MBA612 chapter4MgtAcct

MADAWALAMU UNIVERSITY, SCHOOL OF POST GRADUATE STUDIES, Bale-Robe, January, 2015
CHAPTER FOUR
MANAGEMENT ACCOUNTING: CONCEPTS AND TECHNIQUES
4.1. Management Accounting
Introduction
The person at the helm of affairs of business entities including trading concerns, manufacturing
companies, Service Providing Organizations, etc… have to take a number of decisions. For the
purpose of taking these decisions, the managerial personnel, owners, directors of boards,
executives, etc., need lot relevant information. Because, these piece of information in the form of
facts, figures etc., are essential for objective evaluation, as far as possible, of each of the
alternatives available so that right decisions can be taken. Hence, the decision-makers need an
information system which is capable of furnishing the precise and relevant information at the
right time. Management accounting serves the managerial personnel by providing the required
information and reports.
Of course, one can also find other two important kinds of accounting viz., financial accounting
and Cost accounting which are also functioning as information systems. However, they are
suffering from a few limitations and also the fact that their beneficiaries are different and/or they
are providing information to the same beneficiaries (viz., managerial personnel) but for different
purpose. The limitations, like this, of financial accounting and cost accounting and their inability
to serve the managerial personnel have led to the emergence of another branch of accounting
viz., Management Accounting.
Though a few concept of Management Accounting were known to the managerial personnel in
the first quarter of 20th century, it was developed substantially only during the last five decades.
Even the term “Management Accounting” was coined in the 1950s as a separate course of study.
Since then, it has developed substantially.
Management accounting can be viewed as Management-oriented Accounting. Basically it is the
study of managerial aspect of financial accounting, "accounting in relation to management
function". It shows how the accounting function can be re-oriented so as to fit it within the
framework of management activity. The primary task of management accounting is, therefore, to
Re-design the entire accounting system so that it may serve the operational needs of the firm. If
furnishes definite accounting information, past, present or future, which may be used as a basis
Financial and Managerial Acct(MBA612): Lecture Note for CH 4I Compiled by Teferi D. Page 1
for management action. The financial data are so devised and systematically development that
they become a unique tool for management decision.
Management Accounting: Meaning and Definition
Management Accounting has been defined by money experts and institutions in different ways.
But all definitions highlight the fact that it aims at furnishing the relevant information to the
managerial personnel. And the managerial personnel use these facts and figures for the purpose
of taking decisions. These aspects become obvious from the following definitions:
 A team of British Industrial Accountants and Managers has defined Management
Accounting as the presentation of accounting information in such a way as to assist
management in the creation of policy and day-to day operation of undertaking.
 Batty has defined Management Accounting as … the term used to describe the
accounting methods, systems, and techniques which, coupled with special knowledge
and ability, assist management in its task of maximizing profits or minimizing losses.
 According to Rose, Management Accounting is the collection, analysis, diagnosis,
and interpretation of accounting information in such a way as to help the
management.
 As per Anthony, management accounting is concerned with accounting information
that is useful to management
 In the words of American Accounting Association(AAA), Management Accounting
includes the methods and concepts necessary for choosing among alternative
business actions and for control through the evaluation and interpretation of
performance
 Broad and Carmichael have viewed Management Accounting as covering … all those
services by which the accounting department can assist the top management and
other departments in the formulation of policy, control of execution and appreciation
of effectiveness.
Analysis of the above definitions brings about, among others, one important aspect, viz.,
functions of management accounting. Management Accounting deals with the internal reporting.
On the basis of the nature of these reports and their contents, and the parties who receive these
reports, it may be said that the Management Accounting deals primarily with furnishing of
required and relevant data to the managerial personnel for the purpose of planning, controlling,
and decision making. The type of accounting information required by the management differs
from one type of decisions to another, and also from one level of management to another.
It is not necessary confined to the financial accounting information but it is much more than this
depending upon the type, importance, complexity, etc., of the problem. Another aspect which is
to be clarified at this stage is about terminology. The terminologies: Managerial Accounting,
Management Accounting and Management Accountancy are used synonymously to denote
the same as there is no difference in the subject matter of these terms.
NATURE OF MANAGEMENT ACCOUNTING

