Unit-I: Introduction to Cost Accounting

Cost Accounting
As compared to the financial accounting, the focus of cost accounting is different. In the modern
days of cut throat competition, any business organization has to pay attention towards their cost
of production. Computation of cost on scientific basis and thereafter cost control and cost
reduction has become of paramount importance. Hence it has become essential to study the basic
principles and concepts of cost accounting. These are discussed in the subsequent paragraphs.

1. Cost: - Cost can be defined as the expenditure (actual or notional) incurred on or

attributable to a given thing. It can also be described as the resources that have been
sacrificed or must be sacrificed to attain a particular objective. In other words, cost is the
amount of resources used for something which must be measured in terms of money.
For example Cost of preparing one cup of tea is the amount incurred on the elements
like material, labor and other expenses; similarly cost of offering any services like
banking is the amount of expenditure for offering that service. Thus cost of production or
cost of service can be calculated by ascertaining the resources used for the production or
services.

2. Costing: - Costing may be defined as the technique and process of ascertaining costs.
According to Wheldon, Costing is classifying, recording, allocation and appropriation of
expenses for the determination of cost of products or services and for the presentation of
suitably arranged data for the purpose of control and guidance of management. It includes
the ascertainment of every order, job, contract, process, service units as may be
appropriate. It deals with the cost of production, selling and distribution. If we analyze
the above definitions, it will be understood that costing is basically the procedure of
ascertaining the costs. As mentioned above, for any business organization, ascertaining of
costs is must and for this purpose a scientific procedure should be followed. Costing is
precisely this procedure which helps them to find out the costs of products or services.

3. Cost Accounting: - Cost Accounting primarily deals with collection, analysis of relevant
of cost data for interpretation and presentation for various problems of management. Cost
accounting accounts for the cost of products, service or an operation. It is defined as, the
establishment of budgets, standard costs and actual costs of operations, processes,
activities or products and the analysis of variances, profitability or the social use of
funds.

4. Cost Accountancy: - Cost Accountancy is a broader term and is defined as, the
application of costing and cost accounting principles, methods and techniques to the
science and art and practice of cost control and the ascertainment of profitability as well

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 as presentation of information for the purpose of managerial decision making. If we
analyze the above definition, the following points will emerge,

A. Cost accounting is basically application of the costing and cost accounting principles.
B. This application is with specific purpose and that is for the purpose of cost control,
ascertainment of profitability and also for presentation of information to facilitate
decision making.
C. Cost accounting is a combination of art and science, it is a science as it has well
defined rules and regulations, it is an art as application of any science requires art and
it is a practice as it has to be applied on continuous basis and is not a onetime
exercise.

5. Objectives of Cost Accounting :- Objectives of Cost Accounting can be summarized as

under:-
a) To ascertain the cost of production on per unit basis, for example, cost per kg, cost
per meter, cost per liter, cost per ton etc.
b) Cost accounting helps in the determination of selling price. Cost accounting enables
to determine the cost of production on a scientific basis and it helps to fix the selling
price.
c) Cost accounting helps in cost control and cost reduction.
d) Ascertainment of division wise, activity wise and unit wise profitability becomes
possible through cost accounting.
e) Cost accounting also helps in locating wastages, inefficiencies and other loopholes in
the production processes/services offered.
f) Cost accounting helps in presentation of relevant data to the management which helps
in decision making. Decision making is one of the important functions of
Management and it requires presentation of relevant data. Cost accounting enables
presentation of relevant data in a systematic manner so that decision making becomes
possible.
g) Cost accounting also helps in estimation of costs for the future.

6. Essentials of a good Costing system: - For availing of maximum benefits, a good

costing system should possess the following characteristics.
A) Costing system adopted in any organization should be suitable to its nature and size
of the business and its information needs.
B) A costing system should be such that it is economical and the benefits derived from
the same should be more than the cost of operating of the same.
C) Costing system should be simple to operate and understand. Unnecessary
complications should be avoided.

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 D) Costing system should ensure proper system of accounting for material, labor and
overheads and there should be proper classification made at the time of recording of
the transaction itself.
E) Before designing a costing system, need and objectives of the system should be
identified.
F) The costing system should ensure that the final aim of ascertaining of cost as
accurately possible should be achieved.

