School of Business Management

SCHOOL OF BUSINESS MANAGEMENT

DEPARTMENT OF COMMERCE

B.com 503

MANAGEMENT ACCOUNTING

Unit I

Meaning of Management Accounting:

Management Accounting is the presentation of accounting information in such a way as to assist management in the creation of policy and the day-to-day operation of an undertaking. Thus, it relates to the use of accounting data collected with the help of financial accounting and cost accounting for the purpose of policy formulation, planning, control and decision-making by the management.

Management accounting links management with accounting as any accounting information required for taking managerial decisions is the subject matter of management accounting.

Some leading definitions of Management Accounting are given below:

“Management Accounting is concerned with accounting information that is useful to management.” —R.N. Anthony

“Management Accounting is the term used to describe accounting methods, systems and techniques which coupled with special knowledge and ability, assists management in its task of maximizing profits or minimizing losses. Management Accountancy is the blending together into a coherent whole, financial accounting, cost accountancy and all aspects of financial management.” —Batty

“Management accounting is a system of collection and presentation of relevant economic information relating to an enterprise for planning, controlling and decision-making.” —ICWA of India

“Management accounting is the provision of information required by management for such purposes as formulation of policies, planning and controlling the activities of the enterprise, decision-making on the alternative courses of action, disclosure to those external to the entity (shareholders and others), disclosure to employees and safeguarding of assets.” —CIMA London

Management Accounting is “the application of appropriate techniques and concepts in processing historical and projected economic data of an entity to assist management in establishing plans for reasonable economic objectives and in the making of rational decisions with a view towards these objectives”. —American Accounting Association

From the above it is clear that management accounting uses all techniques of financial accounting, cost accounting and statistics to collect and process data for making it available to management so that it can take decisions in a scientific manner.

Characteristics of Management Accounting:

It is matter of fact that management accounting is the backbone for every organization. Because it assists the management of organization through providing the relevant and accurate information at the right time for taking rational decisions to short out the business problems. Thus, it is clear that a management accounting should possess these essential characteristics:-

Helpful in Decision Making:- It is an important feature of management accounting. In fact, it helps the management of organization by providing relevant and accurate information from various sources (like financial and cost accounting) in order to make sound decisions to remove business problems.

Provides Data, Not the Decision:- It only provides required data and information to the management, not the decision. It is up to the management that how they utilize the available data and information to resolving the business problems through taking effective decisions.

Selective in Nature:- It is also a potent characteristic of this accounting system. Here selective means, in management accounting a management accountant is only collect those data and information from a variety of alternatives which may create more benefits and easiness to the management in decision making. Hence, it is selective in nature.

Assist in Achieving Objectives:- Management Accounting is always assist organization in achieving its predetermined goals. Because it provides detailed information in regarding the weakness and the strength of organization in the form of report, on the basis of that any organization can eliminate recognized weakness (business problems) and may achieve its goal easily.

Related to Future:- Management Accounting is an accounting system which is directly related to future course of events. It means by preparing this account any organization can forecast its future on the basis available information in relating the past events (Historical data).

Increase in Efficiency:- It also plays an essential role in increasing efficiency of organization. As we know that in this competitive business age it is difficult for every organization to carry out its entity forever. Hence to survive for long run it is important for organization to increase its efficiency by finding the errors and removing it through management accounting techniques (standard costing, budgetary control, control accounting),

Use of Special Techniques:- Management Accounting uses special tools or techniques (like standard costing, budgetary control, control accounting, marginal costing etc) for composing the accounting information and data more accurate and relevant. So that management can easily make their decisions. The type of technique to be applied will be determined according to the situation and necessity.

Need and Importance of Management Accounting:

The Present complex industrial world, management accounting has become an integral part of management, Management accountant guides and advises management at every step. Management accounting not only Increase Efficiency of the management but it also increases the efficiency of the employees. The main Advantage of management accounting is given below:

Determine of Aim: Management accounting on the basis of the information available determines its goal and tries to find out the route through which it can reach the goal.

Helps in the Preparation of Plan: Present age is the age of planning. That producer is considered as most successful producer who produces articles according to the plan and needs of the consumers. Before taking any plan the manager must study and analyze the present and future of the business.
Better Services to Customers: The cost control device is management accounting enables the reduction in prices of the Product. All employees in the concern are made cost Conious. The quality of the Product become good because quality standards ate pre-determined. The Customers are supplied goods and goods quality at reasonable price.
Easy to take judgment: Before taking any plan or to determine policy. There are several plans or policies before the management on the basis of the study he decides which plan and policy was to be adapted so that it may be more useful and helpful.
Measurements of performance: The techniques of budgetary control standard costing enables the measurement of performance In standard costing, standards are determined 1^st and then actual cost of compared with standard cost. It enables the management to find out deviations between standard cost and actual cost. The performance will be good it actual cost does not exceed the standard cost. Budgetary control system too helps in measuring efficiency of all employees.
Its Increase Efficiency of the business: Management accounting increases efficiency of the business concern. The targets of different departments of the enterprise are determined in advance and the achievement of these goals is taken as a tool for measuring their efficiency.
Its Provide effective management control : The Tools and techniques of the management accounting are helpful to the management in planning controlling and coordinating activities of the business, the getting of standard and assessing actual performance regularly enables the management to have ‘management by exception’. Everybody assesses his own work and immediate actions are taken as a tool for measuring their efficiency.
Maximum profits of can be obtained: in this process every possible effort are made to control unnecessary expenses. The incapability or inefficiency is removed. New systems or techniques are found out to achieve the goal, so that there may be maximum profits out if the capital invested in the Business.
Safety and security from trade cycle: The Information received form the management accounting gives more or throws enough light over the past trade cycle. The management tries to ascertain the Causes of trade cycle and its affect. Thus, management accounting tries to safeguard the organization from the affect of trade cycle.

Functions of Management Accounting:

The bask function of management accounting is to assist the management in performing its functions effectively.

The manner in which management accounting satisfies the requirements of the management for arriving at appropriate business decisions may be described as follows:

1. Modification of Data:

Accounting data as such are not suitable for managerial decision-making and control purposes. However, they may be used as the basis for making future estimates and projections.

In fact management accounting modifies the available accounting data by rearranging the same, by resorting to a process of classification and combination, which enable retention of the similarities of data without eliminating the dissimilarities.

For example, the sales figures for different months may be classified to know the total sales made during the period product-wise, salesman-wise, and territory-wise.

2. Analysis and Interpretation of Data:

The accounting data is analyzed and interpreted meaningfully for effective planning and decision-making. For this purpose the data is presented in a comparative form. Analytical tools such as Comparative Financial Statements, Common-size Statements, Trend percentages, and ratio Analysis are used and likely trends are projected.

3. Facilitating Management Control:

Management accounting enables all accounting efforts to be directed towards the attainment of goals efficiently by controlling the operations of the company more effectively.

Standards of performance and measure of variation there from are the essential elements of any control system. All these are made possible through standard costing and budgetary control systems, which are an integral part of management accounting.

4. Use of Qualitative Information:

Mere financial data and its analysis and interpretation are not sufficient for decision-making purposes. The management may need qualitative information, which cannot be readily converted into monetary terms.

Such information may be obtained from statistical compilations, engineering records, case studies, minutes of meetings, etc. Management accounting does not restrict itself to financial data alone for helping management; it also uses such [qualitative] information.

5. Satisfaction of Informational Needs of Different Levels of Management:

Different levels of management such as top level, middle level, and lower level managements need different types of information. The top management needs concise information covering the entire field of business activities at relatively long intervals.

The middle level management requires technical data regularly, and the lower level management is interested in detailed figures relating to the particular sphere of activity at short intervals.

Hence, the main function of management accounting is to process accounting and other data in such a way as to satisfy the needs of different levels of management.

Scope of Management Accounting:

The main concern of management accounting is to provide necessary quantitative and qualitative information to the management for planning and control. For this purpose it draws out information from accounting as well as non-accounting sources.

