BBA II SEMESTER (FINANCIAL & MANAGEMENT ACCOUNTING-II) UNIT -III
Management Accounting Definition
Management accounting also is known as managerial accounting and can be defined as a process of providing financial information and resources to the managers in decision making. Management accounting is only used by the internal team of the organization, and this is the only thing which makes it different from financial accounting. In this process, financial information and reports such as invoice, financial balance statement is shared by finance administration with the management team of the company. Objective of management accounting is to use this statistical data and take a better and accurate decision, controlling the enterprise, business activities, and development.
Financial accounting is the recording and presentation of information for the benefit of the various stakeholders of an organization. Management accounting, on the other hand, is the presentation of financial data and business activities for the internal management of the organization. In this article, we will learn what is management accounting and its functions.
Introduction to Management Accounting
One of the definitions of Management accounting says that it is the application of professional skills and knowledge in the preparation of financial and accounting information in a manner in which it will assist the internal management in the formulation of policies, planning, and control of the operations of the firm.
The basic function of management accounting is to help the management make decisions. There is no fixed structure or format for it.
Financial accounting, costing, business analysis, economics, etc are some tools and techniques of management accounting.
The only need for management accounting is that the data should serve its purpose, which is helping the management take important business decisions.
How Managerial Accounting Works?
Managerial accounting involves many aspects of accounting. It aims at improving the quality of information about business operation metrics. Information relating to the cost and sales revenue of goods and services of the company is useful to the managerial accountants. Cost accounting is a large subset of managerial accounting. Cost Accounting focuses on ascertaining a company’s total costs of production by assessing the variable costs as well as fixed costs. It helps businesses in identifying and reducing unnecessary expenses and maximizing profits.
Types of Managerial Accounting
1. Product Costing and Valuation
Costs can be bifurcated into the variable, fixed, direct, or indirect costs. Cost accounting helps in measuring and identifying these costs as well as assigning overheads to each type of product or service. Product costing, thus, determines the total costs incurred in the production of a good or service.
2. Cash Flow Analysis
Cash flow analysis helps in determining the cash impact of business decisions. Most companies follow the accrual basis of accounting to record their financial information as it provides a more accurate picture of a company’s true financial position. However, it also makes it difficult to measure the true cash impact of a single financial transaction. By implementing working capital management strategies, one may optimize cash flow and ensure that the company has enough liquid assets to cover short-term obligations. While performing the cash flow analysis, one needs to consider the cash inflow or outflow generated as a result of a specific business decision.
3. Inventory Turnover Analysis
Inventory turnover involves a calculation of how many times the inventory has been sold and replaced in a given period of time. It helps businesses in making better decisions on pricing, manufacturing, marketing, and purchasing inventory. Inventory Turnover analysis also helps in identifying the carrying cost of inventory. The carrying cost of inventory is the amount of expense a company incurs to store unsold items.
4. Constraint Analysis
Reviewing the constraints within a production line or sales process is also a part of Managerial accounting. It involves determining where bottlenecks occur and calculating the impact of these constraints on revenue, profit, and cash flow. This information is useful to implement changes and improve efficiencies in the production or sales process.
5. Financial Leverage Metrics
Financial leverage refers to the use of borrowed funds in order to acquire assets and increase its return on investments. Through balance sheet analysis, the company’s debt and equity mix in order to put leverage to its most optimal use can be studied. Performance measures such as return on equity, debt to equity, and return on invested capital help the managers to identify key information about borrowed capital.
6. Accounts Receivable (AR) Management
Accounts Receivables invoices are categorized by the length of time they have been outstanding in an accounts receivable ageing report. It may list all outstanding receivables less than 30 days, 30 to 60 days, 60 to 90 days, and 90+ days. It helps the managers to ascertain whether certain customers are becoming credit risks. If a customer routinely pays late, management may reconsider doing any future business on credit with that customer.
7. Budgeting, Trend Analysis, and Forecasting
Budgets are a quantitative expression of the company’s plan of operation. Performance reports are used to study the deviations of actual results from budgets. The positive or negative deviations from a budget are analyzed in order to make appropriate changes going forward with the future planning.
Managerial accounting also helps in analyzing information related to capital expenditure decisions with the use of standard capital budgeting metrics, such as NPV and IRR. It assists decision-makers on whether to invest in capital-intensive projects or purchases or not.