The term management accounting is composed of 'management' and 'accounting'. The word
'management' here does not signify only the top management but the entire personnel charged
with the authority and responsibility of operating an enterprise. The task of management
accounting involves furnishing accounting information to the management, which may base its
decisions on it. It is through management accounting that the management gets the tools for an
analysis of its administrative action and can lay suitable stress on the possible alternatives in
terms of costs, prices and profits, etc. but it should be understood that the accounting information
supplied to management is not the sole basis for managerial decisions. Along with the
accounting information, management takes into consideration or weighs other factors concerning
actual execution. For reaching a final decision, management has to apply its common sense,
foresight, knowledge and experience of operating an enterprise, in addition to the information
that is already has.
The word 'accounting' used in this phrase should not lead us to believe that it is restricted to a
mere record of business transactions i.e., book keeping only. It has indeed a 'macro-economic
approach'. As it draws its raw material from several other disciplines like costing, statistics,
mathematics, financial accounting, etc., it can be called an interdisciplinary subject, the scope of
which is not clearly demarcated. Other fields of study, which can be covered by management
accounting, are political science, sociology, psychology, management, economics, statistics, law,
etc. A knowledge of political science helps to understand authority relationship and
responsibility identification in an organization. A study of sociology helps to understand the
behaviour of man in groups. Psychology enables us to know the mental make-up of employers
and employees. A knowledge of these subjects helps to increase motivation, and to control the
actions of the people who are ultimately responsible for costs. This builds a better employer-
employee relationship and a sound morale. The subject of management reveals the processes
involved in the art of managing, knowledge of economics assists in the determination of
optimum output in the forecasting of sales and production, etc., and also makes it possible to
analyze management action in terms of cost revenues, profits, growth, etc. It is with the help of
statistics that this information is presented to the management in a form that can be assimilated.
The subject of management accounting also encompasses the subject of law, knowledge of
which is necessary to find out if the management action is ultra-vires or not. It is, therefore, a
wide and diverse subject. Management accounting has no set principles such as the double entry
system of bookkeeping. In place of generally accepted accounting principles, the philosophy of
cost benefit analysis is the core guide of this discipline. It says that no accounting system is good
or bad but is can be considered desirable so long as it brings incremental benefits in excess of its
incremental costs. Applying management accounting principles to financial matters can arrive at
no single perfect solution. It is, therefore, an inexact science, which uses its own conventions
rather than standardized principles. The facts to be studied here can be interpreted in different
ways and the precision of the inferences depends upon the skill, judgment and common sense of
different management accountants. It occupies a middle position between a fully matured and an
infant subject.
Since management accounting is managerially oriented, its data is selective in nature. It focuses
on potential opportunities rather than opportunities lost. The data is operative in nature catering
to the operational needs of a firm. It details events, monetary and non-monetary. The nature of
data, the form of presentation and its duration are mainly determined by managerial needs. It is
quite frequently reported as it is meant for internal uses and managerial control. An accountant
should look at his enterprise from the management's point of view. Whenever he fails to do that
he ceases to be a management accountant.
Management accounting is highly sensitive to management needs. However, it assists the
management and does not replace it. It represents a service phase of management rather than a
service to management from management accountant. It is rather highly personalized service.
Finally, it can be said that the management accounting serves as a management information
system and so enables the management to manage better.
Need for Management Accounting