Hence, its scope is quite vast and it includes within its fold almost all aspects of business operations. However, the following areas may rightly be pointed out as lying within the scope of management accounting.

i. Financial Accounting:

The major function of management accounting is the rearrangement or modification of data. Financial accounting provides the very basis for such a function. Hence, management accounting cannot obtain full control and coordination of operations without a well-designed financial accounting system.

ii. Cost Accounting:

Planning, decision-making and control are the basic managerial functions. The cost accounting system provides necessary tools such as standard costing, budgetary control, inventory control, marginal costing, and differential costing etc., for carrying out such functions efficiently. Hence, cost accounting is considered a necessary adjunct of management accounting.

iii. Revaluation Accounting:

Revaluation or replacement value accounting is mainly concerned with ensuring that capital is maintained in real terms and profit is calculated on this basis.

iv. Statistical Methods:

Statistical tools such as graph, charts, diagrams and index numbers etc., make the information more impressive and comprehensive. Other tools such as time series, regression analysis, sampling techniques etc., are highly useful for planning and forecasting.

v. Operations Research:

Modern managements are faced with highly complicated business problems in their decision-making processes. O P techniques like linear programming, queuing theory, decision theory, etc., enable management to find scientific solutions for the business problems.

vi. Taxation:

This includes computation of income tax as per tax laws and regulations, filing of returns and making tax payments. In recent times, it also includes tax planning.

vii. Organization and Methods [O&M]:

O&M deal with organizations reducing cost and improving the efficiency of accounting, as also of office systems, procedures, and operations etc.

viii. Office Services:

This includes maintenance of proper data processing and other office management services, communication and best use of latest mechanical devices.

ix. Law:

Most of the management decisions have to be taken in a legal environment where the requirements of a number of statutory provisions or regulations are to be fulfilled.

Some of the Acts, which have their influence on management decisions, are as follows:

The Companies Act, MRTP Act, FEMA, SEBI Regulations, etc.

x. Internal Audit:

This includes the development of a suitable system of internal audit for internal control.

xi. Internal Reporting:

This includes the preparation of quarterly, half yearly, and other interim reports and income statements, cash flow and funds flow statements, scarp reports, etc.

Limitations of Management Accounting:

The origin of management accounting can be traced to overcome the limitations of financial accounting and cost accounting.

Financial accounting is very useful to the different categories of persons but it suffers from the following limitations:

(i) Historical Nature:

Financial accounting is of historical nature. It does not provide the necessary information to the management for planning, control and decision-making. It does not tell how to increase the profit and maximize the return on the capital employed.

(ii) Recording of Actual Cost:

In financial accounting assets and properties are recorded at their cost. No effect of changes in their value is recorded in the books after its acquisition. Thus, it has nothing to do with their realizable or replaceable value.

(iii) Incomplete Knowledge of Costs:

In financial accounting data relating to cost is not available according to different products or jobs or processes in order to judge the profitability of each. Information regarding wastages and losses is also not available from the financial accounts. It is also difficult to fix the prices of the products without the availability of a detailed analysis of costs which is not available in financial accounts.

(iv) No Provision for Cost Control:

Costs cannot be controlled through financial accounting as there is no provision for corrective action because of expenses being recorded after their incurrence. No technique to check the reasonableness of any expenditure or no system for fixing definite responsibility on any authority for wastage or excessive expenditure is available in financial accounting.

(v) No Evaluation of Business Policies and Plans:

There is no device in financial accounting by which the actual progress can be measured against the targets in order to evaluate the business policies and plans, to know the reasons for deviations and how to correct them, if need be.

(vi) Not Helpful in Decision-Making:

As the data available is of historical nature, the financial accounting is not of much help to the management in selecting a profitable alternative. There are many situations where management is required to take decisions but information provided by financial accounting is not adequate.

(vii) Technical Subject:

Financial accounting is highly technical in nature. Financial accounts can be prepared and interpreted only by those persons who possess adequate knowledge of accounting concepts and conventions and are well conversant to the practice of accounting.

Though cost accounting came into existence to remove the limitations of financial accounting but its scope as compared to management accounting is limited as it deals primarily with the cost data. In actual practice, cost accountants are doing the jobs of management accountants.

Further, most of the techniques of management accounting are also being used by the cost accountants. That is why; management accounting is treated as extension of cost accounting. But for our purpose of study we treat the management accounting more broad as compared to cost accounting as management accounting, includes many more aspects of the study besides the cost accounting.

Thus, the science of accounting is not in a finished state. It is in the process of evolution. The role of accounting has changed after the Second World War.

Now, it is not a mere recording of business transactions in the books of original entry, then classifying them into the ledger and finally summarizing them by preparing the profit and loss account and balance sheet as is done in financial accounting or calculation and control of cost as is done in cost accounting.

Rather accounting helps in forecasting, planning and controlling the business events and taking managerial decisions. Keeping this in view a new branch of accounting known as Management Accounting has been developed to cope with the limitations of financial accounting and cost accounting.

Management Accounting vs. Cost Accounting vs. Financial Accounting

Both cost accounting and financial accounting help the management formulate and control organization policies. Financial management gives an overall picture of profit or loss and costing provides detailed product-wise analysis.

No doubt, the purpose of both is same; but still there is a lot of difference in financial accounting and cost accounting. For example, if a company is dealing in 10 types of products, financial accounting provides information of all the products in totality under different categories of expense heads such as cost of material, cost of labor, freight charges, direct expenses, and indirect expenses. In contrast, cost accounting gives details of each overhead product-wise, such as much material, labor, direct and indirect expenses are consumed in each unit. With the help of costing, we get product-wise cost, selling price, and profitability.

The following table broadly covers the most important differences between financial accounting and cost accounting.

Point of Differences	Financial Accounting	Cost Accounting
Meaning	Recoding of transactions is part of financial accounting. We make financial statements through these transactions. With the help of financial statements, we analyze the profitability and financial position of a company.	Cost accounting is used to calculate cost of the product and also helpful in controlling cost. In cost accounting, we study about variable costs, fixed costs, semi-fixed costs, overheads and capital cost.
Purpose	Purpose of the financial statement is to show correct financial position of the organization.	To calculate cost of each unit of product on the basis of which we can take accurate decisions.
Recording	Estimation in recording of financial transactions is not used. It is based on actual transactions only.	In cost accounting, we book actual transactions and compare it with the estimation. Hence costing is based on the estimation of cost as well as on the recording of actual transactions.
Controlling	Correctness of transaction is important without taking care of cost control.	Cost accounting done with the purpose of control over cost with the help of costing tools like standard costing and budgetary control.
Period	Period of reporting of financial accounting is at the end of financial year.	Reporting under cost accounting is done as per the requirement of management or as-and-when-required basis.
Reporting	In financial accounting, costs are recorded broadly.	In cost accounting, minute reporting of cost is done per-unit wise.
Fixation of Selling Price	Fixation of selling price is not an objective of financial accounting.	Cost accounting provides sufficient information, which is helpful in determining selling price.
Relative Efficiency	Relative efficiency of workers, plant, and machinery cannot be determined under it.	Valuable information about efficiency is provided by cost accountant.
Valuation of Inventory	Valuation basis is ‘cost or market price whichever is less’	Cost accounting always considers the cost price of inventories.
Process	Journal entries, ledger accounts, trial balance, and financial statements	Cost of sale of product(s), addition of margin and determination of selling price of the product.

Management accounting collects data from cost accounting and financial accounting. Thereafter, it analyzes and interprets the data to prepare reports and provide necessary information to the management.

On the other hand, cost books are prepared in cost accounting system from data as received from financial accounting at the end of each accounting period.