Managerial accounting also includes reviewing the trendline for certain expenses as well as investigating unusual deviations.
Advantages and Objectives of Management Accounting
There are many objectives but the prime objective is to assist the management team of an organization in improving the quality of their decisions. The purpose of management accounting is to help the managerial team with financial information so that they can execute business operations and activities more efficiently. Following is the list of all benefits of management accounting –
- Decision Making
- Planning
- Controlling business operations
- Organizing
- Understanding financial data
- Identifying business problem areas
- Strategic Management
Decision Making
This is the most important benefit of the process of management accounting. In fact, it is the main purpose of it. In this form of accounting, we use techniques from all fields like costing, economics, statistics, etc.
It provides us with charts, tables, forecasts and various such analysis that makes the process of decision making easier and more justified.
Planning
Managerial accounting does not have any strict timelines like financial accounting. It is, in fact, a continuous and ongoing process.
So financial and other information is presented to the management at regular intervals like weekly, monthly or sometimes even daily.
Hence managers can use this analysis and data to plan the activities of the organization. For example, if the recent data shows a dip in the sales for a certain region, then the sales manager can advise his team and plan some action to rectify the situation.
Identifying Business Problem Areas
If some product is not performing well, or some department is running into unexpected losses, etc. managerial accounting can help us identify the underlying cause.
Actually, if the management is diligent and their data and reports are frequent, they can identify the problem very early on. This will allow the management to get ahead of the problem.
Strategic Management
Concept of management accounting is not mandatory by any law. So it can have its own structure according to the company’s requirements. So if the company feels certain areas need more in-depth analysis or investigation it can do so freely.
This allows them to focus on some core areas. The information presented to them allows them to make strategic management decisions.
Like if the company wishes to launch a new product line, or discontinue an existing one, management accounting will play a huge part in this strategy.
Limitations of Management Accounting
- Data based on Financial accounting – Decisions taken by the management team are based on the data provided by Financial Accounting
- Less knowledge – Management has insufficient knowledge of economics, finance, statistics, etc.
- Outdated data – Management team receives historical data, which may change eventually when management is taking the decisions.
- Expensive – Setting up a management accounting system requires a lot of investment.
What is a Relevant Cost?
A relevant cost is a cost that only relates to a specific management decision, and which will change in the future as a result of that decision. The relevant cost concept is extremely useful for eliminating extraneous information from a particular decision-making process. Also, by eliminating irrelevant costs from a decision, management is prevented from focusing on information that might otherwise incorrectly affect its decision.
This concept is only applicable to management accounting activities; it is is not used in financial accounting, since no spending decisions are involved in the preparation of financial statements.
Example of Relevant Costs
For example, the Archaic Book Company (ABC) is considering purchasing a printing press for its medieval book division. If ABC buys the press, it will eliminate 10 scribes who have been copying the books by hand. The wages of these scribes are relevant costs, since they will be eliminated in the future if management buys the printing press. However, the cost of corporate overhead is not a relevant cost, since it will not change as a result of this decision.
As another example, if ABC wants to close its medieval book division entirely, the only relevant costs will be those costs specifically eliminated as a result of the decision. Once again, the cost of corporate overhead is not a relevant cost when making this decision, since it will not change if the division is sold.
Relevant Costs vs. Sunk Costs
The reverse of a relevant cost is a sunk cost. A sunk cost is an expenditure that has already been made, and so will not change on a go-forward basis as the result of a management decision.
What Is a Make-or-Buy Decision?
A make-or-buy decision is an act of choosing between manufacturing a product in-house or purchasing it from an external supplier.
Also referred to as an outsourcing decision, a make-or-buy decision compares the costs and benefits associated with producing a necessary good or service internally to the costs and benefits involved in hiring an outside supplier for the resources in question.
To compare costs accurately, a company must consider all aspects regarding the acquisition and storage of the items versus creating the items in-house, which may require the purchase of new equipment, as well as storage costs.
Understanding a Make-or-Buy Decision
Regarding in-house production, a business must include expenses related to the purchase and maintenance of any production equipment and the cost of production materials. Costs to make the product can include the additional labor required to produce the items, which takes the form of wages and benefits, storage requirements within the facility, holding costs overall, and the proper disposal of any remnants or byproducts from the production process.