When the financial accounting is capable of furnishing the information even to the internal
parties or when there is no bar on the management to utilize the financial reports meant for
external parties, and when cost accounting is serving the internal parties by providing cost
details, a question normally crops up as to “what is and where is the need for another
Accounting, viz., Management Accounting?” of course, these reasons are true. But what is
important is that both the financial accounting and cost accounting has emphasis on different
objectives. Management cannot base its decisions only on the information furnished by the
financial and cost accounting. Therefore, there is a need for a system which utilizes and analyzes
the abundant data(including the data generated by the Financial and cost accounting) with the
sole objective of furnishing the relevant data to the management for the purpose of assisting it to
take appropriate decisions. Management Accounting furnishes only those data which are relevant
to the decision under consideration and these relevant data include data collected from both
financial and cost records and other sources.
Illustration
Assume that in XYZ Company, the price of the company’s product is to be revised once or twice
in a year depending upon the policy of the company and also other influencing factors. On the
basis of the financial reports, it not possible to determine the extent to which the price is to be
increased. Because, it is very difficult to get an idea, from the financial reports, about the extent
to which the costs have been increased. Therefore, financial accounting is not useful to the
management to decide about the extent of price revision. Cost books of accounts are of much
help than the financial reports as the cost records provide some insight into the impact of hike in
the prices of input factors and their effect on the cost of sales, margin etc. in spite of this
usefulness, even cost accounting is not of much use to the management in this regard. Because,
the management of ABC company cannot increase the price equivalent to, or more than, the
increase in the cost of sales. It needs information about the number of other aspects such as,
whether the competitors are also planning to increase their prices, reactions of the customers to
the proposed increase, etc. There is, therefore, a need for management accounting which collects
the information from different sources, analyzes them systematically and furnishes only the
relevant information in the manner which is most suitable, to the management and which uses
the sophisticated tools and techniques, including the tools and techniques derived from other
disciplines, to present the reports to the management in the most suitable and useful manner.
Since the managerial personnel are accountable to the owners of the company and since their
very contribution in the company depends on the results produced by them which in turn depend
upon the quality of decisions and their implementation, the managerial personnel need a system
which furnishes the relevant information to them to take decisions. Therefore, the need for
Management Accounting is devised/designed to serve the management through the reports. On
the basis of the analysis made hitherto, the specific reasons which unequivocally bring out the
need for Management Accounting are:
A. Increasing complexity of managerial decisions
B. Increase in size and problems of corporate entities
C. Different sets of information required by different levels of management
D. Management needs relevant and timely information to take decisions
E. Financial and cost accounting lay emphasis on other objectives and fail to
provide necessary information to management
Characteristics of Management Accounting

The following are the important characteristics of Management Accounting and these
characteristics also explain the nature of Management Accounting:
1. Cause and Effect Analysis: one of the important features of Management Accounting is
that it attempts to study the causative Relationship (cause and effect) between different
variables. For instance, analysis of the reasons for the increased or reduced profit of the
company reveals the factors responsible for the lower profit or factors contributing to the
higher profit. In the same way, reasons for the changes in Return on Investment analyzed
and unearthed by the Management Accountant.
2. Both Science and Art: management accounting possesses the features of both science
and art in that it aims at achieving accuracy, perfection and objectivity at each stage of
the works related to collection, analysis, and interpretation of data, and in the
communication of the results of the same to the management. It is also concerned with
the quantification of problems, performance, etc. Hence, Management Accounting can be
considered as a science. Further, for the successful completion of his work, the
management accountant is expected to use some sort of subjective or personal judgment
which also influences the inferences, conclusions, etc., to greater extent. Management
accounting is therefore, an art in nature. Hence, management accounting is both a science
and an art.
3. Information System: as management accounting is solely designed to provide
information to the management for the purpose of helping it to take various decisions, it
is basically an information system. It provides both the monetary(quantitative) and non-
monetary (qualitative) information, both the historical and future related information,
both the actuals and the forecasts or projections, both the accounting and the non-
accounting information, etc. for this purpose, it makes use of the techniques such as
Budgetary Control, Standard Costing, Statistical tools, etc…
4. Relevancy of Information: the other most important feature of management accounting
is its emphasis on the relevancy of information to the decisions under the consideration of
management. If both the relevant and relevant data are applied by the management, the
decision of the management may be influenced more by the irrelevant lot than the
relevant few. Hence, the management may not be able to take the right decision. In this
background, this future of management accounting assumes importance as it segregates
the data into relevant and irrelevant, and as it uses only the relevant data for evaluation
and communications to management.
5. Facilitator of Decision – making: management accountant only provides the relevant
information and evaluates the alternative solutions to each of the problems, but s/he does
not take the decisions as s/he not empowered to do so. Hence, s/he only facilitates the
decision making processes by helping the decision makers.
6. Flexibility but not rigidity: in the case of financial accounting, certain rules, principles,
etc., are to be observed strictly. But the management accountant is not bound by such
rigidity. He is free to use appropriate procedure, format, analysis, etc. for reporting to the
management. Usefulness of the report is more important than the formalities of the
report.
Functions of Management Accounting