The difference between management and cost accounting are as follows:

S.No.	Cost Accounting	Management Accounting
1	The main objective of cost accounting is to assist the management in cost control and decision-making.	The primary objective of management accounting is to provide necessary information to the management in the process of its planning, controlling, and performance evaluation, and decision-making.
2	Cost accounting system uses quantitative cost data that can be measured in monitory terms.	Management accounting uses both quantitative and qualitative data. It also uses those data that cannot be measured in terms of money.
3	Determination of cost and cost control are the primary roles of cost accounting.	Efficient and effective performance of a concern is the primary role of management accounting.
4	Success of cost accounting does not depend upon management accounting system.	Success of management accounting depends on sound financial accounting system and cost accounting systems of a concern.
5	Cost-related data as obtained from financial accounting is the base of cost accounting.	Management accounting is based on the data as received from financial accounting and cost accounting.
6	Provides future cost-related decisions based on the historical cost information.	Provides historical and predictive information for future decision-making.
7	Cost accounting reports are useful to the management as well as the shareholders and creditors of a concern.	Management accounting prepares reports exclusively meant for the management.
8	Only cost accounting principles are used in it.	Principals of cost accounting and financial accounting are used in management accounting.
9	Statutory audit of cost accounting reports are necessary in some cases, especially big business houses.	No statutory requirement of audit for reports.
10	Cost accounting is restricted to cost-related data.	Management accounting uses financial accounting data as well as cost accounting data.

‘Accounting’ is a process of systematically identifying, recording, classifying, reporting, analyzing and interpreting the results thereof to the users of the financial statement. The two major branches of Accounting are Financial Accounting and Management Accounting. The former, is an accounting system which gives true and a fair view of the financial position of the company to various parties. The latter, is an accounting system which provides both the quantitative and qualitative information to the managers. Here we are going to discuss about the differences between Financial Accounting and Management Accounting.

BASIS FOR COMPARISON	FINANCIAL ACCOUNTING	MANAGEMENT ACCOUNTING
Meaning	Financial Accounting is an accounting system that focuses on the preparation of financial statement of an organization to provide the financial information to the interested parties.	The accounting system which provides relevant information to the managers to make policies, plans and strategies for running the business effectively is known as Management Accounting.
Is is compulsory?	Yes	No
Objective	To provide financial information to outsiders.	To assist the management in planning and decision making process by providing detailed information on various matters.
Format	Specified	Not specified
Time Frame	Financial Statements are prepared at the end of the accounting period which is usually one year.	The reports are prepared as per the need and requirements of the organization.
User	Internal and external parties	Only internal management.
Reports	Summarized Reports about the financial position of the organization	Complete and Detailed reports regarding various information.

Forms of Financial Statements

If you own a small business, you understand the importance of keeping your financial information organized. You probably also know that bookkeeping can be a headache. If you are trying to make your accounting as easy and seamless as possible, it's helpful to understand the four basic financial statements. You can even download templates of these statements.

Income Statement

One of the four major financial statements is the income statement, which shows net income or net loss. This type of statement tracks all the money coming in and all the money going out. Money paid out is called expenses and coming in is called revenue. When the expenses exceed the revenue, the income statement will show a net loss. The income statement is broken down into categories, including:

Sales
Operating expenses
Non-operating expenses

Operating expenses include things like advertising and rent for office space. Non-operating expenses can include a one-time purchase and interest on borrowed money. Sales encompass the cost of all goods sold.

Balance Sheet

The balance sheet is another one of the four basic financial statements and it contains assets, liabilities, and owners' or shareholders' equity. The assets include cash, property, inventory, and anything else owned by the company. Assets are listed on the left side of the balance sheet. Liabilities and equity are listed on the right side. Liabilities include accounts payable or any type of payment made on a long-term loan.

The owners' or shareholders' equity is established when the amount of liabilities is subtracted from the amount of assets. The reason it's called a balance sheet is because the formula should always look like this:

Assets = Liabilities + Shareholders' Equity

Statement of Cash Flow

The third of the four major financial statements is the statement of cash flow. The number of categories on this statement will be different depending on the size of the company. For larger companies, the categories include:

Operating activities
Investing activities
Financing activities
Supplemental information

For smaller companies there are only two categories: cash inflows and cash outflows. The basic principal of the statement of cash flow is to know and understand exactly where cash is flowing in from and where it is flowing out to. It enables the company to see if they are spending more than they are earning or vice versa. If the amount of cash is consistently more than the net income, it means the company's net earnings are "high-quality."

Statement of Owner's Equity

If there are any changes in the owner's equity between accounting periods, it is listed on the statement of owners' equity, another of the four main financial statements. The key components listed on this statement include:

Beginning equity balance
Additions and subtractions
Ending balance

The additions and subtractions are for a particular period and can include things like net income, dividend payments, and withdrawals.

Tools or Techniques of Financial Statement Analysis

Important tools or techniques of financial statement analysis are as follows.

Comparative Statement or Comparative Financial and Operating Statements.
Common Size Statements.
Trend Ratios or Trend Analysis.
Average Analysis.
Statement of Changes in Working Capital.
Fund Flow Analysis.
Cash Flow Analysis.
Ratio Analysis.
Cost Volume Profit Analysis

A brief explanation of the tools or techniques of financial statement analysis presented below.

1. Comparative Statements

Comparative statements deal with the comparison of different items of the Profit and Loss Account and Balance Sheets of two or more periods. Separate comparative statements are prepared for Profit and Loss Account as Comparative Income Statement and for Balance Sheets.

As a rule, any financial statement can be presented in the form of comparative statement such as comparative balance sheet, comparative profit and loss account, comparative cost of production statement, comparative statement of working capital and the like.

2. Comparative Income Statement

Three important information are obtained from the Comparative Income Statement. They are Gross Profit, Operating Profit and Net Profit. The changes or the improvement in the profitability of the business concern is find out over a period of time. If the changes or improvement is not satisfactory, the management can find out the reasons for it and some corrective action can be taken.

3. Comparative Balance Sheet

The financial condition of the business concern can be find out by preparing comparative balance sheet. The various items of Balance sheet for two different periods are used. The assets are classified as current assets and fixed assets for comparison. Likewise, the liabilities are classified as current liabilities, long term liabilities and shareholders’ net worth. The term shareholders’ net worth includes Equity Share Capital, Preference Share Capital, Reserves and Surplus and the like.

4. Common Size Statements

A vertical presentation of financial information is followed for preparing common-size statements. Besides, the rupee value of financial statement contents are not taken into consideration. But, only percentage is considered for preparing common size statement.

The total assets or total liabilities or sales is taken as 100 and the balance items are compared to the total assets, total liabilities or sales in terms of percentage. Thus, a common size statement shows the relation of each component to the whole. Separate common size statement is prepared for profit and loss account as Common Size Income Statement and for balance sheet as Common Size Balance Sheet.

5. Trend Analysis

The ratios of different items for various periods are find out and then compared under this analysis. The analysis of the ratios over a period of years gives an idea of whether the business concern is trending upward or downward. This analysis is otherwise called as Pyramid Method.

6. Average Analysis

Whenever, the trend ratios are calculated for a business concern, such ratios are compared with industry average. These both trends can be presented on the graph paper also in the shape of curves. This presentation of facts in the shape of pictures makes the analysis and comparison more comprehensive and impressive.

7. Statement of Changes in Working Capital

The extent of increase or decrease of working capital is identified by preparing the statement of changes in working capital. The amount of net working capital is calculated by subtracting the sum of current liabilities from the sum of current assets. It does not detail the reasons for changes in working capital.

8. Fund Flow Analysis

Fund flow analysis deals with detailed sources and application of funds of the business concern for a specific period. It indicates where funds come from and how they are used during the period under review. It highlights the changes in the financial structure of the company.

9. Cash Flow Analysis

Cash flow analysis is based on the movement of cash and bank balances. In other words, the movement of cash instead of movement of working capital would be considered in the cash flow analysis. There are two types of cash flows. They are actual cash flows and notional cash flows.

10. Ratio Analysis

Ratio analysis is an attempt of developing meaningful relationship between individual items (or group of items) in the balance sheet or profit and loss account. Ratio analysis is not only useful to internal parties of business concern but also useful to external parties. Ratio analysis highlights the liquidity, solvency, profitability and capital gearing.

11. Cost Volume Profit Analysis

This analysis discloses the prevailing relationship among sales, cost and profit. The cost is divided into two. They are fixed cost and variable cost. There is a constant relationship between sales and variable cost. Cost analysis enables the management for better profit planning.

Tools and techniques of Management Accounting

The various tools used at present in management accounting may be classified into the following groups.