Buy costs related to purchasing the products from an outside source must include the price of the good itself, any shipping or importing fees, and applicable sales tax charges. Additionally, the company must factor in the expenses relating to the storage of the incoming product and labor costs associated with receiving the products into inventory. It also includes signing any contracts with suppliers that might require the company to be locked-in to certain deals for a certain period of time.
Pricing approaches
The three key approaches relate to pricing from a financial, economic, or market perspectives. Each of these has different merits and within these three broad approaches there are different techniques that can be used.
Financial approach to pricing This is often referred to as the traditional approach to pricing. Although there are a number of variations the basic traditional approach is simply: Costs + Mark-up = Selling price Mark-up is a predetermined amount added to the costs to calculate the selling price. Given the calculation, this approach is known as Cost-plus pricing. There are variations to the cost base in this formula that lead to variations to this approach – these are summarised in Figure 6.1 and then discussed in more detail.
Multiple Choice Questions (MCQs)-
1. What is considered the language of business used to communicate financial information?
- Marketing
- Profit
- Pricing
- Accounting
Answer- D) Accounting
Explanation- Accounting is considered the way of communication to attract customers through marketing.
2. When was the term Management Accounting coined?
- 1970
- 1950
- 1940
- 1931
Answer- B) 1950
Explanation- In 1950, management accounting was considered in its original form to keep track of the businesses.
3. What is the main objective of management accounting?
- To identify and analyse the result of business operations.
- To study business transactions
- To check and maintain accounting records
- To remind the amount due to customers
Answer- A) To identify and analyse the result of business operations.
Explanation- Management accounting is focused on analysing the financial performance of a company and creating reports for future use.
4. Which personnel of a financial firm play a key role in management accounting?
- Investors
- Managers
- Suppliers
- Customers
Answer- B)Managers
Explanation- Management accounting helps the managers in initiating policies and in decision making.
5. What are the instruments/ tools related to management accounting?
- Marginal costing
- Standard costing
- Budget control
- All of the above
Answer- D)All of the above
Explanation- Marginal costing, standard costing, and budget control are tools based on cost-accounting information and for future information on management accounting.
6. Where is management accounting applied?
- Small trading organisations
- NPOs
- Cooperative societies
- Large industrial and trading organisations
Answer- D) Large industrial and trading organisations
Explanation- Large-scale companies use management accounting to get an idea about the competition, business environment and production of technology.
7. Who discovered the term Management Accounting?
- R. N Carter
- James H Bliss
- Philip Cotler
- F.W. Taylor
Answer- B) James H Bliss
Explanation- James discovered the term Management through accounts, and he contributed to accounting through his book with the same title.
8. What is the main function of management accounting?
- Decision making
- Planning
- Direction
- Provision of information to management
Answer- D) Provision of information to management
Explanation- Management accounting analyses and creates reports related to the financial performance management of a company with the help of available information.
9. Which of the following options is not characteristic of management accounting?
- Future-oriented
- Accounting information
- Compulsory accounting.
- Management oriented
Answer- C) Compulsory accounting
Explanation- Management accounting is not mandatorily done in all financial institutions or companies.
10. Who stated the definition of management accounting as “Management Accounting is concerned with accounting information which is useful to management”?
- Robert Anthony
- Michael Porter
- J. Batty
- James H Bliss
Answer- A) Robert Antony
Explanation- Robert Anthony has introduced the hierarchy of management in an organisation and created a framework related to managerial accounting.
11. Management accounting is used as …………
- Compulsory
- Optional
- Mandatory
- Any of the above
Answer- B) Optional
Explanation- The reports and business performance results may not be compulsorily maintained in all the organisations so management accounting is optional.
12. The management is provided with invaluable services by management accounting through?
- Controlling functions
- Financial data evaluation
- All managerial functions
- None of the above
Answer- C) All managerial functions
Explanation- The management accounting handles and regulates all the management functions of a company.
13. Which of the following statements are true according to management accounting?
- Management accounting is compulsory.
- Is objective in nature?
- It is mainly focused on future
- Management accounting and cost-accounting are similar.
Answer– A) It is only focused on the future.
Explanation- Management accounting helps in evaluating and keeping records of the activities and performance of the business which will be important for managers in the future.
