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COURSE: MANAGEMENT ACCOUNTING COURSE CODE: MC-105 AUTHOR: Dr. N. S. MALIK LESSON: 01 VETTER: Prof. M S Turan MANAGEMENT ACCOUNTING: NATURE AND SCOPE Objective: The present lesson explains the meaning, nature, scope and limitations of accounting. Further, it discusses the activities covered under management accounting and its difference with financial accounting. LESSON STRUCTURE 1.1 Introduction 1.2 Definitions of Management Accounting 1.3 Nature of Management Accounting 1.4 Functions of Management Accounting 1.5 Scope of Management Accounting 1.6 The Management Accountant 1.7 Management Accounting and Financial Accounting 1.8 Cost Accounting and Management Accounting 1.9 Limitations of Management Accounting 1.10 Self-Test Questions 1.11 Suggested Readings 1.1 INTRODUCTION 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 redesign the entire accounting system so that it may serve the operational 1 needs of the firm. If furnishes definite accounting information, past, present or future, which may be used as a basis for management action. The financial data are so devised and systematically development that they become a unique tool for management decision. 1.2 DEFINITIONS OF MANAGEMENT ACCOUNTING The term “Management Accounting”, observe, Broad and Carmichael, covers all those services by which the accounting department can assist the top management and other departments in the formation of policy, control of execution and appreciation of effectiveness. This definition points out that management is entrusted with the primary task of planning, execution and control of the operating activities of an enterprise. It constantly needs accounting information on which to base its decision. A decision based on data is usually correct and the risk of erring is minimized. The position of the management in respect of its functions can be compared to that of an army general who wants to wage a successful battle. A general can hardly fight successfully unless he gets full information about the surrounding situation and the extent of effectiveness of each of his battalions and, to the extend possible, even the enemy's intentions. Like a general a successful management too strives to outstrip other competitors in the field by streamlining its operating efficiency. It needs a thorough knowledge of the situation and the circumstances in which the firm operates. Such knowledge can only be gained through the processed financial data rendered by the accounting department on the basis of which it can take policy decision regarding execution, control, etc. It is here that the role of management accounting comes in. It supplies all sorts of accounting information in the 2 form of such statements as may be needed by the management. Therefore, management accounting is concerned with the accumulation, classification and interpretation of information that assists individual executives to fulfill organizational objectives. The Report of the Anglo-American Council of Productivity (1950) has also given a definition of management accounting, which has been widely accepted. According to it, "Management accounting is the presentation of accounting information in such a way as to assist the management in creation of policy and the day to day operation of an undertaking". The reasoning added to this statement was, "the technique of accounting is of extreme importance because it works in the most nearly universal medium available for the expression of facts, so that facts of great diversity can be represented in the same picture. It is not the production of these pictures that is a function of management but the use of them." An analysis of the above definition shows that management needs information for better decision-making and effectiveness. The collection and presentation of such information come within the area of management accounting. Thus, accounting information should be recorded and presented in the form of reports at such frequent intervals, as the management may want. These reports present a systematic review of past events as well as an analytical survey of current economic trends. Such reports are mainly suggestive in approach and the data contained in them are quite up to date. The accounting data so supplied thus provide the informational basis of action. The quality of information so supplied depends upon its usefulness to management in decision-making. The usual approach is that, first of all, a thorough analysis of the whole 3 managerial process is made, then the information required for each area is explored, and finally, all the information, after analysis in terms of alternatives, is taken into consideration before arriving at a management decision. It is to be understood here that the accounting information has no end in itself; it is a means to an end. As its basic idea is to serve the management, its form and frequency are all decided by managerial needs. Therefore, accounting aids the management by providing quantitative information on the economic well being of the enterprise. It would be appropriate if we called management accounting an Enterprise Economics. Its scope extends to the use of certain modern sophisticated managerial techniques in analyzing and interpreting operative data and to the establishment of a communication network for financial reporting at all managerial levels of an organization. 1.3 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. 4 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, a 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 5 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, judgement 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 6 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. 