7. Certain Important Terms: - It is necessary to understand certain important terms used

in cost accounting.
A. Cost Center :- Cost Center is defined as, a production or service, function, activity
or item of equipment whose costs may be attribute organizational sub unit for which
separate cost allocation is attempted. To put in simple words, a cost center is nothing
but a location, person or item of equipment for which cost may be ascertained and
used for the purpose of cost control. For example, a production department, stores
department, sales department can be cost centers. Similarly, an item of equipment like
a lathe, fork-lift, and truck or delivery vehicle can be cost center, a person like sales
manager can be a cost center. The main object of identifying a cost center is to
facilitate collection of costs so that further accounting will be easy. A cost center can
be either personal or impersonal, similarly it can be a production cost center or
service cost center. A cost center in which a specific process or a continuous
sequence of operations is carried out is known as Process Cost Center.

B. Profit Center: - Profit Center is defined as, a segment of the business entity by
which both revenues are received and expenses are incurred or controlled. (CEMA)
A profit center is any sub unit of an organization to which both revenues and costs are
assigned. As explained above, cost center is an activity to which only costs are
assigned but a profit center is one where costs and revenues are assigned so that profit
can be ascertained. Such revenues and expenditure are being used to evaluate
segmental performance as well as managerial performance. A division of an
organization may be called as profit center. The performance of profit center is
evaluated in terms of the fact whether the center has achieved its budgeted profits.
Thus the profit center concept is used for evaluation of performance.

8. Costing Systems: - There are different costing systems used in practice. These are
described below.
i) Historical Costing: - In this system, costs are ascertained only after they are incurred
and that is why it is called as historical costing system. For example, costs incurred in
the month of April, 2007 may be ascertained and collected in the month of May. Such
type of costing system is extremely useful for conducting post-mortem examination

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 of costs, i.e. analysis of the costs incurred in the past. Historical costing system may
not be useful from cost control point of view but it certainly indicates a trend in the
behavior of costs and is useful for estimation of costs in future.
ii) Absorption Costing: - In this type of costing system, costs are absorbed in the
product units irrespective of their nature. In other words, all fixed and variable costs
are absorbed in the products. It is based on the principle that costs should be charged
or absorbed to whatever is being costed, whether it is a cost unit, cost center.
iii) Marginal Costing: - In Marginal Costing, only variable costs are charged to the
products and fixed costs are written off to the Costing Profit and Loss A/c. The
principle followed in this case is that since fixed costs are largely period costs, they
should not enter into the production units. Naturally, the fixed costs will not enter into
the inventories and they will be valued at marginal costs only.
iv) Uniform Costing: - This is not a distinct method of costing but is the adoption of
identical costing principles and procedures by several units of the same industry or by
several undertakings by mutual agreement. Uniform costing facilitates valid
comparisons between organizations and helps in eliminating inefficiencies.

9. To cost Classification of Costs: - An important step in computation and analysis of cost

is the classification of costs into different types. Classification helps in better control of
the costs and also helps considerably in decision making. Classification of costs can be
made according to the following basis.

A. Classification according to elements: - Costs can be classified according to the

elements. There are three elements of costing, viz. material, labor and expenses. Total
cost of production/services can be divided into the three elements to find out the
contribution of each element in the total costs.

B. Classification according to nature: - As per this classification, costs can be

classified into Direct and Indirect. Direct costs are the costs which are identifiable
with the product unit or cost center while indirect costs are not identifiable with the
product unit or cost center and hence they are to be allocated, apportioned and then
absorb in the production units. All elements of costs like material, labor and expenses
can be classified into direct and indirect.

They are mentioned below.

i) Direct and Indirect Material: - Direct material is the material which is identifiable
with the product. For example, in a cup of tea, quantity of milk consumed can be
identified, quantity of glass in a glass bottle can be identified and so these will be
direct materials for these products. Indirect material cannot be identified with the

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 product, for example lubricants, fuel, oil, cotton wastes etc cannot be identified with a
given unit of product and hence these are the examples of indirect materials.
ii) Direct and Indirect Labor: - Direct labor can be identified with a given unit of
product, for example, when wages are paid according to the piece rate, wages per unit
can be identified. Similarly wages paid to workers who are directly engaged in the
production can also be identified and hence they are direct wages. On the other hand,
wages paid to workers like sweepers, gardeners, maintenance workers etc are indirect
wages as they cannot be identified with the given unit of production.
iii) Direct and Indirect Expenses :- Direct expenses refers to expenses that are
specifically incurred and charged for specific or particular job, process, service, cost
center or cost unit. These expenses are also called as chargeable expenses. Examples
of these expenses are cost of drawing, design and layout, royalties payable on use of
patents, copyrights etc, consultation fees paid to architects, surveyors etc. Indirect
expenses on the other hand cannot be traced to specific product, job, process, service
or cost center or cost unit. Several examples of indirect expenses can be given like
insurance, electricity, rent, salaries, advertising etc. It should be noted that the total of
direct expenses is known as Prime Cost while the total of all indirect expenses is
known as Overheads.