The basic function of management accounting is to serve the managerial personnel by furnishing
them with complete and relevant information whenever they are called for. By doing so,
management accounting aims at assisting management to take appropriate decisions and
discharging their responsibility satisfactorily. Hence, management accounting is called
management oriented- accounting. In order to accomplish this objective, management accounting
has to perform a number of functions. However, the following are the important function of
management accounting:
1. Provision of Relevant Data: management accounting primarily aims at serving the
people who are internal to the business entity. That means, its objective is to furnish the
pertinent facts and figures to the managerial personnel and assists them to take various
decisions. For this purpose, it collects the data from different sources and presents the
same to the management whenever required and in suitable form. Further, it provides
information and/or submits reports to different level of management. Because,
management at different level (Top, middle and lower level) needs different information
for making decision at their respective level.
2. Provision of Qualitative Information: In order to assist the management in its decision
making task, only the quantitative data are not sufficient. Management should be
provided even with qualitative information if they are relevant to the decision under
consideration. For instance, in order to decide whether a plan is to be shut down or not
temporarily (due to trade recession), it is not sufficient if the management report include
only the financial data. It should also include information about the impact on the
reputation, loss of market to competitors, loss of experienced employees, etc.
Management accountant submits comprehensive reports which include both the
quantitative and the qualitative information.
3. Modification of Data: both the financial and cost accounting generate voluminous data
about the performance and the financial position of business entities. In majority of the
cases, these data cannot be used as extracted from the financial and/or cost books of
accounts for managerial decisions. Because, the data is to be modified in such a way that
it become more useful for the management. The sales data can be classified according to
product, territory, customer sales, cash sales, etc. These details are easily understandable
and they are more useful for the management for taking decisions. This way,
Management Accounting classifies and modifies financial and other data according to the
requirement of the management.
4. Analysis and Interpretation: since the financial data lack communication, they are to be
analyzed and interpreted properly to get an insight into the profitability, solvency,
liquidity, etc. of the company. Management Accounting, with the help of the tools of
financial analysis undertakes this task and presents the results with necessary comments,
conclusions, etc. to the management. Further, the managerial personnel may lack
technical knowledge about the financial information. Hence, the management
accountants analyze and interpret the financial data in simple ways and report the same
using non-technical knowledge. Besides, the management accountants also undertake the
task of evaluating the alternatives and present the same to the management together with
their opinion.
5. Assistance in Planning: Management accounting prepares and submits the necessary
reports to the management for the purpose of assisting it in the process of planning for,
and forecasting, the future. Because the management has to formulate various policies,
both short-term, and long-term, for the future. To formulate or design policies, the
management needs various information, and these facts and figures are furnished by the
management accountants. Because, Management Accounting uses different techniques
such as Budgetary Control, Standard Costing, Marginal Costing, Funds flow statements,
etc. and helps the management in its planning and forecasting activities.
6. Facilitates Overall Control: with the help of standard costing, budgetary control and
Responsibility accounting, management accounting identifies the areas where the control
by the management is required. It is carried out through a process called comparison –
comparing the actuals with standards and budgets, and identifying the variances. It also
identifies the factors which are, and persons who are, responsible for the poor
performance and based on this, the management takes all necessary corrective measures.
Scope of Management Accounting