1. Based on Financial Accounting Information

Analysis of Financial Statements through Ratio Analysis.
Analysis of Financial Statements through comparative statements, trend, graph and diagram.
Fund flow and cash flow analysis.
Return on capital employed techniques.

2. Based on Cost Accounting Information

Marginal costing (including cost volume profit analysis).
Direct or incremental Costing and differential costing.
Standard Costing.
Analysis of Cost Variances.

3. Based on Mathematics

Operations Research.
Linear Programming.
Network analysis.
Queing theory and Games Theory.
Simulation Theory.

4. Based on Future Information

Budget and Budgeting.
Budgetary control: Analysis of Budget Variance / Revenue Variance.
Business Forecasting.
Project Appraisal or Evaluation.

5. Miscellaneous Tools

Managerial Reporting.
Integrated Auditing.
Financial Planning.
Revaluation Accounting.
Decision making Accounting.
Management Information System.

Important tools and techniques used in management accounting

Some of the important tools and techniques are briefly explained below.

1. Financial Planning: The main objective of any business organization is maximization of profits. This objective is achieved by making proper or sound financial planning. Hence, financial planning is considered as best tool for achieving business objectives.

2. Financial Statement Analysis: Profit and Loss account and Balance Sheet are important financial statements. These statements are analyzed for different period. This type of analysis helps the management to know the rate of growth of business concern. This analysis is done through comparative financial statements, common size statements and ratio analysis.

3. Cost Accounting: Cost accounting presents cost data in product wise, process wise, department wise, branch wise and the like. These cost data are compared with predetermined one. This comparison of two costs enables the management to decide the reasons responsible for the difference between these costs.

4. Fund Flow Analysis: This analysis find out the movement of fund from one period to another. Moreover, this analysis is very useful to know whether the fund is properly used or not in a year when compared to the previous year. The working capital changes and funds from operation are also find out through this analysis.

5. Cash Flow Analysis: The movement of cash from one period to another can be find out through this analysis. Besides, the reasons for cash balance and changes between two periods are also find out. It studies the cash from operation and the movement of cash in a period.

6. Standard Costing: Standard costing is predetermined cost. It provides a yard stick for measuring actual performance. It is used to find the reasons for the deviations if any.

7. Marginal Costing: Marginal costing technique is used to fix the selling price, selection of best sales mix, best use of scarce raw materials or resources, to take make or buy decision, acceptance or rejection of bulk order and foreign order and the like. This is based on the fixed cost, variable cost and contribution.

8. Budgetary Control: Under Budgetary control techniques, future financial needs are estimated and arranged according to an orderly basis. It is used to control the financial performances of business concern. Business operations are directed in a desired direction.

9. Revaluation Accounting: The fixed assets are revalued as per the revaluation accounting method so that the capital is properly represented with the assets value. It helps to find out the fair return on capital employed.

10. Decision-making Accounting: A business problem can be solved by choosing any one of the best and most profitable alternative. To select such alternative, the relevant costs are compared. Thus, accounting information are used to solve the business problem which are arising out of increasing complexity of nature of business.

11. Management Information System: The free flow communication within the organization is essential for effective functioning of business. Hence, the management can design the system through which every employee of an organization can assess the information and used for discharging their duties and taking quality decisions.

12. Statistical Techniques: There are a lot of statistical techniques used in removing management problems. Methods of least square, regression and quality control etc. are some examples of statistical techniques.

13. Management Reporting: The management accountant is preparing the report on the basis of the contents of profit and loss account and balance sheet and submit the same before the top management. Thus prepared reports disclose the strength and weakness indifferent areas of operating activities and financial activities. This identification are highly useful to management for exercising control and decision-making.

14. Historical Cost Accounting: It means that costs are recorded after being incurred. This is used for comparing with predetermined costs to evaluate performance.

15. Ratio Analysis: It is used to management in the discharge of its basic functions of forecasting, planning, coordination, communication and control. It paves the way for effective control of business operations by undertaking an appraisal of both the physical and monetary targets.

Unit II

The costs that vary with a decision should only be included in decision analysis. For many decisions that involve relatively small variations from existing practice and/or are for relatively limited periods of time, fixed costs are not relevant to the decision. This is because either fixed costs tend to be impossible to alter in the short term or managers are reluctant to alter them in the short term.

Marginal costing - definition

Marginal costing distinguishes between fixed costs and variable costs as convention ally classified.

The marginal cost of a product –“is its variable cost”. This is normally taken to be; direct labour, direct material, direct expenses and the variable part of overheads.

Marginal costing is formally defined as:

‘the accounting system in which variable costs are charged to cost units and the fixed costs of the period are written-off in full against the aggregate contribution. Its special value is in decision making’.

The term ‘contribution’ mentioned in the formal definition is the term given to the difference between Sales and Marginal cost. Thus

MARGINAL COST =

VARIABLE COST DIRECT LABOUR

DIRECT MATERIAL

DIRECT EXPENSE

VARIABLE OVERHEADS

CONTRIBUTION SALES - MARGINAL COST

The term marginal cost sometimes refers to the marginal cost per unit and sometimes to the total marginal costs of a department or batch or operation. The meaning is usually clear from the context.

Alternative names for marginal costing are the contribution approach and direct costing In this lesson, we will study marginal costing as a technique quite distinct from absorption costing.

Features of Marginal Costing

The main features of marginal costing are as follows:

1. Cost Classification
The marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing technique.

2. Stock/Inventory Valuation
Under marginal costing, inventory/stock for profit measurement is valued at marginal cost. It is in sharp contrast to the total unit cost under absorption costing method.

3. Marginal Contribution
Marginal costing technique makes use of marginal contribution for marking various decisions. Marginal contribution is the difference between sales and marginal cost. It forms the basis for judging the profitability of different products or departments.

Advantages and Disadvantages of Marginal Costing Technique

Advantages

1. Marginal costing is simple to understand.

2. By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided.

3. It prevents the illogical carry forward in stock valuation of some proportion of current year’s fixed overhead.

4. The effects of alternative sales or production policies can be more readily available and assessed, and decisions taken would yield the maximum return to business.

5. It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate overhead recovery rate.

6. Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed overhead, efforts can be concentrated on maintaining a uniform and consistent marginal cost. It is useful to various levels of management.

7. It helps in short-term profit planning by breakeven and profitability analysis, both in terms of quantity and graphs. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for decision making.

Disadvantages

1. The separation of costs into fixed and variable is difficult and sometimes gives misleading results.

2. Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing.

3. Under marginal costing, stocks and work in progress are understated. The exclusion of fixed costs from inventories affect profit, and true and fair view of financial affairs of an organization may not be clearly transparent.

4. Volume variance in standard costing also discloses the effect of fluctuating output on fixed overhead. Marginal cost data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories.

5. Application of fixed overhead depends on estimates and not on the actuals and as such there may be under or over absorption of the same.

6. Control affected by means of budgetary control is also accepted by many. In order to know the net profit, we should not be satisfied with contribution and hence, fixed overhead is also a valuable item. A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing.

7. In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the theory of marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer.

Marginal Costing versus Absorption Costing

After knowing the two techniques of marginal costing and absorption costing, we have seen that the net profits are not the same because of the following reasons:

1. Over and Under Absorbed Overheads

In absorption costing, fixed overheads can never be absorbed exactly because of difficulty in forecasting costs and volume of output. If these balances of under or over absorbed/recovery are not written off to costing profit and loss account, the actual amount incurred is not shown in it. In marginal costing, however, the actual fixed overhead incurred is wholly charged against contribution and hence, there will be some difference in net profits.

2. Difference in Stock Valuation

In marginal costing, work in progress and finished stocks are valued at marginal cost, but in absorption costing, they are valued at total production cost. Hence, profit will differ as different amounts of fixed overheads are considered in two accounts.

The profit difference due to difference in stock valuation is summarized as follows:

a. When there is no opening and closing stocks, there will be no difference in profit.

b. When opening and closing stocks are same, there will be no difference in profit, provided the fixed cost element in opening and closing stocks are of the same amount.

c. When closing stock is more than opening stock, the profit under absorption costing will be higher as comparatively a greater portion of fixed cost is included in closing stock and carried over to next period.

d. When closing stock is less than opening stock, the profit under absorption costing will be less as comparatively a higher amount of fixed cost contained in opening stock is debited during the current period.