1.4 FUNCTIONS OF MANAGEMENT ACCOUNTING The basic function of management accounting is to assist the management in performing its functions effectively. The functions of the management are planning, organizing, directing and controlling. Management accounting helps in the performance of each of these functions in the following ways: (i) Provides data: Management accounting serves as a vital source of data for management planning. The accounts and documents are a repository of a vast quantity of data about the past progress of the enterprise, which are a must for making forecasts for the future. (ii) Modifies data: The accounting data required for managerial decisions is properly compiled and classified. For example, purchase figures for different months may be classified to know total purchases made during each period product-wise, supplier-wise and territory-wise. (iii) Analyses and interprets data: The accounting data is analyzed meaningfully for effective planning and decision-making. purpose the data is presented in a comparative form. For this Ratios are calculated and likely trends are projected. (iv) Serves as a means of communicating: Management accounting provides a means of communicating management plans upward, downward and outward through the organization. Initially, it means identifying the feasibility and consistency of the various segments of 7 the plan. At later stages it keeps all parties informed about the plans that have been agreed upon and their roles in these plans. (v) Facilitates control: Management accounting helps in translating given objectives and strategy into specified goals for attainment by a specified time and secures effective accomplishment of these goals in an efficient manner. All this is made possible through budgetary control and standard costing which is an integral part of management accounting. (vi) Uses also qualitative information: Management accounting does not restrict itself to financial data for helping the management in decision making but also uses such information which may not be capable of being measured in monetary terms. Such information may be collected form special surveys, statistical compilations, engineering records, etc. 1.5 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 is mainly concerned with the rearrangement of the information provided by financial accounting. Hence, management cannot obtain full control and coordination of operations without a properly designed financial accounting system. 8 (ii) Cost Accounting: Standard costing, marginal costing, opportunity cost analysis, differential costing and other cost techniques play a useful role in operation and control of the business undertaking. (iii) Revaluation Accounting: This is concerned with ensuring that capital is maintained intact in real terms and profit is calculated with this fact in mind. (iv) Budgetary Control: This includes framing of budgets, comparison of actual performance with the budgeted performance, computation of variances, finding of their causes, etc. (v) Inventory Control: It includes control over inventory from the time it is acquired till its final disposal. (vi) Statistical Methods: Graphs, charts, pictorial presentation, index numbers and other statistical methods make the information more impressive and intelligible. (vii) Interim Reporting: This includes preparation of monthly, quarterly, half-yearly income statements and the related reports, cash flow and funds flow statements, scrap reports, etc. (viii) Taxation: This includes computation of income in accordance with the tax laws, filing of returns and making tax payments. (ix) Office Services: This includes maintenance of proper data processing and other office management services, reporting on best use of mechanical and electronic devices. (x) Internal Audit: Development of a suitable internal audit system for internal control. (xi) 9 1.6 THE MANAGEMENT ACCOUNTANT Management Accounting provides significant economic and financial data to the management and the Management Accountant is the channel through which this information efficiently and effectively flows to the management. The Management Accountant has a very significant role to perform in the installation, development and functioning of an efficient and effective management information system. He designs the framework of the financial and cost control reports that provide each management level with the most useful data at the most appropriate time. He educates executives in the need for control information and ways of using it. This is because his position is unique with respect to information about the organization. Apart from top management no one in the organization perhaps knows more about the various functions of the organization than him. He is, therefore, sometimes described as the Chief Intelligence Officer of the top management. He gathers information, breaks it down, sifts it out and organizes it into meaningful categories. He separates relevant and irrelevant information and then ranks relevant information in an intelligible form to the management and sometimes also to those who are interested in the information in the information outside the company. He also compares the actual performance with the planned one and reports and interprets the results of operations to all levels of management and to the owners of the business. Thus, in brief, management accountant or controller is the person who designs the management information system for the organization, operates it by means of interlocked budgets, computes variances and exhorts others to institute 10