative of the management.

7. Continuity and Participation The decisions are taken by the management. Their
implementation is vested in the hands of management accountant. The continuous efforts
of management accountant and full participation of all levels of management are necessary
for successful operation of management accounting system.

8. Broad Based Scope The scope of management accounting is very wide since it
considers both monetary and non-monetary transactions of the business organization. The
limited knowledge and experience of the management accountant can lead to prepare the
data unreliable and undependable.

9. Costly Installation The cost of installation of management accounting system is very

high. Hence, a small business organization can not bear the cost of such installation.
Moreover, the utility of this system is restricted only to big and complex organizations.

10. Resistance to Change The installation of management accounting system brings

some changes in the organizational set up and accounting practice. The personnel
concerned may resist such changes unless they are getting confidence.

11. Evolutionary State Management accounting is a recent development discipline. The

utility of management accounting is depend upon the intelligent interpretation of the data
available for managerial use. Hence, it is presumed that the management accounting
stands in evolutionary stage.

12. Unquantifiable Variables Management accounting seeks to interpret and evaluate an

objective historical event on record in terms of money. But, in practice, the business
organization is facing many problems which cannot be exposed.

Difference Between Financial Accounting and Management Accounting

Accounting, refers to the process of recording, classifying and summarizing in monetary

terms, the business transactions and events and interpreting the results. It is used by
entities to keep a track of their financial transactions. Financial Accounting and
Management accounting are the two branches of accounting. Financial accounting stresses
on giving true and a fair view of the financial position of the company to various parties.

On the contrary, management accounting aims at providing both qualitative and

quantitative information to the managers, so as to assist them in decision making and thus
maximizing the profit. This article excerpt is created to help you learn the significant
differences between financial accounting and management accounting.

The following points explain the major differences between financial accounting
and managerial accounting:

 Financial Accounting is the branch of accounting which keeps track of all the financial
information of the entity. Management Accounting is that branch of accounting which
records and reports both the financial and nonfinancial information of an entity.
 Users of financial accounting are both the internal management of the company and
the external parties while the users of the management accounting are only the
internal management.
 Financial accounting is to be publicly reported whereas the Management Accounting is
for the use of the organisation and hence it is very confidential.
 Only monetary information is contained in financial accounting. As against this,
management accounting contains both monetary and non-monetary information such
as the number of workers, the quantity of raw material used and sold, etc.
 Financial Accounting is done in the prescribed format, whereas there is no prescribed
format for the Management Accounting.
 Financial Accounting focuses on providing information about the functioning of the
entity’s business to its users, whereas Management Accounting focuses on providing
information to help them in evaluating the performance and devising plans for the
future.

 The Financial Accounting is mainly done for a specific period, which is usually one
year. On the other hand, the management accounting is done as per the needs of the
management say quarterly, half yearly, etc.
 Financial accounting is a must for any company for auditing purposes. On the
contrary, management accounting is voluntary, as no editing is done.
 Financial accounting information is required to be published and audited by statutory
auditors. Unlike, management accounting, which does not require information to be
published and audited, as they are for internal use only.

3. What is the break-even point for a business and how it is calculated?

In simple words, the break-even point can be defined as a

point where total costs (expenses) and total sales (revenue)
are equal. Break-even point can be described as a point
where there is no net profit or loss. The firm just “breaks
even.” Any company which wants to make abnormal profit,
desires to have a break-even point. Graphically, it is the point where the total cost and the total
revenue curves meet