Management accounting is concerned with presentation of accounting information in the most
useful way for the management. Its scope is, therefore, quite vast and includes within its fold
almost all aspects of business operations. However, the following areas can rightly be identified
as falling within the ambit of management accounting:
i. Financial Accounting: Management accounting gathers maximum data from
financial Accounting. Because, the annual reports (which includes among others, the
financial statements) provides voluminous data. Financial accounting though provides
historical information but it furnishes very important inputs for planning and financial
forecasting. It is an essential perquisite of any discussion of management accounting.
Financial statements contain enough information that is used by management for
decision making. Management accounting contains only tools and techniques and its
get the data for interpretation and analysis mainly firm financial accounting. Thus,
without efficient financial accounting system, management accounting cannot be
operative.
ii. Cost accounting: cost accounting provides various techniques for determining cost
of manufacturing products of cost of providing service. It uses financial data for
finding out cost of various jobs, Producst or processes. Business executives depend
heavily on accounting information in general and on cost information in particular
because any activity of an organisation can be described by its cost. They make use of
various cost data in managing organisation effectively. Cost accounting is Considered
as a backbone of management accounting as it provides the analytical tools such as
Budgetary Control, Standard Costing, Marginal Costing, Inventory costing, Operating
Costing Etc., which are used by management to discharge its responsibilities
effectively.
iii. Financial Management: Financial management is concerned with the planning and
controlling of the financial resources of the firm. It deals with the raising funds and
their effective utilization. Its main aim is to use the fund in such a way that the
earning of the firm is maximized. Today finance has become the life blood of any
business concerned. Although, financial management has emerged as a separate
subject, management accounting includes and extends to the operation of financial

management etc.
iv. Financial Statement Analysis: The Various parties concerned with the financial
statements may need information, which can be obtained by financial statement
analysis and developing certain trends and ratios. A person can gain meaningful
insights and conclusions about the firm with the help of analysis and Interpretation of
the information contained in financial statements. Different techniques have been
developed which can be used for the proper interpretation and analysis of financial
statement.
v. Interpretation of data: The Work of interpreting of financial data is done by the
management accountant. He interprets various financial statements to the
management. These statements may be studied in comparison to statements of earlier
periods or in comparison with the statements of similar other concerns. The
significance of these reports is explained to the management in a simple language. If
the statements are not properly interpreted then wrong conclusions may be drawn. So,
interpretation is Important as compiling of financial statements.
vi. Management Reporting: Clear informative, timely reports are essential management
tools in reaching decisions that make the best use of firm's resources. Thus, one of the
basic responsibilities of management accounting is to keep the management well
informed about the operations of the business. The reports are presented in the form
of graphs, diagrams, index numbers or other statistical techniques so as to make them
easily understandable. The management accountant send interim reports may be
monthly, quarterly, half yearly or annually. These reports cover profits or order in
hand, etc. and they are helpful in giving a constant review of the working of the
business.
vii. Quantitative Techniques: Modern managers believe that the financial and economic
data available for managerial decisions can be more useful when analyzed with more
sophisticated analysis and evaluation techniques. This Techniques such a time series,
regression analysis and sampling techniques are commonly used for this purpose,
Further, managers also use techniques such a linear programming, game theory,
Queuing theory etc in their decision making Process.
viii. Inflation Accounting: Inflation accounting attempts to identify certain characteristics

of accounting that tend the reporting of financial results during the period of rapidly
changing prices. It devices and implements appropriate methods to analysis and
interpret the Inflation on the Financial Information.
Objectives of Management Accounting