C) Classification according to behavior: - Costs can also be classified according to their

behavior. This classification is explained below.
i. Fixed Costs: - Out of the total costs, some costs remain fixed irrespective of
changes in the production volume. These costs are called as fixed costs. The
feature of these costs is that the total costs remain same while per unit fixed cost
is always variable. Examples of these costs are salaries, insurance, rent, etc t units.
ii. Variable Costs: - These costs are variable in nature, i.e. they change according to
the volume of production. Their variability is in the same proportion to the
production. For example, if the production units are 2,000 and the variable cost is
Rs. 5 per unit, the total variable cost will be Rs. 10,000, if the production units are
increased to 5,000 units, the total variable costs will be Rs. 25,000, and i.e. the
increase is exactly in the same proportion of the production. Another feature of
the variable cost is that per unit variable cost remains same while the total
variable costs will vary. In the example given above, the per unit variable cost
remains Rs. 2 per unit while total variable costs change. Examples of variable
costs are direct materials, direct labor etc.
iii. Semi-variable Costs: - Certain costs are partly fixed and partly variable. In other
words, they contain the features of both types of costs. These costs are neither
totally fixed nor totally variable. Maintenance costs, supervisory costs etc are
examples of semi-variable costs. These costs are also called as stepped costs.

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 D) Classification according to functions: - Costs can also be classified according to the
functions/activities. This classification can be done as mentioned below.
i) Production Costs: - All costs incurred for production of goods are known as
production costs.
ii) Administrative Costs: - Costs incurred for administration are known as
administrative costs. Examples of these costs are office salaries, printing and
stationery, office telephone, office rent, office insurance etc.
iii) Selling and Distribution Costs :- All costs incurred for procuring an order are called
as selling costs while all costs incurred for execution of order are distribution costs.
Market research expenses, advertising, sales staff salary, sales promotion expenses
are some of the examples of selling costs. Transportation expenses incurred on sales,
warehouse rent etc are examples of distribution costs.
iv) Research and Development Costs: - In the modern days, research and development
has become one of the important functions of a business organization. Expenditure
incurred for this function can be classified as Research and Development Costs.

E) Classification according to time: - Costs can also be classified according to time. This
classification is explained below.
I) Historical Costs: - These are the costs which are incurred in the past, i.e. in the
past year, past month or even in the last week or yesterday. The historical costs
are ascertained after the period is over. In other words it becomes a post-mortem
analysis of what has happened in the past. Though historical costs have limited
importance, still they can be used for estimating the trends of the future, i.e. they
can be effectively used for predicting the future costs.
II) Predetermined Cost: - These costs relating to the product are computed in
advance of production, on the basis of a specification of all the factors affecting
cost and cost data. Pre determined costs may be either standard or estimated.
Standard Cost is a predetermined calculation of how much cost should be under
specific working conditions. It is based on technical studies regarding material,
labor and expenses. The main purpose of standard cost is to have some kind of
benchmark for comparing the actual performance with the standards. On the other
hand, estimated costs are predetermined costs based on past performance and
adjusted to the anticipated changes. It can be used in any business situation or
decision making which does not require accurate cost.

F. Classification of costs for Management decision making: - One of the important

functions of cost accounting is to present information to the Management for the purpose
of decision making. For decision making certain types of costs are relevant. Classification
of costs based on the criteria of decision making can be done in the following manner:

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 I) Marginal Cost: - Marginal cost is the change in the aggregate costs due to
change in the volume of output by one unit. For example, suppose a
manufacturing company produces 10,000 units and the aggregate costs are Rs.
25,000; if 10,001 units are produced the aggregate costs may be Rs. 25,020 which
means that the marginal cost is Rs. 20. Marginal cost is also termed as variable
cost and hence per unit marginal cost is always same, i.e. per unit marginal cost is
always fixed. Marginal cost can be effectively used for decision making in
various areas.
II) Differential Costs: - Differential costs are also known as incremental cost. This
cost is the difference in total cost that will arise from the selection of one
alternative to the other. In other words, it is an added cost of a change in the level
of activity. This type of analysis is useful for taking various decisions like change
in the level of activity, adding or dropping a product, change in product mix,
make or buy decisions, accepting an export offer and so on.
III) Opportunity Costs: - It is the value of benefit sacrificed in favor of an alternative
course of action. It is the maximum amount that could be obtained at any given
point of time if a resource was sold or put to the most valuable alternative use that
would be practicable. Opportunity cost of goods or services is measured in terms
of revenue which could have been earned by employing that goods or services in
some other alternative uses.
IV) Relevant Cost: - The relevant cost is a cost which is relevant in various decisions
of management. Decision making involves consideration of several alternative
courses of action. In this process, whatever costs are relevant are to be taken into
consideration. In other words, costs which are going to be affected matter the
most and these costs are called as relevant costs. Relevant cost is a future cost
which is different for different alternatives. It can also be defined as any cost
which is affected by the decision on hand. Thus in decision making relevant costs
plays a vital role.
V) Replacement Cost: - This cost is the cost at which existing items of material or
fixed assets can be replaced. Thus this is the cost of replacing existing assets at
present or at a future date.
VI) Abnormal Costs: - It is an unusual or a typical cost whose occurrence is usually
not regular and is unexpected. This cost arises due to some abnormal situation of
production. Abnormal cost arises due to idle time, may be due to some
unexpected heavy breakdown of machinery. They are not taken into consideration
while computing cost of production or for decision making. Cost and
Management Accounting12
VII) Controllable Costs: - In cost accounting, cost control and cost reduction is
extremely important. In fact, in the competitive environment, cost control and
reduction are the key words. Hence it is essential to identify the controllable and