.Calculating your break-even point

There are a few basic formulas for determining a business’s break-even point. One is
based on the number of units of product sold and the other is based on
points in sales dollars.
To calculate a break-even point based on units: Divide fixed costs by the
revenue per unit minus the variable cost per unit. The fixed costs are those that do
not change no matter how many units are sold. The revenue is the price for which
you’re selling the product minus the variable costs, like labor and materials.
Calculation (formula)
Break-even point is the number of units (N) produced which make zero profit.
Revenue – Total costs = 0
Total costs = Variable costs * N + Fixed costs
Revenue = Price per unit * N
Price per unit * N – (Variable costs * N + Fixed costs) = 0
So, break-even point (N) is equal
N = Fixed costs / (Price per unit - Variable costs)
When determining a break-even point based on sales dollars: Divide the fixed
costs by the contribution margin. The contribution margin is determined by
subtracting the variable costs from the price of a product. This amount is then used
to cover the fixed costs.
Break-Even Point (sales dollars) = Fixed Costs ÷ Contribution Margin
Contribution Margin = Price of Product – Variable Costs
To get a better sense of what this all means, let’s take a more detailed look at the
formula components.

Fixed costs: As noted above, fixed costs are not affected by the number of items
sold, such as rent paid for storefronts or production facilities, computers, and
software. Fixed costs also include fees paid for services like graphic design,
advertising, and public relations.
Contribution margin: The contribution margin is calculated by subtracting an
item’s variable costs from the selling price. So if you’re selling a product for $100
and the cost of materials and labor is $40, then the contribution margin is $60. This
$60 is then used to cover the fixed costs, and if there is any money left after that,
it’s your net profit.
Contribution margin ratio: This figure, usually expressed as a percentage, is
calculated by subtracting your fixed costs from your contribution margin. From
there, you can determine what you need to do to break even, like cutting production
costs or raising your prices.
Profit earned following your break even: Once your sales equal your fixed and
variable costs, you have reached the break-even point, and the company will report
a net profit or loss of $0. Any sales beyond that point contribute to your net profit.
Top 10 Managerial Uses of Break-Even Analysis

The following points highlight the top ten managerial uses of break-even analysis. the managerial uses
are: 1. Safety Margin 2. Target Profit 3. Change in Price 4. Change in Costs 5. Decision on Choice of
Technique of Production 6. Make or Buy Decision 7. Plant Expansion Decisions 8. Plant Shut Down
Decisions 9. Advertising and Promotion Mix Decisions 10. Decision Regarding Addition or Deletion of
Product Line.

Use # 1. Safety Margin:

The break-even chart helps the management to know at a glance the profits generated at the various
levels of sales. The safety margin refers to the extent to which the firm can afford a decline before it
starts incurring losses.

The formula to determine the sales safety margin is:

Safety Margin = (Sales – BEP)/Sales x 100

Use # 2. Target Profit:

The break-even analysis can be utilised for the purpose of calculating the volume of sales necessary to
achieve a target profit.

When a firm has some target profit, this analysis will help in finding out the extent of increase in sales by
using the following formula:

Target Sales Volume = Fixed Cost + Target Profit/Contribution Margin Per Unit.

Use # 3. Change in Price:

The management is often faced with a problem of whether to reduce prices or not. Before taking a
decision on this question, the management will have to consider a profit. A reduction in price leads to a
reduction in the contribution margin.

This means that the volume of sales will have to be increased even to maintain the previous level of
profit. The higher the reduction in the contribution margin, the higher is the increase in sales needed to
ensure the previous profit.

The formula for determining the new volume of sales to maintain the same profit, given a reduction in
price, will be

New Sales Volume = Total Fixed Cost + Total Profit/New Selling Price – Average Variable Cost

Use # 4. Change in Costs:

When costs undergo change, the selling price and the quantity produced and sold also undergo changes.
Changes in cost can be in two ways:

(i) Change in variable cost, and

An increase in variable costs leads to a reduction in the contribution margin. This reduction in the
contribution margin will shift the break-even point downward. Con-versely, with the fall in the proportion
of variable costs, contribution margins increase and break-even point moves upwards.

Under conditions of changing variable costs, the formula to determine the new quantity or the new
selling price are:

(a) New Quantity or Sales Volume = Contribution to Margin/Present Selling Price – New Variable Cost Per
Unit

(b) New Selling Price = Present Sale Price + New Variable Cost-Present Variable Cost

(ii) Fixed Cost Change:

An increase in fixed cost of a firm may be caused either due to a tax on assets or due to an increase in
remuneration of management, etc. It will increase the contribution margin and thus push the break-even
point upwards. Again to maintain the earlier level of profits, a new level of sales volume or new price has
to be found out.