14. Which of the following is not a management accounting tool?
- Cash flow statement
- Fund flow statement
- Ratio analysis
- Process costing
Answer- D)Process costing
Explanation- Process costing is a part of the management accounting which is used to ascertain the cost, process and operations of manufacture.
15. What is the scope of management accounting?
- Cost accounting
- Budgeting
- Forecasting
- All of the above
Answer- D)All of the above
Explanation- Management accounting aims to perform correct budgeting, forecasting and cost accounting based on the information source.
16. The accounting data are analysed and evaluated with the help of …………
- Tools and techniques
- Auditory
- Statutory forms
- None of the above
Answer- A) tools and techniques
Explanation– It facilitates the financial and accounting data by using appropriate tools and techniques.
17. Management accounting deals with managing …………
- Decision making
- Raising finance
- Tax returns
- Final accounts preparation
Answer- A) Decision making
Explanation- Decision making is the most important function of a management account which helps the managers to resolve any financial problems.
18. What are the decisions that are made for a long term period called?
- Working capital decision
- Future decisions
- Capital budgeting decisions
- Profit volume analysis.
Answer- C) Capital budgeting decisions
Explanation- These decisions are made for long term investment whether or not the project will be fruitful in terms of cash flow.
19. What is the basic function of management accounting?
- To serve public
- To manage the performance of the financial function
- To serve government
- All of the above
Answer- B) To manage the performance the financial function
Explanation- The financial operations are managed and regulated by management accounting.
20. Which type of information can be recorded in management accounting?
- Quantitative
- Qualitative
- Both (a) and (b)
- All of the above
Answer- A) Quantitative information
Explanation- Management accounting identifies and stores the quantitative information of the operations performed in a company.
Management accounting can be viewed as __________.
A. Marketing-oriented Accounting
B. Management-oriented Accounting
C. Accounting-oriented Management
D. Manager-oriented Accounting
View Answer
B. Management-oriented Accounting
________ is the language of Business which used to communicate financial information.
A. Accounting
B. Marketing
C. Profit
D. Pricing
View Answer
A. Accounting
The term management accounting was first coined in ____.
A. 1940
B. 1950
C. 1960
D. 1970
View Answer
B. 1950
_______ the sub-field of accounting.
A. Management accounting
B. Cost accounting
C. Financial accounting
D. All of the above
View Answer
D. All of the above
The main objective of management accounting is _________
A. To maintain the accounting records
B. To know the amount due from customers and suppliers
C. To ascertain analyse and interpret the results of business operations
D. To record all the business transactions
View Answer
C. To ascertain analyse and interpret the results of business operations
The term Management Accounting was coined by ______
A. F.W. Taylor
B. James H Bliss
C. R. N Carter
D. Philip Kotler
View Answer
B. James H Bliss
____________ is the study of managerial aspects of financial accounting
A. Cost accounting
B. Financial accounting
C. Management accounting
D. Business accounting
View Answer
C. Management accounting
The purpose of management accounting is to help ______ make decisions
A. managers
B. investors
C. marketers
D. banks
View Answer
A. managers
Managerial accounting information is generally prepared for _______
A. managers
B. stakeholders
C. government agencies
D. competitors
View Answer
A. managers
_______ play a key role in management accounting
A. Investors
B. Managers
C. Customers
D. Suppliers
View Answer
B. Managers
_________shows how the accounting function can be represented so as to fit it within the framework of Management activity.
A. Management accounting
B. Cost accounting
C. Financial accounting
D. Tax accounting cancer is Management accounting
View Answer
A. Management accounting
The primary task of management accounting is, therefore, to redesign the entire accounting system so that it may serve the ___________ needs of the firm.
A. Marketing
B. Operational
C. Human resource
D. Production
View Answer
B. Operational
_______ is the tool/s of management accounting.
A. Marginal Costing
B. Budget and budgetary control
C. Standard Costing
D. All A, B & C
View Answer
D. All A, B & C
Management accounting provides information to management so that planning organising directing and controlling of business operations can be done in an orderly manner.
A. Organising controlling planning and directing
B. Planning controlling organising directing
C. Planning organising directing controlling
D. Organising planning directing controlling
View Answer
C. Planning organising directing controlling
Which is the main characteristic of Management accounting?