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 uncontrollable costs. Controllable costs are those which can be controlled or
influenced by a conscious management action. For example, costs like telephone,
printing stationery etc can be controlled while costs like salaries etc cannot be
controlled at least in the short run. Generally, direct costs are controllable while
uncontrollable costs are beyond the control of an individual in a given period of
time.
VIII) Shutdown Cost: - These costs are the costs which are incurred if the operations
are shut down and they will disappear if the operations are continued. Examples
of these costs are costs of sheltering the plant and machinery and construction of
sheds for storing exposed property. Computation of shutdown costs is extremely
important for taking a decision of continuing or shutting down operations.
IX) Capacity Cost: - These costs are normally fixed costs. The cost incurred by a
company for providing production, administration and selling and distribution
capabilities in order to perform various functions. Capacity costs include the costs
of plant, machinery and building for production, warehouses and vehicles for
distribution and key personnel for administration. These costs are in the nature of
long-term costs and are incurred as a result of planning decisions.
X) Urgent Costs: - These costs are those which must be incurred in order to continue
operations of the rm. For example, cost of material and labor must be incurred if
production is to take place.

10. Costing Methods and Techniques :-

Introduction: - It is necessary to understand the difference between the costing methods

and techniques. Costing methods are those which help a firm to compute the cost of
production or services offered by it. On the other hand, costing techniques are those
which help a firm to present the data in a particular manner so as to facilitate the decision
making as well as cost control and cost reduction. Costing methods and techniques are
explained below.

Methods of Costing: - The following are the methods of costing.

I. Job Costing: - This method is also called as job costing. This costing method is used
in firms which work on the basis of job work. There are some manufacturing units
which undertake job work and are called as job order units. The main feature of these
organizations is that they produce according to the requirements and specifications of
the consumers. Each job may be different from the other one. Production is only on
specific order and there is no pre demand production. Because of this situation, it is
necessary to compute the cost of each job and hence job costing system is used. In
this system, each job is treated separately and a job cost sheet is prepared to find out

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 the cost of the job. The job cost sheet helps to compute the cost of the job in a phased
manner and finally arrives the total cost of production.
II. Batch Costing: - This method of costing is used in those firms where production is
made on continuous basis. Each unit coming out is uniform in all respects and
production is made prior to the demand, i.e. in anticipation of demand. One batch of
production consists of the units produced from the time machinery is set to the time
when it will be shut down for maintenance. For example, if production commences
on 1st January 2007 and the machine is shut down for maintenance on 1st April 2007,
the number of units produced in this period will be the size of one batch. The total
cost incurred during this period will be divided by the number of units produced and
unit cost will be worked out. Firms producing consumer goods like television, air-
conditioners, washing machines etc use batch costing.
III. Process Costing: - Some of the products like sugar, chemicals etc involve continuous
production process and hence process costing method is used to work out the cost of
production. The meaning of continuous process is that the input introduced in the
process I travels through continuous process before finished product is produced. The
output of process I becomes input of process II and the output of process II becomes
input of the process III. If there is no additional process, the output of process III will
be the finished product. In process costing, cost per process is worked out and per
unit cost is worked out by dividing the total cost by the number of units. Industries
like sugar, edible oil, chemicals are examples of continuous production process and
use process costing.
IV. Operating Costing: - This type of costing method is used in service sector to work
out the cost of services offered to the consumers. For example, operating costing
method is used in hospitals, power generating units, transportation sector etc. A cost
sheet is prepared to compute the total cost and it is divided by cost units for working
out the per unit cost.
V. Contract Costing: - This method of costing is used in construction industry to work
out the cost of contract undertaken. For example, cost of constructing a bridge,
commercial complex, residential complex, highways etc is worked out by use of this
method of costing. Contract costing is actually similar to job costing, the only
difference being that in contract costing, one construction job may take several
months or even years before they are complete while in job costing, each job may be
of a short duration. In contract costing, as each contract may take a long period for
completion, the question of computing of profit is to be solved with the help of a well
defined and accepted method.