New Sales Volume = Present Sale Volume + (New Fixed Cost + Present Fixed Costs)/(Present Selling Price-
Present Variable Cost)

New Sale Price = Present Sale Price + (New Fixed Costs – Present Fixed Costs)/Present Sale Volume

Use # 5. Decision on Choice of Technique of Production:

A firm has to decide about the most economical production process both at the planning and expansion
stages. There are many techniques available to produce a product. These techniques will differ in terms of
capacity and costs.

The break-even analysis is the most simple and helpful in the case of decision on a choice of technique of
produc-tion. For example, for low levels of output, some conventional methods may be most probable as
they require minimum fixed cost.

For high levels of output, only automatic machines may be most profitable. By showing the cost of
different alternative techniques at different levels of output, the break-even analysis helps the decision of
the choice among these techniques.

Use # 6. Make or Buy Decision:

Firms often have the option of making certain components or for purchasing them from outside the
concern. Break-even analysis can enable the firm to decide whether to make or buy.
A manufacturer of car buys a certain components at Rs. 20 each. In case he makes it himself, his fixed and
variable cost would be Rs. 24,000 and Rs.8 per component respectively.

BEP = Fixed Cost/Purchase Price – Variable Cost

Use # 7. Plant Expansion Decisions:

The break-even analysis may be adopted to reveal the effect of an actual or proposed change in
operation condition. This may be illustrated by showing the impact of a proposed plant on expansion on
costs, volume and profits. Through the break-even analysis, it would be possible to examine the various
implications of this proposal.

Use # 8. Plant Shut Down Decisions:

In the shut-down decisions, a distinction should be made between out of pocket and sunk costs. Out of
pocket costs include all the variable costs plus the fixed cost which do not vary with output. Sunk fixed
costs are the expenditures previously made but from which benefits still remain to be obtained e.g.,
depreciation.

Use # 9. Advertising and Promotion Mix Decisions:

The main objective of advertisement is to stimulate or increase sales to all customers—former, present
and future. If there is keen competition, the firm has to undertake vigorous campaign of advertisement.
The management has to examine those marketing activities that stimulate consumer purchasing and
dealer effectiveness.

The break-even point concept helps the management to know about the circumstances. It enables him
not only to take appropriate decision but by showing how these additional fixed cost would influence
BEPs. The advertisement cost pushes up the total cost curve by the amount of advertisement
expenditure.

Use # 10. Decision Regarding Addition or Deletion of Product Line:

If a product has outlived its utility in the market immediately, the production must be abandoned by the
management and examined what would be its consequent effect on revenue and cost. Alternatively, the
management may like to add a product to its existing product line because it expects the product as a
potential profit spinner. The break-even analysis helps in such a decision.

What is Marginal Costing in BEA?

Definition: Marginal Costing is a costing technique wherein the marginal cost, i.e. variable cost is charged
to units of cost, while the fixed cost for the period is completely written off against the contribution.

The term marginal cost implies the additional cost involved in producing an extra unit of output, which
can be reckoned by total variable cost assigned to one unit. It can be calculated as:
Marginal Cost = Direct Material + Direct Labor + Direct Expenses + Variable Overheads

Characteristics of Marginal Costing

Classification into Fixed and Variable Cost: Costs are bifurcated, on the basis of variability into fixed cost
and variable costs. In the same way, semi variable cost is separated.

Valuation of Stock: While valuing the finished goods and work in progress, only variable cost are taken
into account. However, the variable selling and distribution overheads are not included in the valuation of
inventory.

Determination of Price: The prices are determined on the basis of marginal cost and marginal
contribution.

Profitability: The ascertainment of departmental and product’s profitability is based on the contribution
margin. In addition to the above characteristics, marginal costing system brings together the techniques
of cost recording and reporting.