A. Cause and effect analysis
B. providing accounting information
C. Helping to achieve organisational goals
D. All of the above
View Answer
D. All of the above
Management accounting is generally applied to __________
A. Large industrial and trading organisations
B. Cooperative societies
C. Non Profit Organisations
D. Small trading organisations
View Answer
A. Large industrial and trading organisations
Management accounting assists the management in_______
A. planning
B. directing
C. Controling
D. All of the above
View Answer
D. All of the above
Management accounting is mainly applicable to _______entities.
A. non profit
B. service
C. manufacturing
D. All of the above
View Answer
D. All of the above
The scope of Management accounting includes _______
A. Budgeting and forecasting
B. Internal audit and tax accounting
C. Financial and cost accounting
D. All of the above
D. All of the above
The origin of the term Management Accounting goes back to year _______
A. 1950
B. 1939
C. 1929
D. 1896
View Answer
A. 1950
Which is NOT a limitation of Management accounting?
A. Management accounting is only a tool
B. Personal prejudice and bias
C. Evaluation and control of performance
D. Psychological resistance
View Answer
C. Evaluation and control of performance
Which is NOT an advantage of Management accounting?
A. Economic appraisal
B. Helps in decision making
C. Influenced by personal bias
D. Facilitates communication
View Answer
C. Influenced by personal bias
Goodwill is one of the _______
A. Current assets
B. Tangible assets
C. Intangible assets
D. Liquid assets
View Answer
C. Intangible assets
The concept of management accounting was introduced by ______
A. Arthur Andersen
B. James H. Bliss
C. William Beaver
D. Herman Bevis
View Answer
B. James H. Bliss
The term Management Accounting is mainly related to _______
A. presentation of account data
B. planning of account data
C. accurate recording of data
D. sharing the most reliable cost data with agencies
View Answer
A. presentation of account data
Salary is one of the ________
A. Direct expenses
B. Non cash expenses
C. Capital expenses
D. Revenue expenses
View Answer
D. Revenue expenses
Wealth maximization is a _________
A. short term concept
B. temporary concept
C. long term concept
D. outdated concept
View Answer
C. long term concept
Management Accounting provides invaluable services to management in performing___________
A. planning and controlling management principles
B. analysis and interpretation of financial data
C. supply of regular funds
D. all management functions
View Answer
D. all management functions
_______ deals with the accounting & reporting of information to management regarding the detail information.
A. cost accounting
B. financial accounting
C. management accounting
D. traditional accounting
View Answer
C. management accounting
Management accounting is mainly _____
A. Future oriented
B. Past oriented
C. Customer oriented
D. Bank oriented
View Answer
A. Future oriented
Management accounting concentrates on _______
A. preparation of PL account
B. creation of balance sheet
C. providing accounting details to macro environment
D. control of business operations
View Answer
D. control of business operations
In management accounting, an emphasis and focus must be _____ oriented.
A. bank
B. communication
C. future
D. past
View Answer
C. future
Salaries, wages, depreciations, rent & utilitie are used to calculate ________
A. marginal costs
B. output cost
C. operating costs
D. fixed costs
View Answer
C. operating costs
______ is responsible for financial operations of the organization.
A. CEO
B. CMO
C. CFO
D. CA
View Answer
C. CFO (Chief Financial Officer)
The primary objective of management accounting is to ______
A. furnish management complete and true information
B. supply profit and loss details to stakeholders
C. manage company account and improve sales
D. cut the operation cost to provide more savings
View Answer
A. furnish management complete and true information
The use of management accounting is ______
A. mandatory
B. compulsory
C. most essential
D. optional
View Answer
D. optional
____ is the type of accounting.
A. cost accounting
B. management accounting
C. financial accounting
D. all of the above
View Answer
D. all of the above
Management accounting helps ______ to make decisions.
A. Customers
B. Investors
C. Managers
D. Banks
View Answer
C. Managers
Difference between Management Accounting and Financial Accounting
| Sr. No. | Management Accounting | Financial Accounting |
| 1 | Only used for internal purposes of the firm | For external reporting to various stakeholders and mandatory by law in most cases |
| 2 | Is not under the regulation of any law or regulations | Is governed by Standards, Laws, regulations, etc |
| 3 | The main purpose is to help internal management take decisions | Helps investors, creditors, etc. take investment decisions |
| 4 | Includes both financial and non-financial information | Is only concerned with financial information |
| 5 | Not subject to any audits or investigation | Financial records are audited as per the norms |
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