11. Technique of Costing: - As mentioned above, costing methods are for computation of
the total cost of production/services offered by a rm. On the other hand, costing
technique help to present the data in a particular format so that decision making becomes

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 easy. Costing techniques also help for controlling and reducing the costs. The following
are the techniques of costing.

I. Marginal Costing: - This technique is based on the assumption that the total cost of
production can be divided into fixed and variable. Fixed costs remain same
irrespective of the changes in the volume of production while the variable costs vary
with the level of production, i.e. they will increase if the production increases and
decrease if the production decreases. Variable cost per unit always remains the same.
In this technique, only variable costs are taken into account while calculating
production cost. Fixed costs are not absorbed in the production units. They are written
off to the Costing Profit and Loss Account. The reason behind this is that the fixed
costs are period costs and hence should not be absorbed in the production. Secondly
they are variable on per unit basis and hence there is no equitable basis for charging
them to the products. This technique is effectively used for decision making in the
areas like make or buys decisions, optimizing of product mix, key factor analysis,
fixation of selling price, accepting or rejecting an export offer, and several other
areas.
II. Standard Costing: - Standard costs are predetermined costs relating to material,
labor and overheads. Though they are predetermined, they are worked out on
scientific basis by conducting technical analysis. They are computed for all elements
of costs such as material, labor and overheads. The main objective of fixation of
standard cost is to have benchmark against which the actual performance can be
compared. This means that the actual costs are compared with the standards. The
difference is called as variance. If actual costs are more than the standard, the
variance is adverse while if actual costs are less than the standard, the variance is
favorable. The adverse variances are analyzed and reasons for the same are found
out. Favorable variances may also be analyzed to find out the reasons behind the
same. Standard costing thus is an important technique for cost control and reduction.

Budgets and Budgetary Control: - Budget is defined as, a quantitative and/or a monetary
statement prepared to prior to a defined period of time for the policies during that period for
the purpose of achieving a given objective. If we analyze this definition, it will be clear that
a budget is a statement, which may be either in monetary form or quantitative form or both.
For example, a production budget can be prepared in quantitative form showing the target
production; it can also be prepared in monetary terms showing the expected cost of
production. Some budgets can be prepared only in monetary terms, e.g. cash budget showing
the estimated receipts and payments in a particular period can be prepared in monetary terms
only. Another feature of budget is that it is always prepared prior to a defined period of time
which means that budget is always prepared for future and that too a defined future. For
example, a budget may be prepared for next 12 months or 6 months or even for 1 month, but
the time period must be certain and not vague. One of the important aspects of budgeting is

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 that it lays down the objective to be achieved during the defined period of time and for
achieving the objectives, whatever policies are to be pursued are reflected in the budget.
Budgetary control involves preparation of budgets and continuous comparison of actual with
budgets so that necessary corrective action can be taken. For example, when a production
budget is prepared, the production targets are laid down in the same for a particular period.
After the period is over, the actual production is compared with the budget and the deviation
is found out so that necessary corrective action can be taken. Budget and Budgetary Control
is one of the important techniques of costing used for cost control and also for performance
evaluation. The success of the technique depends upon several factors such as support from
top management, involvement of employees and coordination within the organization.

Cost Management: - The term Cost Management has not been defined as such. However it
can be said that cost management identifies, collects, measures, classifies and reports
information that is useful to managers and other internal users in cost ascertainment, planning,
controlling and decision making. Cost management aims to produce and provide information to
internal users and personnel working in the organization.

Need for Cost Management: - Effective management of cost makes an organization more
strong, more stable and helps in improving the potentials of a business. The organization calls for
a system that would monitor the full economic impact of the business, on resource acquisition
and consumption. This provides supplying of information to the top management for exploring
various alternatives by which cost effectiveness can be improved. Cost management also helps in
optimizing resources which will improve overall efficiency of the organization and help the firm
to achieve its objectives.

12. Difference between Cost Accounting and Financial Accounting

The distinguishing features of financial accounting and cost accounting are given below.