Comparison Chart

BASIS FOR COMPARISON	MARGINAL COSTING	ABSORPTION COSTING
Meaning	A decision making technique for ascertaining the total cost of production is known as Marginal Costing.	Apportionment of total costs to the cost center in order to determine the total cost of production is known as Absorption Costing.
Cost Recognition	The variable cost is considered as product cost while fixed cost is considered as period costs.	Both fixed and variable cost is considered as product cost.
Classification of Overheads	Fixed and Variable	Production, Administration and Selling & Distribution
Profitability	Profitability is measured by Profit Volume Ratio.	Due to the inclusion of fixed cost, profitability gets affected.
Cost per unit	Variances in the opening and closing stock does not influence the cost per unit of output.	Variances in the opening and closing stock affects the cost per unit.
Highlights	Contribution per unit	Net Profit per unit

Applications of Marginal Costing

Marginal Costing Application # 1. Fixation of Selling Price:

Fixation of selling price of a product is, no doubt, one of the most significant factors in modern management.

It becomes necessary for various purposes, like, under normal circumstances of the interest; at trade depression, accepting additional order etc.

Under normal conditions, according to Financial Accounting technique, the selling price of the product must cover the total cost plus a certain margin of profit. But, under Marginal Costing technique, the price must equal the marginal cost plus a certain amount which depends on the nature, variety, demand and supply, policy pricing and other related factors.

Needless to mention that, if the selling price of the product is fixed at Marginal Cost, the amount of loss will be the amount of fixed overheads and the amount of loss will be same or lower if the production is suspended or closed down.

That is why selling in all the periods/loss must be higher than Marginal Cost. In this regard we should remember that it would be easier for us if profitability of a product is known while fixation of selling price.

Marginal Costing Application # 2. Diversification of Products:

In order to capture a new market or to utilise idle facilities etc., it may so happen that a new product may be introduced in the market together with the existing one. Naturally, the question arises before us whether the same will be a profitable product one.

In this regard it may be mentioned that the new product may be introduced only when the same is capable of contributing something against fixed cost and profit. Fixed cost will not be considered here on the assumption that the same will not increase, i.e., the new product will be produced out of existing resources.

Marginal Costing Application # 3. Selection of Most Profitable Product-Mix:

If any firm produces more than one product it may have to decide in what ratio should the products be produced or sold in order to earn maximum profit. However, the marginal costing techniques help us to a great extent while determining the most profitable product or sales mix.

Contribution under various mix will be determined first. Then the product which gives the highest contribution must be given the highest priority, and vice versa. Similarly, any product which gives negative contribution should be discontinued.

Marginal Costing Application # 4. Make-or-Buy Decisions:

Sometimes a firm may have to face a problem as to whether a part should be produced or the same should be purchased from the outside open market.

In this case, the following two points should carefully be considered:

(a) The Marginal Cost of the product; and

(b) Whether surplus capacity is available.

Needless to mention here that the decision in such a case is taken after comparing the price which has to be paid and the savings which can also be effected in terms of Marginal

Cost, as question of savings usually does not arise in case of fixed cost.

In other words, if the marginal costs are lower than the purchase price it may be suggested to produce that article in the factory itself.

Moreover, if the surplus capacity is not available and, at the same time, making the parts in the factory involves putting aside other work, the loss on contribution so made must also be considered together with marginal cost. In short, if the purchase price—which are quoted by the outside sellers—is higher than the marginal cost plus a portion of fixed cost plus loss of contribution, the same may be produced by the factory.

Marginal Costing Application # 5. Alternative Method of Production:

It is interesting to note that the techniques of marginal costing are frequently applied while comparing the alternative methods of production, viz., whether one machine is to be employed instead of another, machine-work or hand-work etc.

It should be remembered that the basis of selection would, however, be the relative contribution available from various methods when fixed costs are constant. That is, the method of production which will give the greatest contribution should be selected. Time factor or limiting factor, if any, should carefully be considered.

Marginal Costing Application # 6. Effect of Change in Selling Price:

Effect of change in selling prices is another significant factor which creates problem, particularly when a firm needs expansion. For its wider market the selling price of the product may be reduced. Needless to mention that the effect of such a change in selling price should carefully be considered.

Marginal Costing Application # 7. Shut-Down or Continue Decisions:

Due to trade recession, unprofitable operation etc. it often becomes necessary for the management to suspend or close-down temporarily or permanently a part of activity which should be taken after careful relevant consideration. In the circumstances, absorption costing techniques will distort the position due to fixed cost while marginal costing technique helps us to take proper decision in this case.

That is, if the products make a contribution towards fixed costs, it is advisable to continue the same because losses are minimised. Similarly, if the operation is suspended, certain fixed costs may be avoided but certain fixed costs may yet have to be incurred (i.e., maintenance of plant).

Thus, the decision depends on whether the contribution so made is more than the difference between the fixed costs in the normal courses of operation and the fixed costs incurred in the plant is shut-down.

Cost-Volume-Profit Analysis: Meaning, Objectives and Elements

Meaning of Cost-Volume-Profit Analysis:

Cost-Volume-Profit Analysis (or Break-Even Analysis) is a logical extension of marginal costing. It is based on the same principles of classifying the operating expenses into fixed and variable. Now-a-days it has become a powerful instrument in the hands of policy makers to maximise profits.

Earning of maximum profit is the ultimate goal of almost all business undertakings. The most important factor influencing the earning of profit is the level of production (i.e., volume of output). Cost-volume-profit analysis examines the relationship of costs and profit to the volume of business to maximise profits.

There may be a change in the level of production due to many reasons, such as competition, introduction of a new product, trade depression or boom, increased demand for the product, scarce resources, change in selling prices of products, etc.

In such cases management must study the effect on profit on account of the changing levels of production. A number of techniques can be used as an aid to management in this respect. One such technique is the cost-volume-profit analysis.

The term cost volume profit analysis is interpreted in the narrower as well as broader sense. Used in its narrower sense, it is concerned with finding out the “crisis point”, (i.e., break-even point) i.e., level of activity when the total cost equals total sales value.

In other words, it helps in locating the level of output which evenly breaks the costs and revenues. Used in its broader sense, it means that system of analysis which determines profit, cost and sales value at different levels of output. The cost-volume-profit analysis establishes the relationship of cost, volume and profits.

Objectives of Cost-Volume-Profit Analysis:

There exists close relationship between the cost, volume and profit. If volume is increased, the cost per unit will decrease and profit per unit will increase. Thus, there is direct relation between volume and profit but inverse relation between volume and cost.

Analysis of this relationship has become interesting and useful for the cost and management accountant. This analysis may be applied for profit-planning, cost control, evaluation of performance and decision making.

The main objectives of cost-volume-profit analysis are given below:

(i) This analysis helps to forecast profit fairly and accurately as it is essential to know the relationship between profits and costs on the one hand and volume on the other.

(ii) This analysis is useful in setting up flexible budget which indicates costs at various levels of activity. We know that sales and variable costs tend to vary with the volume of output. It is necessary to budget the volume first for establishing budgets for sales and variable costs.

(iii) This analysis assists in evaluation of performance for the purpose of control. In order to review profits achieved and costs incurred, it is necessary to evaluate the effect on costs of changes in volume.

(iv) This analysis also assists in formulating price policies by showing the effect of different price structures on costs and profits. We are aware that pricing plays an important part in stabilizing and fixing up volumes especially in depression period.

(v) This analysis helps to know the amount of overhead costs to be charged to the products at various levels of operation as we know that pre-determined overhead rates are related to a selected volume of production.

(vi) This analysis makes possible to attain target profit by locating the volume of sales required for such profit and finally achieving such sales volume.

(vii) This analysis helps management in taking number of decisions like make or buy, suitable sales mix, dropping of a product etc.