11 Main Areas of Marginal Costing | Cost Accounting

The following points highlight the eleven main areas of marginal costing. The areas are: 1. Fixation of
Selling Prices 2. Key Factor 3. Make or Buy Decision 4. Selection of a Suitable Product Mix 5. Effect of
Change in Sales Price 6. Maintaining a Desired Level of Profits 7. Alternative Methods of Production 8.
Cost Indifferent Point 9. Diversification of Products 10. Suspending Activities 11. Alternative Course of
Action.
1. Fixation of Selling Prices:

Although prices are more controlled by market conditions and other economic factors than by decisions
of management yet fixation of selling prices is one of the most important functions of management.

This function is to be performed:

 Under normal circumstances.

 Under special circumstances.
 In times of trade depression.
 In accepting additional orders for utilizing idle capacity.
 In exporting and exploring new markets.

2. Key Factor:

A key factor is that factor which puts a limit on production and profit of a business. Usually the limiting
factor is sales. A concern may not be able to sell as much as it can produce. But, sometimes a concern can
sell all it produces but production is limited due to the shortage of materials, labour, plant capacity, or
capital.

In such a case, a decision has to be taken regarding the choice of the product whose production is to be
increased, reduced or stopped. Ordinarily, when there is no limiting factor, the choice of the product will
be on the basis of the highest P/V ratio.

But when there are scarce or limited resources, selection of the product will be on the basis of
contribution per unit of scarce factor of production. In short, scarce resources should be utilized in those
directions where contribution per unit of limited resources is the maximum.

3. Make or Buy Decision:

A concern can utilize its idle capacity by making component parts instead of buying them from market. In
arriving at such a make or buy decision, the price asked by the outside suppliers should be compared with
the marginal cost of producing the component parts.

If the marginal cost is lower than the price demanded by the outside suppliers, the component parts
should be manufactured in the factory itself to utilize unused capacity.

4. Selection of a Suitable Product Mix:

When a factory manufactures more than one product, a problem is faced by the management as to which
product mix will give the maximum profits. The best product mix is that which yields the maximum
contribution.

The products which give the maximum contribution are to be retained and their production should be
increased. The products which give comparatively less contribution should be reduced or closed down
altogether. The effect of sales mix can also be seen by comparing the P/V ratio and breakeven point. The
new sales mix will be favourable if it increases the P/V ratio and reduces the breakeven point.

5. Effect of Change in Sales Price:

Management is confronted with the problem of cut in prices of products from time to time on account of
competition, expansion programme or government regulations. It is, therefore, necessary to know the
effect of a cut in prices of the products. The effect of a cut in selling price per unit will be that
contribution per unit will reduce.

6. Maintaining a Desired Level of Profits:

Management may be interested in maintaining a desired level of profits. The volume of sales needed to
have a desired level of profits can be ascertained by the marginal costing technique as is shown in the
following illustration.

7. Alternative Methods of Production:

Marginal costing is helpful in comparing the alternative methods of production, i.e., in chine work or hand
work. The method which gives the greatest contribution (assuming fixed expenses remaining same) is to
be adopted keeping, of course, the limiting factor in view. Where, however, fixed expenses change, the
decision will be taken on the basis of profit contributed by each.

8. Cost Indifferent Point:

Sometimes there are two alternatives—one having low variable cost and high fixed cost and the other
having high variable cost and low fixed cost. The cost indifferent point has to be determined by linking the
incremental fixed overhead by the savings in variable costs.

A indifferent point the total cost of the two alternatives will be the same. In case of selection of machine,
this point will be helpful in calculating the levels of sales at which both machines earn equal profits and
the range of sales at which one is more profitable than the other.

9. Diversification of Products:

Sometimes it becomes necessary for a concern to introduce a new product to the existing product or
products in order to utilize the idle capacity or to capture a new market or for other purposes. The new
product must be profitable.

