Module : 2

Scope, Tools and Techniques, Functions and Limitations of

Management Accounting

My dear friends, now second day of our journey we are going to explore more about
Management Accounting.
Introduction:
We studied meaning, nature and objectives of management accounting in the first
session. As you know management accounting facilitates management for decision
making, it has much more wider scope than financial and cost accounting. In this
session we are going to discuss some more aspects of management accounting. Let
us see first these aspects.
Objectives: In this session we are going to discuss
 Scope of Management Accounting:
 Tools and techniques used in management Accounting
 Functions of Management Accounting
 Limitations of Management Accounting
Let us first discuss scope of Management Accounting
Scope of Management Accounting:
Management Accounting provides accounting information to the top level
management to facilitate better decision making. The scope of management
accounting is very broad based and covers all the areas. You can see the Systems
and techniques fall within the ambit of management accounting in the figure .

1
 Financial
Accounting
Internal Cost
Audit Accounting

Management Scope of Management Budgetary

Reporting Accounting Control

Statistical &
Inventory
Quantitive
Control
Techniques
Tax
Accounitng

Let us discuss the scope of Management Accounting in detail.

1. Financial accounting:
Financial accounting includes the recording and summarising of business
transactions such as income, expenses, inventory movement, assets, liabilities, cash
receipts, payments etc. and the preparation of financial statements regularly at the
end of each accounting year for knowing operating results for a definite period. The
financial statements include profit and loss account and balance sheet. Management
Accounting analyses and interprets the financial statements to report to top level
management for future projections. Thus financial accounting serves as basis for
management accounting.
2. Cost Accounting:
Cost accounting is concerned with the ascertainment of various elements of costs
such as material, labour and overheads of different products, processes and jobs for
business operations. It also serves efficiency of different departments, divisions and
products. With the help of various techniques like standard costing, marginal costing,
absorption costing etc., it helps in knowing the deviations in the costs. Marginal

2
costing is the most important tool in decision-making. Management accounting
makes use of cost information in taking managerial decisions.
3. Budgetary Control:
Budgets are blueprints for future activity to be planned today. Budgeting means
expressing the plans, policies and goals of the enterprise for a definite period in
future. Different types of budget systems, like production, sales, materials, labour
etc. do exist in organizations. The targets are set for different departments and
responsibility is fixed for achieving these targets. The comparison of actual
performance with budgeted figures will give an idea to the management about the
performance of different departments. If differences remain vast then corrective
measures are taken for prevention in future. Budgetary control is the system of
controlling the cost with the help of budgets. This helps management accounting in
future forecasting.
4. Statistical and Quantitative Techniques:
Management accounting makes use of various statistical methods to provide
relevant information to management in the most reliable and lucid manner. Statistical
methods like sampling techniques, probability, linear programming, and regression
analysis are used by management accountant to make the information more
accurate and impressive. Thus, statistical and quantitative techniques are essential
part of management accounting.
5. Tax Accounting:
Tax accounting includes the computation of corporate income tax in accordance with
the tax laws, filing of returns and making tax payments. Tax accounting is an
important aspect of management accounting. Tax accounting comes under the
purview of management accountant’s duties and tax planning has become an
integral part of management in the present scenario.
6. Inventory Control:
Inventory control refers to exercising control over the utilization of raw materials,
processing of work in progress and disposal of finished goods for a specific period. It
is the system devised and adopted for controlling investment in inventory. The
management should determine different levels of stocks, i.e. minimum level,
maximum level, re- ordering level for inventory control. The control of inventory will
help in controlling costs of products. Management accountant will guide
management as to when and from where to purchase and how much to purchase.
3
So the study of effective inventory control will be helpful for taking managerial
decisions.

7. Management Reporting :
Corporate Reporting is divided into two types interim reporting and external
reporting. Interim reporting is supplying information to the top management. External
reporting is supplying information to outsiders i.e. shareholders, banks and financial
institutions. Management reporting refers preparation of monthly, quarterly, half-
yearly reports providing information on the financial, costing and other aspects of
business and updating internal management about real time financial changes in the
organization.

8. Internal Audit :
Internal audit is conducted by the business organization through professionals who
have thorough accounting knowledge. It helps the management in fixing individual
responsibility for internal control. All the relevant records are maintained under the
management accounting system so that the internal audit is conducted in an
effective manner.
To facilitate the management in evaluation of performance and decision making the
management accounting uses certain tools and techniques. Now let us discuss
these tools and techniques.
Tools and techniques used in management accounting are:
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

4
  Operations Research.
 Linear Programming.
 Network analysis.
 Queuing 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.
Let us discuss some of the important tools and techniques.

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.

5
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

[Link]-making Accounting

6
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. These 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.

The last point we are going to discuss is the functions of Management Accounting.

Functions of management accounting

7
The basic function of management accounting is to assist the management in
performing its functions effectively. The functions of the management are planning,
organizing, directing and controlling. Management accounting helps in the
performance of each of these functions in the various ways:

(1) Providing data:

Management accounting serves as a vital source of data for management planning.

The accounts and documents are a repository of a vast quantity of data about the
past progress of the enterprise, which are a must for making forecasts for the future.

(2) Modifying data:

The accounting data required for managerial decisions is properly compiled and
classified. For example, purchase figures for different months may be classified to
know total purchases made during each period product-wise, supplier-wise and
territory-wise.

(3) Analyses and interprets data:

The accounting data is analyzed meaningfully for effective planning and decision-
making. For this purpose the data is presented in a comparative form. Ratios are
calculated and likely trends are projected.

(4) Serves as a means of communicating:

Management accounting provides a means of communicating management plans

upward, downward and outward through the organization. Initially, it means
identifying the feasibility and consistency of the various segments of the plan. At later
stages it keeps all parties informed about the plans that have been agreed upon and
their roles in these plans.

