chapter introduction to managerial accounting-overview of cost accounting

407 Pages·2014·1.71 MB·English

CHAPTER
1
INTRODUCTION TO
MANAGERIAL
ACCOUNTING-OVERVIEW
OF COST ACCOUNTING
Definition of Management Accounting:
The Managerial Accounting is another name of Management Accounting so we have been
using Management Accounting in our discussion throughout.
Management Accounting may be defined as the “Process of identification, measurement,
accumulation, analysis, preparation, interpretation and communication of information
(both financial & operating) used by the management to plan, evaluate and control
within an organization and to assure use of and accountability for its resources.”
(IMAP by FMAC pg: 37)
Management accounting, therefore, is an integral part of organization process. It provides
information essential for:
 Controlling the current activities of an organization
 Planning its future strategies, tactics and operations
 Optimizing the use of its resources
 Measuring and evaluating performance
 Reducing subjectivity in the decision making process and
 Improving internal and external communication
The Concept:
Accountability:
Management accounting presents information measuring the achievement of the objectives
of an organization and appraising the conduct of its internal affairs in that process. In order
that further action necessary can be taken, based on this information, it is necessary at all
times to identify the responsibilities and key result areas of the individuals within the
organization.
Controllability:
Management accounting identifies the elements of activities which management can or
cannot influence, and seeks to assess the risk and sensitivity factors. This facilitates the
proper monitoring, analysis, comparison and interpretation of information which can be used
constructively in the control, evaluation and corrective functions of management.
Reliability:
Management accounting information must be of such quality that confidence can be placed
in it. Its reliability to the user is dependent on its source, integrity and comprehensiveness.
Interdependency:
Management accounting, in recognition of the increasing complexity of business, must
access both external and internal information sources from interactive functions such as
marketing, production, personnel, procurement, finance, etc. This assists in ensuring that the
information is adequately balanced
Relevancy:
Management accounting must ensure that flexibility is maintained in assembling and
interpreting information. This facilitates the exploration and presentation, in a clear,
understandable and timely manner, of as many alternatives as are necessary for impartial
and confident decisions to be taken. The process is essentially forward looking and dynamic.
Therefore, the information must satisfy the criteria of being applicable and appropriate.
(IMAP by FMAC pg: 37)
Evolution of Management Accounting:
The field of organizational activity encompassed by management accounting has developed
through four recognizable stages.
• Stage 1 – Prior to 1950, the focus was on cost determination and financial control,
through the use of budgeting and cost accounting technologies.
• Stage 2 – By 1965 the focus have been shifted to the provision of information for
management planning and control, through the use of such technologies as decision
analysis and responsibility accounting:
• Stage 3 – By 1985, attention was focused on the reduction of waste in resources used in
business processes, through the use process analysis and cost management
technologies.
• Stage 4 – By 1995, attention had shifted to the generation or creation of value, through
the use of technologies which examine the drivers of customer value, shareholder value,
and organizational innovation.
While these four stages are recognizable, the process of change from one to another has
been evolutionary.
• Cost determination and financial control
• Information for management Planning and control
• Reduction of waste of resources in business processes
• Creation of value through effective resource use
(IMAP by FMAC pg: 29)
Comparison of Financial Accounting with Managerial Accounting:-
Financial Accounting Management Accounting
1- Origin Since 1497- Double Entry book keeping th
From 19 century.
System.
2. Purpose The main purpose of Financial Accounting The main purpose of management
is to prepare profit and loss account and accounting is to provide detailed
balance sheet. information.
3. Target Reporting to owner and outside agencies Mainly to management
Group
4. Statutory These accounts have to be prepared Maintenance of these accounts is
Requirements according to the legal requirements of voluntary.
Companies Acts.
5. Analysis of Financial account reveal the profit or loss Managerial accounts show the
Cost and of the business as a whole during a detailed cost and profit data for each
Profit particular period. It does not show the product line,department, process
figure of cost and profit for individual etc.
products, departments and processes.
6. Period of Financial Statements are prepared Management Reporting is a
reporting periodically, usually on an annual basis. continuous process that may be
daily, monthly, as required by
management.
7. Control It lays emphasis on the recording of It provides for a detailed system of
Aspect financial transactions and does not attach controls with the help of certain
any importance to control aspect. special techniques like standard
costing and budgetary control.
8. Nature It is concenrned almost exclusively with It is concenrned not only with
historical records. The historical nature of historical costs but also with
financial accounting can be easily predetermined costs. This is
understood in the context of the purposes because management accounting
for which it was designed. does not end with what has
happened in the past.
9-Audit There is an audit requirement of financial There is no such audit
statements. requirements.Cost audit concept is
getting importance in some
countries.
10. There are international accounting There are few guidelines issued by
International standards to be followed. MAC(Management Accounting
Standards Committee).
Role of a Management Accountant:-
Traditional Role:
In a traditional role, the Management Accountant is primarily concerned with the application
of accounting techniques and to the provision of information designed to assist all levels of
management in planning, reporting and controlling the activities of the organization.
Dynamic Role:
In today’s business environment, role of a Management Accountant is much more dynamic
than his traditional role. This is to create and enhance value of the organization through
stakeholders. This concept of value creation gives Management Accountant a more
dominant position in the organization. It includes:
 Suggesting ways and means to add more value
 Involvement in facilitating change processes in the organization
 Being a business advisor and not just a “corporate policeman”. Complete understanding
of organizational strategy, helping to solve problems and functioning as an effective
member of cross-functional teams.
 Being pro-active by following Feedforward control (i.e. forecasting of differences between
actual and planned outcomes, and the implementation of action, before the event, to
avoid such differences.
 Being able to address not only real concerns but also the perceived concerns, described
to include timeliness and trustworthiness.
 Fully participating in members of the Management team, playing pivotal role in
achievement of business objectives by expertise and diversified knowledge.
 Playing effective role in Project Management
 Preparing cashflow on the basis of realistic assumptions to determine debt-servicing
capability.
 Monitoring of growth initiatives and planning
 Conducting SWOT Analysis
 Strengthening the role as Cost auditor
 Assisting the government in developing audit process for income tax and sales tax.
(Management Accountant Executive Summary by Ali Imran Siddiqui Pg: 34)
Management Audit in a dynamic business environment:
A systematic assessment of methods and policies of an organization’s management in the
administration and the use of resources, tactical and strategic planning, and employee and
organizational improvement
The objectives of a management audit are to
1. Establish the current level of effectiveness
2. Suggest improvements
3. Lay down standards for future performance
Management auditors (employees of the company or independent consultants) do not
appraise individual performance, but may crtitically evaluate the senior executives as a
management team.
CHAPTER
2
COST CLASSIFICATION
IN MANAGEMENT
ACCOUNTING
PERSPECTIVE
1. Classification according to function:
 Manufacturing cost
 Administration cost
 Selling and distribution costs
 Financial costs
 Research and development costs
2. Classification according to variability
 Fixed Cost
 Variable Cost
 Semi-variable or semi-fixed costs
3. Classification according to identifiability with cost units:
 Direct costs
 Indirect costs
4. Classification according to controllability
 Controllable costs
 Uncontrollable Costs
5. Classification on the basis of time.
 Historical costs
 Predetermined Costs
6. By department
7. Budgeted Cost and Standard Costs
8. For Analytical Process
1. Functional Classification:-
This is a traditional classification. A business has to perform a number of functions like
manufacturing, administration, selling, distribution and research. Cost may have to be
ascertained for each of these functions. On this basis, costs are classified into the
following groups:
a) Manufacturing Cost: Also named “Production Cost” or “factory cost”. This is the
cost of the sequence of operations which begins with supplying materials, labour and
services and ends with completion of production.
b) Administration Cost: This is general administrative cost and includes all expenditure
incurred in formulating the policy, directing the organization and controlling the
operations of an undertaking, which is not directly related to production, selling and
distributions, research and development activity of function.
c) Selling & distribution costs: Selling cost is the cost of seeking to create and
stimulating demand and securing orders.
Distribution cost is the cost of sequence of operations which begins with making the
packed product available for despatch and ends with making the re-conditioned returned
empty package for re-use.
d) Financial Cost: It includes Interest/mark-up, bank charges and various fees paid to
lenders for borrowing funds.
e) Research and development cost: Research cost is the cost of searching new or
improved products or methods. It includes the cost incurred at Pre-production stage
which is the core focus of Life Cycle Costing.
2. Behavioural Classification:-
Costs sometimes have a definite relationship to volume of production. They behave
differently when volume of production rises or falls. As such they are described as fixed,
variable and semi-variable or semi-fixed.
a) Fixed Cost: These cost remain fixed in ‘total amount’ and do not increase or decrease
when the volume of production changes. But the fixed cost per unit decreases when
volume of production increases and vice versa.