Assumptions Underlying Cost-Volume-Profit Analysis:

Following are the main assumptions to be taken into consideration while making a simple system of cost-volume-profit analysis:

(i) Fixed and variable cost patterns can be established with reasonable accuracy and that fixed costs remain static and marginal costs are completely variable at all levels of output.

(ii) Selling prices are constant at all sales volumes.

(iii) Factor prices (e.g. material prices, wage rates) are constant at all sales volumes.

(iv) Efficiency and productivity remain unchanged.

(v) In a multi product situation, there is constant sales mix at all levels of sales.

(vi) Turnover level (volume) is the only relevant factor affecting costs and revenue.

(vii) The volume of production equals the volume of sales.

Unit III

Meaning of Standard Costing:

It is a method of costing by which standard costs are employed. According to ICMA, London, Standard Costing is “the preparation and use of standard costs, their comparison with actual cost and the analysis of variances to their causes and points of incidence”.

According to Wheldon, it is a method of ascertaining the costs whereby statistics are prepared to show:

(i) The standard cost;

(ii) The actual cost;

(iii) The difference between these costs which is termed the variance.

But W. Bigg expresses:

“Standard Costing discloses the cost of deviations from standards and clarifies these as to their causes, so that management is immediately informed of the sphere of operations in which remedial action is necessary.”

Thus, from the above, it becomes clear that Standard Costing involves:

(i) Ascertainment and use of Standard Costs;

(ii) Recording the actual costs;

(iii) Comparison of actual costs with standard costs in order to find out the variance;

(iv) Analysis of variance; and

(v) After analysing the variance, appropriate action may be taken where necessary.

Objectives of Standard Costing:

The objectives of Standard Costing for which it is implemented are:

(a) It helps to implement budgetary control system in operation;

(b) It helps to ascertain performance evaluation.

(d) It also helps to motivate the employees of a firm to improve their performance by setting up a ‘standard’.

(e) It also helps the management to supply necessary data relating to cost element to submit quotations or to fix up the selling price of a firm.

(f) It also helps the management to make proper valuations of inventory (viz., Work-in- progress, and finished products).

(g) It acts as a control device to the management.

(h) It also helps the management to take various corrective decisions viz., fixation of price, make-or-buy decisions etc. which will be more beneficial to the firm.

Development of Standard Costing:

Importance of Standard Costing cannot be ignored for the following and that is why the same is well-developed in the present-day world:

(i) Compilation of Historical Cost is very expensive and difficult:

A manufacturing firm making large number of parts requires too much clerical work which is required in order to compile the materials, labour and overhead charges to each and every cost of parts produced for ascertaining the average cost of the product.

(ii) Historical Costs are inadequate:

In order to measure the manufacturing efficiency, historical costs are not practically adequate. It fails to explain the reasons of increased cost or any change in cost structure.

(iii) Historical Costs are too old:

In many firms, costs are determined and selling prices are ascertained even before the production starts—which is not desirable.

(iv) Historical Costs are not typical:

This is due to the wide fluctuation in market for which there is no relation between the selling price per unit and cost price per unit.

Advantages of Standard Costing:

The following advantages may be derived from Standard Costing:

(i) Standard Costing serves as a guide to the management in several management functions while formulating prices and production policies etc.

(ii) More effective cost control is possible under standard costing if the same is reviewed and analysed at regular intervals for improvements and immediate action can be taken if deviations from standards are found out which, ultimately, leads to cost reduction.

(iii) Analysis of variance and its measurement helps to detect inefficiencies and mistakes which enable the management to investigate the reasons.

(iv) Since standard costs are predetermined costs they are very useful for planning and budgeting. It also helps to estimate the effect of changes in Cost-Price-Volume relationship which also helps the management for decision-making in future.

(v) As standard is fixed for each product, its components, materials, process operation etc. it improves the overall production efficiency which also ultimately reduces cost and thereby increases profit.

(vi) Once the Standard Costing System is implemented it will lead to saving cost since most of the costing work can be eliminated.

(vii) Delegation of authority and responsibility becomes effective by setting up standards for each cost centre as the supervisors or executives of each cost centre will know the standard which they have to maintain.

(viii) This system also helps to prepare Profit and Loss Account promptly for short period in order to know the trend of the business which helps the management to take decisions promptly.

(ix) Standard costing also is used for inventory valuation purposes. Stock can be valued at standard cost which can reduce the fluctuation of profit for different methods of valuation for the same.

(x) Efficiency of labour is promoted.

(xi) This system creates cost-consciousness among all employees, executives and top management which increase efficiency and productivity as well.

Disadvantages of Standard Costing:

The alleged disadvantages of Standard Costing are:

(i) Since Standard Costing involves high degree of technical skill, it is, therefore, costly. As such, small organisations cannot, introduce the system due to their limited financial resources. But, once introduced, the benefits achieved will be far in excess to its initial high costs.

(ii) The executives are liable for those variances that are found from actions which are actually controllable by them. Thus, in order to fix up the responsibilities, it becomes necessary to segregate variances into non-controllable and controllable portions although that is not an easy task.

(iii) Standards are always changing since conditions of the business are equally changing. So, standards are to be revised in order to make them comparable with actual results. But revision of standards creates many problems, particularly in inventory adjustment.

(iv) Standards are either too liberal or rigid since the same are based on average past results, attainable good performance or theoretical maximum efficiency. So, if the standards are very high, it will adversely affect the morale and motivation of the employees.

Variance analysis

The primary objective of variance analysis is to exercise cost control and cost reduction. Under standard costing system, the management by exception principle is applied through variance analysis. The variances are related to efficiency. The showing of efficiency leads to favorable variance. In this case, the responsible persons are rewarded. On the other hand, the showing of in efficiency leads to unfavorable variance. In this case, the responsible persons are enquired and find the root causes for such unfavorable variances. This type of findings is used for taking remedial action.

Meaning of Variance

A variance is the deviation of actual from standard or is the difference between actual and standard.

Types of Variances

There is a need of knowing types of variances before measuring the variances. Generally, the variances are classified on the following basis.

A. On the basis of Elements of Cost.

Material Cost Variance.
Labor Cost Variance.
Overhead Variance.

B. On the basis of Controllability

Controllable Variance.
Uncontrollable Variance.

C. On the basis of Impact

Favorable Variance.
Unfavorable Variance

D. On the basis of Nature

Basic Variance.
Sub-variance.

A brief explanation of the above mentioned variances are presented below

1. Material Cost Variance: It is the difference between actual cost of materials used and the standard cost for the actual output.

2. Labor Cost Variance: It is the difference between the actual direct wages paid and the direct labor cost allowed for the actual output to be achieved.

3. Overhead Variance: Overhead variance is the difference between the standard cost of overhead allowed for actual output (in terms of production units or labor hours) and the actual overhead cost incurred.

4. Controllable Variance: A variance is controllable whenever an individual or a department or section or division may be held responsible for that variance.

5. Uncontrollable Variance: External factors are responsible for uncontrollable variances. The management has no power or is unable to control the external factors. Variances for which a particular person or a specific department or section or division cannot be held responsible are known as uncontrollable variances.

6. Favourable Variances: Whenever the actual costs are lower than the standard costs at per-determined level of activity, such variances termed as favorable variances. The management is concentrating to get actual results at costs lower than the standard costs. It shows the efficiency of business operation.

7. Unfavorable Variances: Whenever the actual costs are more than the standard costs at predetermined level of activity, such variances termed as unfavorable variances. These variances indicate the inefficiency of business operation and need deeper analysis of these variances.

8. Basic Variances: Basic variances are those variances which arise on account of monetary rates (i.e. price of raw materials or labor rate) and also on account of non-monetary factors (such as physical units in quantity or time). Basic variances due to monetary factors are material price variance, labor rate variance and expenditure variance. Similarly, basic variance due to non-monetary factors is material quantity variance, labor efficiency variance and volume variance.

9. Sub Variance: Basic variances arising due to non-monetary factors are further analyzed and classified into sub-variances taking into account the factors responsible for them. Such sub variances are material usage variance and material mix variance of material quantity variance. Likewise, labor efficiency variance is subdivided into labor mix variance and labor yield variance. At the same time, variable overhead variance is sub-divided into variable overhead efficiency variance and variable overhead expenditure variance.