(5) Facilitates control:

Management accounting helps in translating given objectives and strategy into

specified goals for attainment by a specified time and secures effective
accomplishment of these goals in an efficient manner. All this is made possible
through budgetary control and standard costing which is an integral part of
management accounting.

8
(6) Uses also qualitative information:

Management accounting does not restrict itself to financial data for helping the
management in decision making but also uses such information which may not be
capable of being measured in monetary terms. Such information may be collected
form special surveys, statistical compilations, engineering records, etc.

Limitations of Management Accounting

Management accounting techniques -- accounting procedures that emphasize

current information and analysis for managerial decision-making -- can provide
small-business owners with useful information for making business decisions.
However, this information isn't without fault or cost. Making sure you understand
some of the problems related to managerial accounting information can help you
ensure that you only implement managerial accounting systems that will provide a
net positive benefit to your small business.

The management accountant has the responsibility of producing and providing

dependable accounting and other relevant data for the use of management. The
data provided, if it has to be really effective in the management process, must be:

(i) relevant and precise, (ii) consistent and comparable, (iii) presented in an
appropriate and understandable form, (iv) provided at appropriate time intervals, and
(v) provided to meet the needs of various levels of management. The management
accountant is expected to keep in mind the above points while producing his
product. However, the information and reports presented by management
accountant still suffers from certain limitations. Let discuss these limitations

1. Different meaning of the same term:

In accounting different terms carry different meanings under different set of

circumstances and conditions. Such meanings and figures may superficially
resemble one another and a person who is not, familiar with them may easily
become confused or frustrated. The most common source of confusion is the word
‘cost’. There are historical costs, full costs, direct costs, variable costs, standard
costs, original costs, residual costs, net costs, differential costs, opportunity costs,
estimated cost and incremental costs. Some of these terms are synonymous,

9
 others are not exactly synonymous through resembling each other, still others,
although not synonymous at all, may be used as if they were synonymous. In order
to avoid such confusion and misunderstanding, the management accountant should
in approaching a specific problem, define, as carefully and clearly as possible, the
meaning in which such words are being used. He should as far as possible be
consistent in prescribing the meanings to such terms.

2. Approximations:

Management accounting data cannot be completely accurate in all respects. A

good deal of approximation is involved in the compilation and preparation of such
data. The smaller the time gap between the happening and reporting of an event,
the greater will be the approximation. In addition, in the working out of the estimates
and future costs, approximation has to be resorted to. Even in case of historical
data, the cost and time required for accuracy may be prohibitive and compel the
management accountant to do some approximations. Therefore, while using the
information provided by the management accountant, the management must be
aware of the degree of approximation. The management accountant should follow a
consistent practice in matters of approximations.

3. Incompleteness of the data:

Management accountant can provide only the quantitative data as far as available,
to the management. Business problems and their decisions often require additional
quantitative as well as qualitative data which may be outside the purview of the
management accountant. For example, the management accounting data will not
disclose the extent to which the quality and utility of a product is affected by the
changes in materials or methods of production. The management should guard
itself against the belief that problems could be completely solved by numerical
analysis. The management accountant should point out as far as possible, the
qualitative factors relevant for decision-making in each case.

4. Importance of proper management action:

A management accountant may provide information and figures in most appropriate

form to the management. But figures themselves are nothing more than marks on
pieces of paper, and by themselves they accomplish nothing. Anything that the

10
 business accomplishes is the result of action of the people. Figures can only assist
people in the organisation in various ways. It is the management and the people in
the organisation who are to use the figure by understanding their language and act
accordingly. The same set of figures, if not acted upon by the management,
becomes useless or if misunderstood by the management, may lead to unwise
actions.

5. GAAP Compliance

One of the biggest complaints about management accounting techniques is that

many of these techniques are not compliant with Generally Accepted Accounting
Principles, or GAAP. For example, activity-based costing can provide more accurate
costing information to decision-makers through an alternative way of assigning costs
to products. However, because the method doesn't assign all manufacturing costs to
products, it is not in accordance with GAAP. Therefore, if you wish to use activity-
based costing, then it will be in addition to using a GAAP-compliant method.

6. Costly Affair:

For small-business owners, this can become costly. Before implementing

management accounting techniques, you should ensure that the benefits of the
technique are expected to outweigh the cost of multiple systems. If this is not the
case, then it probably isn't worth the time and money.

7. Adaptability

While some guidelines exist for management accounting procedures, the techniques
are able to be adapted to the specifics of your business. This can be an advantage
of management accounting, but is also a drawback. Because management
accounting is so flexible, it can be difficult to compare results across companies,
especially if you are inconsistent in applying management accounting techniques in-
house. For example, there are only guidelines for preparing many management
accounting reports, with the idea that the report should be tailored to your business
specifics. However, what one manager finds important may be different than what
another manager finds important. As such, the adaptability of these tools can make
comparison difficult.

8. Reliability

11
Management accounting techniques usually emphasize the timeliness of information
to allow business owners to make decisions. This implies a trade-off with reliability.
For example, say you are trying to determine next year's sales. To get the most
accurate figure, you just need to wait until next year occurs, and you will know the
result with near-absolute certainty. However, if you need this information for a
decision that you are planning on making in the present, then timeliness of
information is more important. Before relying on management accounting
information, you should evaluate how important the accuracy of the information is. If
accuracy is the most important quality of the information, then more investigation
should be done to determine how the estimate was made.

Let us conclude this session.

Summary

Management Accounting helps a lot to the management in arranging the factors of

production, assembling and organizing the resources and integrating the
resources in effective manner to achieve goals. It is very useful in directing group
efforts towards achievement of pre-determined goals.

12