(a) (b)

Total  Unit

 Fixed   Fixed 

 Cost   Cost 

 (Rs.)   (Rs.) 

FIGURE 2.1 Fixed Costs (a) total; (b) unit
Activity Level
Activity Level 
(Colin Drury Cost & Management Accounting 7th edition, pg: 38)
The characteristics of fixed cost are:
1. Fixed in total amount within a relevant output range
2. Increase or decrease in per unit fixed cost when quantity of production changes
3. Apportioned to departments on some arbitrary basis
4. Controllable by top management
5. Over a long period of time fixed cost is also variable.
b) Variable Cost: These costs tend to vary in direct proportion to the volume of output. In
other words, when the volume of output increases, the total variable cost will increase
and when volume of output decreases, total variable cost also decreases. But the
variable cost per unit remains fixed.

(a) (b)
Total 
Unit 
variable 
Variable 
Cost 
Cost 
(Rs.) 
(Rs.) 

Activity Level  Activity Level 

FIGURE 2.2 Variable Costs (a) total; (b) unit
(Colin Drury Cost & Management Accounting 7th edition, pg:38)
The characteristics of variable cost are:
1. Variability in total amount in direct proportion to the volume of output
2. Fixed amount per unit in the face of changing volume
3. Easy and reasonably accurate allocation and apportionment to departments
4. Controllable by functional managers
c) Semi-variable or semi-fixed costs: These costs are partly fixed and partly variable. A
semi-variable cost has often a fixed element below which it will not fall at any level of
output. The variable element in semi-variable costs changes either at a constant rate or
in lumps. For example, introduction of an additional shift in the factory will require