Advantages of Variance analysis

The following are the merits of variance analysis.

1. The reasons for the overall variances can be easily find out for taking remedial action.

2. The sub-division of variance analysis discloses the relationship prevailing between different variances.

3. It is highly useful for fixing responsibility of an individual or department or section for each variance separately.

4. It highlights all inefficient performances and the extent of inefficiency.

5. It is used for cost control.

6. The top management can follow the principle of management by exception. Only unfavorable variances are reporting to management.

7. Sometimes, the variances can be classified as controllable and uncontrollable variances. In this case, controllable variances are taken into consideration for further action.

8. Profit planning work can be properly carried on by the top management.

9. The results of managerial action can be a cost reduction.

10. It creates cost consciousness in the minds of the every employee of business organization.

Unit IV

BUDGET

A budget is a plan expressed in quantitative, usually monetary term, covering a specific period of time, usually one year. In other words a budget is a systematic plan for the utilization of manpower and material resources.

In a business organization, a budget represents an estimate of future costs and revenues. Budgets may be divided into two basic classes: Capital Budgets and Operating Budgets.

Capital budgets are directed towards proposed expenditures for new projects and often require special financing. The operating budgets are directed towards achieving short-term operational goals of the organization, for instance, production or profit goals in a business firm. Operating budgets may be sub-divided into various departmental of functional budgets.

The main characteristics of a budget are:

1. It is prepared in advance and is derived from the long-term strategy of the organization.

2. It relates to future period for which objectives or goals have already been laid down.

It is expressed in quantitative form, physical or monetary units, or both.

Different types of budgets are prepared for different purposed e.g. Sales Budget, Production Budget, Administrative Expense Budget, Raw-material Budget etc. All these sectional budgets are afterwards integrated into a master budget, which represents an overall plan of the organization.

ADVANTAGES OF BUDGETS

A budget helps us in the following ways:

1. It brings about efficiency and improvement in the working of the organization.

2. It is a way of communicating the plans to various units of the organization. By establishing the divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus minimizes the possibilities of buck passing if the budget figures are not met.

3. It is a way or motivating managers to achieve the goals set for the units.

4. It serves as a benchmark for controlling on-going operations.

5. It helps in developing a team spirit where participation in budgeting is encouraged.

6. It helps in reducing wastage and losses by revealing them in time for corrective action.

7. It serves as a basis for evaluating the performance of managers.

8. It serves as a means of educating the managers.

Budgetary Control:

Throughout the budget period, the use of budgets & budgetary reports for the purpose of coordinating, evaluating & controlling day-to-day operations according to the goals which are specified by the budget is involved by budgetary control. The mere presentation of budget doesn’t have much value, its real value lies in the aspects of the planning & its utilization during the period for the purposes of control & coordination. Under budgetary control, actual results are constantly checked & evaluated & comparison of actual result is made with the budgeted goals & wherever indicated, corrective action should be undertaken. The following steps are involved in the process of budgetary control:

(a) The objectives which are required to be achieved by the business should be defined & specified by budgetary control.
(b) For the purpose of ensuring that the desired objectives are accomplished, business plans are needed to be prepared by budgetary control.
(c) Budgetary control translates the plans into budgets & relates to particular sections of the budget, the responsibilities of individual executives & managers.
(d) Budgetary control constantly compares the actual results with the budget & the differences between the actual & budgeted performance are calculated.
(e) For the purpose of establishing the causes, the major differences are investigated by budgetary control.
(f) In a suitable form, budgetary control presents the information to the management, relating to variances to individual responsibility.
(g) In order to avoid a repetition of any over-expenditure or wastage, management takes corrective actions. Alternatively, where due to the change in circumstances, the budgeted targets cannot be achieved, the budget is revised.

Characteristics of Budgetary Control:

The salient features of Budgetary Control may be enumerated as follows:

(i) Budgetary Control determines the objectives to be achieved over the budget period. It also frames policies that are expected to be adopted for the achievement of these ends.

(ii) It addresses variety of activities that should be undertaken for the achievement of the objectives.

(iii) An effective budgetary control draws up a plan or a scheme of operation in respect of each class of activity, in physical as well as monetary terms, for the entire budget period and its parts.

(iv) It lays out a system of comparison of actual performance by each person, section or department with the relevant budget and determine the causes for the discrepancies, if any.

(v) It ensures that corrective action will be taken, where the objective is not achieved and, that be not possible, for the revision of the plan.

In brief, it is a technique to assist the management in the allocation of responsibility and authority, to provide it with aid for making estimating and planning for the future and to facilitate the analysis of the variations between estimated and actual performance. By doing so, weak areas of performance are identified and corrective measures are taken so that objectives can be achieved.

Difference between Budget, Budgeting & Budgetary control:

Individual objectives of a department etc. are indicated by budget, whereas the act of setting the budgets is known as budgeting. All are embraced by budgetary control & also the science of planning the budgets themselves & as an overall management tool, the utilization of such budgets, for the purpose of business planning & control are included in budgetary control. Thus, the term by budgetary control is wider in meaning & both budget & budgeting are included in by budgetary control.

Objectives of Budgetary Control:

The objectives of budgetary control are:

(1)Compel for planning: As management is forced to look ahead, responsible for setting of targets, anticipating of problems & giving purpose & direction to the organization, this feature is the most important feature of budgetary control.
(2)Communication of ideas & plans: Communication of ideas & plans to everyone is effected by budgetary control. In order to make sure that each person is aware of what he is supposed to do, it is necessary that there is a formal system.
(3)Coordinating the activities: The budgetary control coordinates the activities of different departments or sub-units of the organization. The coordination concept implies, for example, on production requirements, the purchasing department should base its budget & similarly, on sales expectations, the production budget should in turn be4 based.
(4) Establishing a system of control: A system of control can be established by having a plan against which progressive comparison can be made of actual results.

(5) Motivating employees: Employees are motivated for improving their performances by budgetary control.

Principles of Budgetary Control:

The following are the fundamental principles of budgetary control:

i. Establish a plan or target of performance which coordinates all the activities of the business.

ii. Record the actual performance.

iii. Compare the actual performance with that planned.

iv. Calculate the differences or variances, and analyse the reasons for them.

v. Proper action is to be taken immediately to remedy the situation.

Advantages of Budgetary control:

The advantages of budgetary control system are as follows:

(1) The objectives of the organization as a whole & the results which should be achieved by each department within this overall framework are defined by the budgetary control.
(2) When there is a difference between actual results & budget, then the extent by which actual results have exceeded or fallen short of the budget is revealed by the budgetary control.
(3) The variances or other measures of performance along with the reasons of difference between the actual results with those from budgeted is indicated by the budgetary control. Also, the magnitude of differences is established by it.
(4) As the budgetary control reports on actual performance along with variances & other measures of performance; for correcting adverse trends, a basis for guiding executive action is provided by it.
(5) A basis by which future budget can be prepared or the current budget can be revised is provided by the budgetary control.
(6) A system whereby in the most efficient way possible the resources of the organization are being used is provided by the budgetary control.
(7) The budgetary control indicates how efficiently the various departments of the organization are being coordinated.
(8) Situations where activities & responsibilities are decentralized, some centralizing control is provided by the budgetary control.
(9) The budgetary control provides means by which the activities of the organization can be stabilized, where the organization’s activities are subject to seasonal variations.
(10) By regularly examining the departmental results, a basis for internal audit is established by the budgetary control.
(11) The standard costs which are to be used are provided by it.
(12) For the purpose of paying a bonus to employees, a basis by which the productive efficiency can be measured is provided by the budgetary control.

Limitations of Budgetary Control:
The main limitations of budgetary control are:
(1) It used the estimates as a basis for the budget plan.
(2) In order to fit with the changing circumstances the budgetary programme must be continually adapted. Normally for attaining a reasonably good budgetary programme, it takes several years.
(3) A budget plan cannot be executed automatically. Enthusiastic participation is required by all levels of management in the programme.
(4) The necessity of having a management & administration will not be eliminated by any budgetary control system. The place of the management is not taken by it; rather it is a tool of the management.