In order to decide about the profitability of the new product, it is assumed that the manufacture of the
new product will not increase fixed costs of the concern and if the price realized from the sale of such
product is more than its variable cost of production it is worth trying. If this data is presented under
absorption costing method, the decision will be wrong.
But if with the introduction of new product there is an increase in the fixed costs, then such specific
increase in fixed costs must be deducted from the contribution for making any decision. General fixed
costs will, however, be charged to the old product/products.

10. Suspending Activities:

Sometimes it becomes necessary for a firm to temporarily suspend or close the activities of a particular
product, department or factory as a whole due to trade recession. The decision to close down or suspend
its activities will depend on whether products are making a contribution towards fixed costs or not.

If the products are making a contribution towards fixed costs, it is preferable not to close business or
suspend its activities to minimise the losses.

11. Alternative Course of Action:

When deciding between alternative courses of action, it shall be kept in mind that whatever course of
action is adopted, certain fixed expenses will remain unaffected.

The criterion, therefore, which weighs is the effect of alternative course of action upon the marginal (i.e.,
variable) costs in relation to the revenue obtained. The course of action which yields the greatest
contribution is the most profitable to be followed by the management.

Q.4). Function & Scope of Management Accounting :-

Management Accounting: Any system of accounting, which assists management in carrying out its
functions more efficiently may be termed as management accounting.

The Institute of Cost and Management Accountants, London has defined Management Accounting as the
“application of professional knowledge and skill in the preparation of accounting information in such a
way as to assist management in the formation of policies and in the planning and control of the
operations of the undertakings”.

The above definitions clearly indicate that management accounting is concerned with accounting
information, which is useful to management. The common thread underlying these definitions is that
management accounting is concerned with the efficiency of the various phases of management.

Functions of Management Accounting: The bask function of management accounting is to assist the
management in performing its functions effectively.

The manner in which management accounting satisfies the requirements of the management for arriving
at appropriate business decisions may be described as follows:

1. Modification of Data: Accounting data as such are not suitable for managerial decision-making and
control purposes. However, they may be used as the basis for making future estimates and projections.
For example, the sales figures for different months may be classified to know the total sales made during
the period product-wise, salesman-wise, and territory-wise.
2. Analysis and Interpretation of Data: The accounting data is analyzed and interpreted meaningfully for
effective planning and decision-making. For this purpose the data is presented in a comparative form.
Analytical tools such as Comparative Financial Statements, Common-size Statements, Trend percentages,
and ratio Analysis are used and likely trends are projected.

3. Facilitating Management Control: Management accounting enables all accounting efforts to be

directed towards the attainment of goals efficiently by controlling the operations of the company more
effectively. Standards of performance and measure of variation there from are the essential elements of
any control system.

4. Use of Qualitative Information: Mere financial data and its analysis and interpretation are not sufficient
for decision-making purposes. The management may need qualitative information, which cannot be
readily converted into monetary terms.

Such information may be obtained from statistical compilations, engineering records, case studies,
minutes of meetings, etc.

5. Satisfaction of Informational Needs of Different Levels of Management: Different levels of

management such as top level, middle level, and lower level managements need different types of
information. Hence, the main function of management accounting is to process accounting and other
data in such a way as to satisfy the needs of different levels of management.

Scope of Management Accounting: The main concern of management accounting is to provide necessary
quantitative and qualitative information to the management for planning and control. For this purpose it
draws out information from accounting as well as non-accounting sources.