Financial Accounting Cost Accounting

It aims at finding out results of accounting year
in the form of Profit and Loss Account and
Balance Sheet.
It is more attached with reporting the results
and position of business to persons and
authorities other than management like
government, creditors, investors,
Financial Accounting data is historical in
nature also futuristic in approach.
In financial accounting, the major emphasis is
in cost classification based on type of
transactions, e.g. salaries, repairs, insurance,
It aims at computing cost of production/
service in a scientific manner and then cost
control and cost reduction.
It is an internal reporting system for an
organizations own management for decision
making.
It not only deals with historical data but is also
futuristic in approach
In cost accounting, classification is basically
on the basis of functions, activities, products,
process and on internal planning and control

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stores etc.
In financial accounting, only those transactions
are recorded which can be expressed in
monetary terms.
It aims at presenting true and fair view of the
profit and loss position as well as financial
position.
Financial Accounts are subject to statutory
audit to verify whether they disclose a true and
fair view of the profit and loss as well as
financial position
and Financial Accounting Cost Accounting
Cost accounting uses both monetary as well as
quantitative information.
It aims at computing true and fair view of the
cost of production/services offered by the firm.
Cost accounts are subject to cost audit which
verifies whether the cost accounts disclose true
and fair view of the cost of production of the
company.

Management Accounting
Introduction: - The scope of Management Accounting is broader than the scope of cost
accounting. In cost accounting, as we have seen, the primary emphasis is on cost and it deals
with collection, analysis, relevance, interpretation and presentation for various problems of
management. Management Accounting is an accounting system which will help the Management
to improve its efficiency. The main thrust of Management Accounting is towards determining
policy and formulating plans to achieve desired objectives of management. It helps the
Management in planning, controlling and analyzing the performance of the organization in order
to follow the path of continuous improvement. Management Accounting utilizes the principle
and practices of financial accounting and cost accounting in addition to other modern
management techniques for effective operation of a company. In fact there is an overlapping in
various areas of cost accounting and management accounting. However, the distinguishing
features of Management Accounting are given below.

Features of Management Accounting

The features of Management Accounting are given below.

1. The Management Accounting data are derived from both, the financial accounting and
cost accounting.
2. The main thrust in management accounting is towards determining policy and
formulating plans to achieve desired objectives of management.
3. Management Accounting makes corporate planning and strategy effective and
meaningful.
4. It is concerned with short and long range planning and uses highly sophisticated
techniques like sensitivity analysis, probability techniques, decision tree, ratio analysis
etc for planning, control and evaluation.
5. It is futuristic in approach and predictive in nature.

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 6. Management accounting system cannot be installed without proper cost accounting
system.
7. Management Accounting systems generate various reports which are extremely useful
from the Management point of view.

Management Accounting Information and their use

In the above paragraphs, we have seen the utility of Management Accounting. One of the
distinguishing factors between the financial accounting and management accounting is that the
management accounting does not have a unified structure. The format in which it is prepared
varies widely according to the circumstances in each case and the purpose for which the
information is being summarized. The management accounting generates information, which is
used for three different purposes.

I] Measurement II] Control and III] Decision making [Alternative choice problems] for each of
these purposes, management accounting generates vital information. The uses of information for
each of the three purposes of management accounting are explained below.

I. Measurement: For measurement of full costs, the management accounting system

focuses on the measurement of full costs. Full costs are the total costs required for
producing goods or offering services. These costs are divided into A] Direct costs and B]
Indirect costs. Direct costs are identifiable or traceable to the products or services offered
while indirect costs are not traceable to the products or services. Full cost accounting
measures not only the total costs [direct plus indirect costs] required for producing
products or services but also the full costs required to run other activity like conducting a
research project or running a welfare scheme and so on. Thus full cost accounting is not
restricted to solely to measure the cost of manufacturing.

II. Control: An important aspect of the management accounting information is to provide

information, which can be used for Control. The management accounting system is
structured in such a manner that information is generated for each Responsibility
Center. A responsibility center is an organization unit headed by a manager who is
responsible for its operations and performance. Management accounting helps to prepare
budget for each responsibility center and also facilitates comparison between the
budgeted and actual results. A report is prepared for each responsibility center, which
shows the budgeted and actual performance and also the difference between the two. This
enables the performance analysis of each responsibility center so that proper corrective
action can be taken in this respect.

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III. Decision Making: Management accounting generates useful information for decision
making. Management has to take several decisions in the course of business. Some of the
major decisions are Make or Buy Accepting or rejecting of an Export Order, Working of
second shift, Fixation of selling price, Capital expenditure decisions, increasing
production capacity, Optimizing of Product Mix and so on. For all these decisions,
providing of information is necessary and the management accounting generates this
information, which enables the management to take such decisions.

Tools & Techniques of Management Accounting

With a view to assist management in the decision making process and result oriented
efficient management of any business enterprise, the Management Accountant is always
equipped with different tools and techniques.