Types of Budget

As budgets serve different purposes, different types of budgets have been developed. The following are the different classification of budgets developed on the basis of time, functions, and flexibility or capacity.

(A) Classification on the basis of Time:

1. Long-Term Budgets

2. Short-Term Budgets

3. Current Budgets

(B) Classification according to Functions:

1. Functional or Subsidiary Budgets

2. Master Budgets

(C) Classification on the basis of Capacity:

1. Fixed Budgets

2. Flexible Budgets

(A) Classification on the Basis of Time

1. Long-Term Budgets: Long-term budgets are prepared for a longer period varies between five to ten years. It is usually developed by the top level management. These budgets summarise the general plan of operations and its expected consequences. Long-Term Budgets are prepared for important activities like composition of its capital expenditure, new product development and research, long term finance etc.

2. Short-Term Budgets: These budgets are usually prepared for a period of one year. Sometimes they may be prepared for shorter period as for quarterly or half yearly. The scope of budgeting activity may vary considerably among different organization.

3. Current Budgets: Current budgets are prepared for the current operations of the business. The planning period of a budget generally in months or weeks. As per ICMA London, "Current budget is a budget which is established for use over a short period of time and related to current conditions."

(B) Classification on the Basis of Function

1. Functional Budget: The functional budget is one which relates to any of the functions of an organization. The number of functional budgets depend upon the size and nature of business. The following are the commonly used:

(1) Sales Budget

(2) Purchase Budget

(3) Production Budget

(4) Selling and Distribution Cost Budget

(5) Labor Cost Budget

(6) Cash Budget

(7) Capital Expenditure Budget

2. Master Budget: The Master Budget is a summary budget. This budget encompasses all the functional activities into one harmonious unit. The ICMA England defines a Master Budget as the summary budget incorporating its functional budgets, which is finally approved, adopted and employed.

(C) Classification on the Basis of Capacity

1. Fixed Budget: A fixed budget is designed to remain unchanged irrespective of the level of activity actually attained.

2. Flexible Budget: A flexible budget is a budget which is designed to change in accordance with the various level of activity actually attained. The flexible budget also called as Variable Budget or Sliding Scale Budget, takes both fixed, variable and semi fixed manufacturing costs into account.

Important Questions

“Management Accounting is concerned with accounting information that is useful to management.” Explain the term management accountancy and states its main objectives.
Distinguish between cost accounting & financial accounting.
Distinguish between cost accounting & Management accounting.

4. . Distinguish between Financial accounting & Management accounting.

5. What do you mean by marginal costing? Differentiate between marginal costing and absorption costing?

6. Define budget, budgeting and budgetary control. Give the advantage of budgetary control in a manufacturing organization.

7. “Standard costing is always accompanied by a system of budgeting but budgetary control may be operated in business where standard costing is not applicable.” Comment and elucidate the importance of standard costing.

8. The following data are taken from the manufacturing records of a company for a half year period:

Fixed Expenses:

Wages and Salaries 84000

Rent rates and taxes 56000

Depreciation 70000

Sundry Administration Expenses 89000

299000

Semi-variable Expenses (at 50% capacity):

Maintenance and Repairs 25000

Indirect Labor 99000

Sales Department Salaries 29000

Sundry Administration Expenses 26000

179000

Variable Expenses (at 50% capacity):

Materials 240000

Labor 256000

Others 38000

534000

Assume that fixed expenses remain constant for all levels of production; Semi-variable expenses remain constant between 45% and 65% of capacity, increasing by 10% between 65% and 80% capacity and by 20% between 80% and 100% capacity. Sales at various levels are:

Capacity Rs.

60% 1000000

75% 1200000

90% 1500000

100% 1700000

Prepare a flexible budget for half year and forecast the profits at 60%, 75%, 90% and 100% of capacity.

9. The expenses budgeted for production of 10000 units in a factory are furnished below:

Per Unit (Rs.)

Materials 70

Labor 25

Variable overheads 20

Fixed overheads (Rs. 100000) 10

Variable expenses (direct) 5

Selling expenses (10% fixed) 13

Administration Expenses (Rs. 50000) 5

Distribution Expenses (20% fixed) 7

Total 155

Prepare a budget for production of (a) 8000 units and (b) 6000 units. Assume that administrative expenses are rigid for all level of production.

10. A company is expecting to have Rs. 25,000 cash in hand on 1st April 2014 and it requires you to prepare an estimate of cash position in respect of three months from April to June 2014, from the information given below:

Month Sales Purchase Wages Expenses

Rs. Rs. Rs. Rs.

February 70,000 40,000 8,000 6,000

March 80,000 50,000 8,000 7,000

April 92,000 52,000 9,000 7,000

May 1,00,000 60,000 10,000 8,000

June 1,20,000 55,000 12,000 9,000

Additional Information:

(a) Period of credit allowed by suppliers - two months.

(b) 25 % of sale is for cash and the period of credit allowed to customer for credit sale one month.

(d) Income Tax Rs. 25,000 is to be paid in June 2014.

11. Prasad & Co. wishes to prepare cash budget from January. Prepare a cash budget for the first six months from the following estimated revenue and expenses:

Month Total Sales Materials Wages Production Exp. Selling Exp.

Rs. Rs. Rs. Rs. Rs.

January 10,000 10,000 2,000 1,600 400

February 11,000 7,000 2,200 1,650 450

March 14,000 7,000 2,300 1,700 450

April 18,000 11,000 2,300 1,750 500

May 15,000 10,000 2,000 1,600 450

June 20,000 12,500 2,500 1,800 600

Additional Information:

1. Cash balance on 1st January was Rs. 5,000. New machinery is to be installed at Rs. 10,000 on credit, to be repaid by two equal installments in March and April.

2. Sales commission @ 5 % on total sales is to be paid within a month of following actual sales.

3. Rs. 5,000 being the amount of 2nd call may be received in March. Share Premium amounting to Rs. 1,000 is also obtainable with the 2nd call.

4. Period of credit allowed by suppliers - 2 months.

5. Period of credit allowed to customers - 1 month.

6. Delay in payment of overheads - 1 month.

7. Delay in payment of wages –1/2 month.

8. Assume cash sales to be 50 % of total sales.

12. From the following data calculate:

(a) Material Price Variance

(b) Material Usage Variance

Standard: (i) 250 kg of raw materials is required for producing 175 kg. of finished goods.

(ii) Price of material per kg Rs. 4.

Actuals:

(i) Production 52500 kg

(ii) Material consumed Rs. 70000 kg.

(iii) Cost of material Rs. 273000.

13. Standard

Labor Rate = 25 paise per hour

Hours required for one unit = 2.5 hours

Actual production data:

Output =210 units

Labor rate =28 paise per hour

Hours worked=580 hours

Calculate labor variances.

14. From the following particulars calculate P/V Ratio and with the help of that ratio find out the following:

(i) Fixed costs

(ii) Contribution for both the period

(iii) Variable costs for 2014 and 2015

(iv) Profit when sales are Rs. 2, 00,000.

(v) Sales required earning a profit of Rs. 40,000.

Year Sales Profit

2014 2, 40,000 18,000

2015 2, 80,000 26,000

15. Following records are available from the accounting records of ABC Ltd.:

Year Sales Profit/ Loss

2014 25,000 5,000 (Loss)

2015 75,000 5,000 (Profit)

Find out:

(i) P/V Ratio

(ii) Fixed Costs

(iii) Marginal Costs for 2014 and 2015

(iv) B.E.P.

(v) Margin of safety for the profit of Rs. 10,000.

16. (i) Find out margin of safety, if profit is Rs. 30,000 and P/V Ratio is 40%.

(ii) Find out P/V Ratio if fixed cost is Rs. 10,000 and break even sales are Rs. 40,000.

(iii) Find profit at the sales of Rs. 20,000 if fixed cost is Rs. 4,000 and B.E.P. is Rs. 10,000.

17. What is variance analysis? Why is it called as a tool of management?

18. Classify the budgets on the basis of time, function and flexibility.

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