Hence, its scope is quite vast and it includes within its fold almost all aspects of business operations.
However, the following areas may rightly be pointed out as lying within the scope of management
accounting.

i. Financial Accounting: The major function of management accounting is the rearrangement or

modification of data. Financial accounting provides the very basis for such a function.

ii. Cost Accounting: Planning, decision-making and control are the basic managerial functions. The cost
accounting system provides necessary tools such as standard costing, budgetary control, inventory
control, marginal costing, and differential costing etc., for carrying out such functions efficiently.

iii. Revaluation Accounting: Revaluation or replacement value accounting is mainly concerned with
ensuring that capital is maintained in real terms and profit is calculated on this basis.

iv. Statistical Methods: Statistical tools such as graph, charts, diagrams and index numbers etc., make the
information more impressive and comprehensive.

v. Operations Research: O P techniques like linear programming, queuing theory, decision theory, etc.,
enable management to find scientific solutions for the business problems.
vi. Taxation: This includes computation of income tax as per tax laws and regulations, filing of returns and
making tax payments. In recent times, it also includes tax planning.

vii. Organization and Methods [O&M]:

viii. Office Services:

ix. Law:

x. Internal Audit:

xi. Internal Reporting:

Q.5). Kinds of Budget:

A Budget refers to forecast of company’s incomes and expenses anticipated for a given period of time.
With a budget, an organization is able to analyze how much money they are making and spending, and
they are able to figure the best way to channel it among various categories and departments.

Types of Budget:-

a). Operating Budgets

The long-range operational goals, strategies and action plans of a small business are monetized and
presented in operating budgets, such as the sales, raw material inventory and production budgets. The
operating budgets are created during an annual budgeting cycle that begins with a review of a company's
strategy, which may include the development of new products or the introduction of products to new
markets.

For example, the business might develop a new marketing campaign or build a new facility. Company
leaders then propose the combination of products and services that will generate sales revenues for the
budget period. This information is combined with historical sales data and market data to create a sales
forecast.

b). Sales Budget

The sales revenue documented in the sales budget establishes the maximum dollars available to cover
the costs of producing and selling the company’s product or service and yield a profit. The three primary
elements of the sales budget are the total number of units to be sold during a budget period, the per-unit
sales price and the total sales revenue. For example, if a company’s total expected sales for January are
10,000 units at a price of $5 per unit, the total sales budget for January is $50,000. If the sales volume is
expected to grow by 100 units per month, the February sales forecast is $50,500, or $50,000 January
sales plus 100 units multiplied by $5 per unit equals $50,500.

c). Capital Expenditure Budget

A small business remains a going concern due in part to its ability to quickly adjust its strategy and related
financial plan in response to changing environmental conditions. For example, a business might hire
additional salespeople when a new product is introduced, or a company might decrease production to
accommodate a decline in product sales.

However, a capital project is an element of a company's business plan that requires the long-term
commitment of company resources. Therefore, it's essential that a small business use capital budgets as a
means to evaluate and rank capital projects on the basis of projected lifetime cash flow -- net investment
plus net cash flows -- to determine which project will generate a financial return that's sufficient to
warrant the investment of capital over the long term.

d). Cash Budget

The business objectives specified in the operating budgets and the capital budget are financed with
dollars that are forecast and controlled using a cash budget. The small-business owner relies on a cash
budget to ensure that cash is on hand to meet current financial obligations. However, the budget also
identifies excess cash that can be invested to better meet future budget requirements.

To create the cash budget, management estimates cash flows for a budget period using a two-step
formula. The cash balance at the beginning of a budget period -- the ending cash balance for the prior
period -- is added to the estimated cash received during the period to obtain the cash available during the
period. The estimated cash disbursed is then subtracted from the available cash to determine the cash
available at the end of the budget period.

Advantages and Limitations of Budgeting

Advantages of Budgeting:

Budgeting plays an important role in the effective use of resources and achieving overall organisational
goals.

It has the following advantages:

1. Budgeting compels and motivates management to make an early and timely study of its problems. It
generates a sense of caution and care, and adequate study among managers before decisions are made
by them.

2. Budgeting provides a valuable means of controlling income and expenditure of a business as it is a

“plan for spending.”

3. Budgeting provides a tool through which managerial policies and goals are periodically evaluated,
tested and established as guidelines for the entire organisation.

4. Budgeting helps in directing capital and other resources into the most profitable channels.
5. Budgeting enables management to decentralise responsibility without losing control of the business. It
reveals weaknesses, inefficiencies, deviations in the organisation very promptly which can be checked
immediately to achieve a desired goal.