The importance tools available at his disposal are:

1. Financial Accounting: - All business transactions are recorded in financial accounts

throughout the year and final accounts (i.e., financial statements) are prepared at the end
of specific period. The other statements relevant to the decision making are also prepared.
It also includes ratio analysis, funds flow analysis, analysis and interpretation of financial
statements and any other comparative analysis disclosing tendencies.
2. Cost Accounting: - The system of cost accounting and cost control considerably helps
the management in decision making process. The actual cost can be compared with the
standard (predetermined) cost and it reveals the level of performance of the concern.
3. Standard Costing: - Standard costing is an important technique of cost control. The cost
is determined in advance in the system of standard costing. The actual costs when
incurred and recorded are then compared with standard costs. The variances, if any, are
further analyzed and their reasons are found out. The efficiency of the business concern
thus increases due to standard costing.
4. Marginal Costing: - Under the system of marginal costing, the total expenditure of the
concern is classified into fixed and variable categories. Fixed costs always remain
constant but variable costs change with the change in quantity of production or level of
activity. Marginal costing is helpful for judging the profitability of different products,
various departments and divisions or different lines of business activity.
5. Statistical methods: - As mentioned above, the management account has to present the
information regularly to the management for effective decision making. In case the
information is presented by utilizing the different tools and techniques available in
statistics like: Graphs, Pictures, Tables Diagrams, Maps etc. then the information
becomes easily understandable and more meaningful. The statistical techniques reveal the
tendency and tendencies are considered for decision making by the management.
6. Management Systems: The reporting to management has qualitative Improved because
of the development of electronic devices for recording and classifying data.

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 7. Economic Analysis: The various principles of economic analysis are widely used in
management accounting. Cost of production. Price. Profit, competition, demand, supply,
capital, factors of production are some of the examples of concepts of economics which
are regularly used in the system of management accounting.
8. Revaluation Accounting: This is also known as Replacement Accounting. According to
Batty, "Revaluation accounting is used to denote the methods employed for overcoming
the problems connected with fixed asset replacement in a period of rising prices."

Comparison Between Financial Accounting And Management Accounting

Financial Accounting and Management Accounting are the two branches of the same
accounting system. There are differences in these two systems accounting because they are
designed to serve different objectives. The important points of distinction between Financial
Accounting and Management Accounting arc given below:

1. Object: The three objectives of financial accounting are recording business transactions,
finding profit or loss at the end of every year and judging its financial position. These records are
useful for shareholders, Debenture holders, bankers, creditors, etc. On the other hand,
management accounting is used by the management, personnel in framing policies, taking
decisions and controlling the business.
2. Native: Financial Accounting is a study of past records whereas management accounting is
concerned with future policy of the concern. Past record are used only for taking decisions for
the future. Actual facts and figures are used in financial accounting whereas in management
accounting future events are visualized to anticipate what is likely to happen.
3. Compulsion: The preparation of financial accounts is compulsory by law in many cases and
it is necessary if not compulsory. Management accounting is not compulsory. Only those
business concerns who desire to be efficient and to run business profitability are using the system
of Management accounting fixed set of rules and procedures are adopted in preparing financial
accounts. In management accounting no such fixed procedures, rules or formats are used.
4. Precision: Financial accounting system is based on accuracy and there cannot be any
assumption. In the system of management accounting too much accuracy is not needed as it is
concerned with decision-making where tendency needs to be known and tendency need not be
one hundred percent accurate.
5. Presentation and Reporting: Financial accounts are used internally in the concern and are
also presented to shareholders and useful to outsiders like bankers, Creditors, Government
agencies etc. Management accounting is concerned with internal management of the concern. It
is useful to top and middle level management executives in the decision making process.
6. Contents: In financial accounting, we record only those transactions which can be
expressed in figures {monetary terms). Any transaction which cannot be expressed in figures
cannot be recorded in financial accounting. Management accounting considers both monetary
events and also non-monetary factors, e.g., competition, political situation, trade cycle, etc.

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7. Principles of Accounting: Generally accepted principles, concepts and conventions of
accounting govern the preparation of financial accounting and as such it is an inelastic concept.
In management accounting no fixed set of principles are adopted. The management accounting is
for decision-making and as such the format and procedures are different in different concerns.
8. Period: Generally financial accounting is prepared on year-to-year basis. In management
accounting there are no specific periods for which accounts are to be prepared.
9. Publication: The financial accounts are also published for the benefit of public. For a
registered company, it is compulsory by law. Management accounting is done inside the
company and it is meant to be used for the benefit of management only and is not published.