The important objectives of Management Accounting are presented and analyzed as follows:
1. To Analyze and Interpret the Financial Data: financial accounting generates
voluminous data and most of them are incapable covering any message to the receivers
including management about company‟s performance and financial position. However,
these pieces of information can be made to convey certain message about various
activities of the organization through a process called „analysis and interpretation‟ which
is one of the basis, analyse them and interpret the same in the right perspective. This
helps the management to take the appropriate decisions.
2. To Report to the Management: the primary objective of Management Accounting is to
report to different levels of management about the past performance, latest and/or current
position, and about the performance of different departments, products, etc. either
regularly or at regular interval depending upon the requirement.
3. To Help in Planning and Policy formulation: formulation of plans and policies by the
management is made easy if proper forecasts about production, sales, etc., are available.
Management Accounting helps management by presenting the statements of past
performance and making forecasts about the future.
4. To Facilitate Controlling: Management Accounting aims at helping the management to
exercise its control over different activities, products, departments, etc., this is done
through its reports which contain the comparison between the ‘budgets, standards,
targets, etc.,‟ on the one hand the „actuals‟ on the other. The differences which are called
‘variances’ are analyzed further to identify the reasons for the same and this helps the
management to initiate controlling actions.
5. To Help the Management in its Decisions – Making Process: Decisions play a crucial
role in the success or otherwise of the organizations. The management which is
responsible and/or empowered to take decisions must be very careful, and the
management is not in a position to take the right decision without the help of
Management Accountants. Because, the Management Accountants identify the
alternatives, collect all the relevant information, evaluate each of the alternatives from the
viewpoints of Cost-benefits, pros and cons, etc., and finally identify the most desirable
alternative. Incorporating all these, the reports will be prepared and submitted by the
Management Accountants to the management and based on these reports, the
management will take the appropriate decisions.
6. To Help in Organizing: the word ”organizing” refers to the establishment of relationship
among organizational individuals explaining unequivocally the authority – responsibility
relationship. Management Accounting intends to help the management even in this matter
with the help of “Responsibility Accounting” wherein the entire organization is divided
into a number of responsibility centers (which may take the form of either the cost
centres or profit centers or Investment Centers or a combination), and making the heads
of the centres accountable for the mutually agreed results. Of course, adequate power is
to be delegated to them by the higher authority. This way, the Management Accountant
helps the management.
LIMITATIONS OF MANAGEMENT ACCOUNTING

Management accounting, being comparatively a new discipline, suffers from certain
limitations, which limit its effectiveness. These limitations are as follows:
1. Limitations of Basic Records: Management accounting derives its information from
financial accounting, cost accounting and other records. The strength and weakness of
the management accounting, therefore, depends upon the strength and weakness of
these basic records. In other words, their limitations are also the limitations of
management accounting.
2. Persistent Efforts: The conclusions draws by the management accountant are not
executed automatically. He has to convince people at all levels. In other words, he
must be an efficient salesman in selling his ideas.
3. Management Accounting is only a Tool: Management accounting cannot replace
the management. Management accountant is only an adviser to the management. The
decision regarding implementing his advice is to be taken by the management. There
is always a temptation to take an easy course of arriving at decision by intuition rather
than going by the advice of the management accountant.
4. Wide Scope: Management accounting has a very wide scope incorporating many
disciplines. It considers both monetary as well as non-monetary factors. This all
brings inexactness and subjectivity in the conclusions obtained through it.
5. Top-heavy Structure: The installation of management accounting system requires
heavy costs on account of an elaborate organization and numerous rules and
regulations. It can, therefore, be adopted only by big concerns.
6. Opposition to Change: Management accounting demands a break away from
traditional accounting practices. It calls for a rearrangement of the personnel and their
activities, which is generally not like by the people involved.
7. Evolutionary Stage: Management accounting is still in its initial stage. It has,
therefore, the same impediments as a new discipline will have, e.g., fluidity of
concepts, raw techniques and imperfect analytical tools.
This all creates doubt about the very utility of management accounting.

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MADAWALAMU UNIVERSITY, SCHOOL OF POST GRADUATE STUDIES, Bale-Robe, January, 2015

NATURE OF MANAGEMENT ACCOUNTING

Need for Management Accounting

Characteristics of Management Accounting

Functions of Management Accounting

Scope of Management Accounting

subject, management accounting includes and extends to the operation of financial

viii. Inflation Accounting: Inflation accounting attempts to identify certain characteristics

Objectives of Management Accounting

LIMITATIONS OF MANAGEMENT ACCOUNTING

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