6. The use of budgeting in an organisation develops an attitude of “cost consciousness”, stimulates the
effective use of resources, and creates an environment of profit-mindedness throughout the
organisation. It emphasises how much should be spent to achieve a goal.

7. It provides a norm, basis or yardstick for measuring performance of departments and individuals
working in organisations. Individual managers can evaluate their own decisions and achievements and
take suitable steps to improve their performances.

8. Budgeting encourages productive competition, provides incentive to perform efficiently and gives a
sense of purpose to each individual in the organisation. All these positive factors lead to higher output
and increase employee productivity.

9. Budgeting provides a systematic and disciplined approach to the solution of problems in the
organisation.

10. Budgeting, if executed in nearly every enterprise, helps the total national economy by providing
stability of employment, economic use of resources and effective prevention of waste.

Limitations of Budgeting:

While budgeting performs many functions and has many advantages that are vital to an organi-sation, it
has certain limitations which require careful consideration:

1. Planning, budgeting or forecasting is not an exact science; it uses approximations and judgement which
may not be cent per cent accurate. At best, a budget is an estimate; no one knows precisely what will
happen in the future.

2. The success and utility of budgeting depends on the cooperation and participation of all members of
management. All persons should direct their efforts according to the plan. The top management also
should adhere to the budget and provide cooperation. Many a time budgeting has failed because
executive management has paid only lip service to its execution.

3. A budget is only a tool and neither eliminates nor takes over the place of management. A budget
cannot be substituted for management but should only be used by management for accomplishing
managerial functions. Executives generally feel “circled in” by a budget and its related figures. They fail to
understand that budget is meant to provide detailed information, goals and targets which may help them
in achieving the company objectives.

4. The establishment of a budgeting process taken time. Also, sometimes too much is expected from a
budget and in case expectations are not fulfilled, the blame is put on the budget. An efficient budgeting
programme requires that responsible persons should understand the philosophy, objectives and
essentials of budgeting.

5. Excessive emphasis on budgeting may result in attempts by lower level management and employees to
buck the system by providing inaccurate estimates of future costs and revenues, and by failing to take
advantage of changes in the environment because to do so would result in a deviation from plan, they
would be considered as operating contrary to the budget. Under an unbalanced budget programme,
employees will tend to overestimate costs and underestimate revenues, thus creating budget slack.

6. As the end of budget period approaches and employees realise that actual expenses have not been as
great as allowed by the budget, there may be a temptation to spend excessive amounts in order to “use
up” the budget allowance. Such activities result in sub-optimal profits for the company.

What is a Flexible Budget?

Flexible Budget A flexible budget, also called a variable budget, is financial plan of estimated revenues
and expenses based on the current actual amount of output. In other words, a flexible budget uses the
revenues and expenses produced in the current production as a baseline and estimates how the revenues
and expenses will change based on changes in the output. This is why it’s often called a variable budget.
Management often uses flexible budgets before a period to predict both a best case and worse case
scenario for the upcoming accounting period. This provides a “what if” look at the future of the
company’s financial performance.

Importance of Flexible Budget:

Flexible budgets are important aids to decision making which help the management in the following
ways:

(i) Flexible budget enable an organization to predict its performance and income levels at a given range of
sales levels and activity levels. It can be seen the impact of changes in sales and production levels on
revenue, expenses and ultimately income.

(ii) Flexible budgets enable more accurate assessment of managerial and organizational perfor-mance.

Steps in Preparation of Flexible Budget:

The steps involved in preparation of flexible budget are as follows:

(a) Specify the time period that is used.

(b) Classify all costs into fixed, variable and semi-variable categories.

(c) Determine the types of standards that are to be used.

(d) Analyze cost behaviour patterns in response to past levels of activity.