Comparison between Cost Accounting and Management Accounting

The main purpose of cost accounting is to ascertain the cost and enable the management for
effecting cost control. It is also used for performance evaluation and management decision-
making. That is why most of the concepts of cost accounting are used in management
accounting. There are some areas in cost accounting overlapping with management accounting
but the two systems are not identical. Management accounting as such cover much wider field
than cost accounting. Both cast accounting and management accounting systems are
complementary m nature. In absence of well-organized costing system the relevant cost data may
not be available and the system of management accounting cannot function effectively. The main
points of differences between Cost Accounting and Management Accounting are given below:
1. Objective: The objective of cost accounting is to record the cost of goods manufactured or
services provided. The cost is determined for each products or each function. It also deals with
cost control, decision-making etc. The aim of management accounting is to provide information
to the management for planning, coordinating and controlling the activities of the business.
2. Scope: The scope of cost accounting is generally limited to cost ascertainment and cost
control. The scope of management accounting is much wider. It includes financial accounting,
cost accounting, budgeting reporting to management, analysis and interpretation of financial data.
3. Nature: The system of cost accounting is generally concerned with the figures of past period
and projections for the future. Management accounting in general is concerned with the
projection of activities and figures for future.
4. Use of Data: In the system of cost accounting, only those transactions are considered which
can be expressed in the form of figures. Thus, only quantity aspect is considered in cost
accounting. On the other hand, the system of management accounting makes use of both
quantitative and qualitative information.
5. Evolution: The evolution of cost accounting is due to industrial revolution. Financial
accounting could not provide the information regarding cost needed by management. That is
why, cost accounting has been evolved and it is additional accounting system. Cost accounting
would provide information about cost, its elements and also data for planning and decision
making. Management accounting has been developed very recently. Management accounting and
cost accounting are complementary to each other.

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6. Principles: The basic principles and procedures are adopted in recording cost of different
products and services. In management accounting no such specific procedures or rules are
followed. The information is presented to management, as they required it in easily
understandable language and format.

Role of Management Accountancy

The role of management accounting and financial accounting is quite different from each
other as they have different goals altogether. Management accounting measures analyzes and
reports financial and non financial information that helps managers to take decisions to fulfill the
goals of an organization. Managers use management accounting information to choose,
communicate and implement strategy. They also use management accounting information to
coordinate product design, production and marketing decisions. Management accounting focuses
on internal reporting. The following points highlight the role played by Management Accounting
in the business organization.

I. Implementing Strategy: Managers implement strategies by translating them into

actions. Creating value for customers is an important part of planning and
implementation of strategies. Strategic planning and implementation will include
decisions regarding the design of products, services or processes, research and
development, production, marketing, distribution and customer services. Each of this
area is important for satisfying customers and keeping them satisfied. Management
accounting will help to track the costs of each of the activity mentioned above. The
ultimate target is to reduce costs in each category and to improve efficiency. Cost
information also helps managers make cost benefit analysis. For example, managers
can find out that is it cheaper to buy products from outside vendors or to do
manufacturing in-house? Is it worthwhile to invest more resources in design and
manufacturing if it reduces costs in marketing and customer service?
II. Supply Chain Analysis: Companies can also implement strategy, cut costs and create
value by enhancing their supply chain. The term Supply Chain describes the flow of
goods, services and information from the initial sources of materials and services to
the delivery of products to customers regardless of whether those activities occur in
the same organization or in other organization. Customers expect improved
performance from companies through the supply chain. They expect that the
companies should perform all these activities in an efficient manner so as to reduce
costs and also maintain quality of the products and the products be available easily for
them. This is no doubt a daunting task and the management accounting plays a vital
role in ensuring value for money for the customers. Tools like standard costing and
target costing can be used effectively for cost control and cost reduction and thus
ensure reasonable prices for customers. A system of budgets and budgetary control
will ensure continuous planning and monitoring various functions and thus provide

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 for introspection. Continuous improvement in these activities will help in creating
value for customers.
III. Decision Making: One of the important functions of management is decision
making. Management Accounting helps in this crucial area by providing relevant
information to the management. Techniques like marginal costing helps to generate
information, which will be useful for taking decisions. Decisions include make or buy
decisions, adding or dropping a product line, working of additional shift, shut down
or continue operations, capital expenditure decisions and so on. Decisions based on
information are expected to be more rational and objective rather than subjective.
IV. Performance Measurement: Management accounting helps immensely for the
measurement of performance of the organization. The main aspect of performance
measurement is comparison between the targets and actual. There are several tools
and techniques like budgets and budgetary control, standard costing and marginal
costing, which are used in measuring the actual performance against the target
performance. This will facilitate introspection and corrective action can be taken for
further improving the performance.

*****

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