(e) Build up the appropriate flexible budget for specified levels of activity.
Disadvantages of Flexible Budget:

The procedure for drawing up a flexible budget is quite straight forward. The flexed budget is only
accurate, if costs behave in a predicted manner. All too often assumptions are made about cost behaviour
which are too simplistic and hence do not reflect what actually happens.

(a) Flexed budgets assume linearity of costs and, therefore, take no account of, for example discounts for
bulk purchases of materials. ‘Labour’ costs are unlikely to behave in a linear fashion unless a piecework
scheme is in operation.

(b) Such budgets also rely on the assumption of continuity when costs may actually behave in a stepped
or discontinues manner.

(c) The method of determining the fixed and variable elements of costs is often arbitrary and hence the
flexed cost bear little relation to the correct budgeted cost for the flexed level of activity.

(d) Although flexed budgets tend to maintain fixed costs at the same level whatever the level of
output/sales, very often fixed costs are actually fixed only over a relevant output range.

What is Standard Costing and Variance Analysis?

In fast growing business world, major goal of organizations is to reduce the cost of production and control
the cost as there are limited resources in business and manufacturing concern. Cost accounting has
numerous significant tools in order to attain these goals such as standard costing.

Standard costs are extensively recognized in all countries of world. It is an effectual procedure to control
cost and assist to accomplish organizational goal. Standard costs are realistic estimates of cost based on
analyses of both past and projected operating costs and conditions. In this procedure, standard cost of
the product and services is determined in advance and comparing it with actual cost variance to ascertain
and analyse. Huge accounting literature has stated that standard costing is the preparation and use of
standard costs, their comparison with actual cost and the analysis of variance to their causes and points
of incidence.

The three components of standard costing:

 Standard costs, which provide a standard, or predetermined performance level.

 A measure of actual performance.
 A measure of the variance between standard and actual performance.

Standard costing uses estimated costs completely to calculate all three elements of product costs: direct
materials, direct labour, and overhead. Managers use standard costs for planning and control in the
management process such as planning for budget development; product costing, pricing, and
distribution.

The main difference between standard costing in a service organization and standard costing in a
manufacturing organization is that a service organization has no direct materials costs. In a standard
costing system, costs are entered into the Materials, Work in Process, and Finished Goods Inventory
accounts and the Cost of Goods Sold account at standard cost; actual costs are recorded separately.

The following elements are used to verify a standard cost per unit:

 Direct materials price standard

 Direct materials quantity standard
 Direct labour rate standard
 Direct labour time standard
 Standard variable overhead rate
 Standard fixed overhead rate

Determination of Standard Costs

The following initial steps must be taken before determination of standard cost:

Establishment of Cost Centres: It is the primary step required before setting of Standards.

Classification and Codification of Accounts: Categorization of Accounts and Codification of different items
of expenses and incomes assist quick ascertainment and analysis of cost information.

Types of Standards to be applied: Determination of the type of standard to be used is vital steps before
establishing of standard cost. There are numerous standards:

 Ideal Standard
 Basic Standard
 Current Standard
 Expected Standard
 Normal Standard

Organization for Standard Costing: The achievement of the standard costing system depends upon the
consistency of standards, therefore the responsibility for setting standard is vested with the Standard
Committee. It consists of following team:

 Purchase Manager
 Production Manager
 Personnel Manager
 Time and Motion Study Engineers
 Marketing Manager and Cost Accountant

Setting of Standards: The Standard Committee is responsible for developing standards for each
component of costs such as Direct Material, Direct Labour, Overheads ( Fixed overheads and Variable
Overheads).

Variance Analysis
Variance analysis is the procedure of computing the differences between standard costs and actual costs
and recognizing the causes of those differences. Studies indicated that variance is the difference between
standard performance and actual performance. It is the process of scrutinizing variance by subdividing
the total variance in such a way that management can assign responsibility for off-Standard Performance.

Variance analysis has four steps:

 Compute the amount of the variance.

 Determine the cause of any significant variance.
 Identify performance measures that will track those activities, analyse the results of the tracking,
and determine what is needed to correct the problem.
 Take corrective action.