CHAPTER-I

INTRODUCTION
1.1 COST ACCOUNTING
1.1 .1 Meaning of Cost Accounting
In the early stages Cost Accounting was merely considered to be a technique for ascertainment of
cost of a products or services on the basis of historical data. In the course of time the
ascertainment of cost is not as important as comparing to cost control due to competitive nature
of the market. Because of technological developments in all areas, now cost reduction has also
come within the scope of cost accounting.
Decision-making is emphasized towards specific goals. Management cannot avoid making
decisions, even if the decision is to do nothing in a particular situation. Decision-making without
relevant information the decision will lack purpose and effectiveness. A good management
decision should be both effective and efficient. An effective decision accomplishes the goals that
the management needs. An efficient decision consumes minimum amount of resources to achieve
the desired goals.

Cost accounting is, thus, concerned with recording, classifying and summarizing costs for
determination of costs of products or services, planning, controlling and reducing costs and
furnishing of information to management for decision making.

Modern cost accounting provides key information to managers for their decision-making. The
study of modern cost accounting yields insights into both the managers’ role and the accountant’s
role in an organization.

Definition
a. According to T. Horngren, Foster and Datar, “Cost accounting measures and
reports financial and other information related to the acquisition or consumption of an
organization’s resources. Cost accounting provides information to both Management
accounting and Financial accounting.”
b. The Terminology of The Chartered Institute of Management Accountants,
London (CIMA) defines it as,” The establishment of budgets, standard costs and
actual cost of operations, processes, activities or products and the analysis of
variances, profitability or the social use of funds”.
1.1.2 Objectives of Cost Accounting.
The main objectives of cost accounting can be summarized as follows:
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 i. Ascertaining product unit cost
ii. Controlling cost
iii. Stimulating cost consciousness
iv. Determining selling price
v. Determining profit and loss for various products and services and inventory valuation and
vi. Providing basis for formulating operating policies.
1.1.3 Advantages of cost accounting
 Helps in optimum utilization of men, materials and machines
 Identifies the areas requiring corrective action
 Helps management in formulation of policies.
 Presents tailor made solution for the problem
 Helps management in making short term decisions by use of techniques like marginal
costing (variable costing)
 Provides useful data for final accounts by giving cost of closing stock of raw materials,
work in progress and finished products.
 Provides a database for reference by government, wage tribunals and trade unions
 Helps in formation of cost centers and responsibility centers to exercise control.
 Helps to face increasing difficulties in setting prices and improving efficiency.
 Facilitates use of specialized techniques like Cost reduction, Value analysis, Operation
research and Management by exception
 Threads its way through every phase of business and to a large extent influences the
make-up of the entire enterprise its products, its markets and its methods of operation.
 Focuses attention on the profitability of each product and service unlike financial
accounting, which presents profitability for company as a whole.
1.1.4 Limitations of Cost accounting
 It is not an exact science and involves inherent element of judgment
 Cost varies with purpose. Therefore, cost collected for one purpose will not be suitable
for another purpose.
 Cost accounting presents the base for taking the best decisions. It does not give outright
the solution of the problems.
 Most of the cost accounting techniques are based on some pre-assumed notions.
 The area’s most vulnerable to criticism in cost accounting are arbitrary apportionment of
common costs.

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  Different views are held by different cost accountants about the items to be included in
cost.
1.1.5 Techniques of Costing
Management only for controlling costs and making some important managerial decisions uses
the following types of costing techniques.
Historical data, i.e. ascertainment of costs after they have been incurred. This costing is based
on recorded data and the costs arrived at are verifiable by past events.
Standard costing, a control technique which compares standard costs and revenues with actual
results to obtain variances which are used to stimulate improved performance
Variable costing, is the accounting system in which variable costs are charged to cost units and
fixed costs of the period written off in full against the aggregate contributions. Its special value is
in decision making
Direct costing, The practice of charging all direct costs to operations, processes or products
leaving all indirect costs to be written off against profits in the period in which they arise, is
termed as direct costing. The technique differs from variable costing because some fixed costs
can be considered as direct costs in appropriate circumstances
Absorption or full costing, The practice of charging all costs both variable and fixed to
operations, products or processes is known as absorption costing.
Uniform costing, A technique, where standardized principles and methods of cost accounting are
employed by a number of different corporation and firms, is known as Uniform costing. The
system thus facilitates inter firm comparisons, establishment of realistic pricing policies etc.

1.2 MANAGEMENT ACCOUNTING

1.2.1 Need for Management Accounting:

Accountants are responsible for all financial and many non-financial reports to management.
Management relies on accountant’s reports to make operating decisions, and so, indirectly, do
outsiders- investors, creditors, vendors and customers. All of these people have a right to expect
objective information and accountants must supply it.

The financial accounting is concerned with recording, classifying, summarizing, analyzing and
interpreting the past transactions for an accounting period of a business enterprise. The objective
of the financial accounting is to report at regular intervals to owners, managers and other
interested parties by means of financial statements. The scope of financial accounting is limited

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i.e. it can’t help the management’s needs like complex problems competition etc. Hence, the
management needs the other system which financial accounting system fails satisfies the
management needs. The other system is known as Management Accounting or Managerial
Accounting.

Management Accounting is a segment of accounting that deals specifically with how accounting
data and other financial information can be used in the management of business, governmental or
non-profit entities. Because management accounting is designed to assist internal management, it
is relatively free from the restrictions imposed by regulatory bodies that prescribe how
accounting information should be presented to the public. Although management accounting is to
a large extent free from restrictions, it does rely upon broad general concepts and certain
applications that are most useful to management.

Management accounting makes use of information that is drawn from financial accounting and
may extend beyond the boundaries of accounting to draw upon economics, finance, statistics,
operation research or other disciplines as necessary. Management accounting is constantly
evolving to meet the changing needs of management; Strong international competition has
generated new management Philosophies that have pushed management accountants in new
directions.
1.2.2 Meaning:

Managerial or Management accounting is part of an organization’s management information

system. Managers rely on managerial accounting information to plan and control an
organization’s operations.

The term management accounting refers to an accounting for the management, i.e. accounting
which provides necessary information to the management for discharging its functions. The
functions of the management are planning, organizing, directing and controlling. Thus,
Management accounting provides information to management so that planning, organizing,
directing and controlling of business operations can be done in an orderly manner.

Management accounting consists of accounting techniques and procedures for gathering and
reporting financial, production and distribution of data to meet management’s information needs.
The management accountant is expected to provide timely, accurate information including

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budgets, standard costs, and variance analyzes, support for day to day operating decisions and
analyses of capital expenditures.

Definitions:
3.1 “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 in the making of rational decisions
with a view towards achieving these objectives.” American Accounting Association.

3.2 “Management accounting is the presentation of accounting information in such a way as

to assist management in the creation of policy and in the day-to-day operations of an
undertaking.” Management Accounting Team of the Anglo-American Council of
Productivity

3.3 “Management accounting as, the process of identification, measurement, accumulation,

analysis, preparation, interpretation, and communication of financial (and non financial)
information used by management to plan, evaluate, and control within the organization
and to assure appropriate use and accountability for its resources”. - The Institute of
Management Accountants.

The information that management accountants gather and analyze is used to support the actions
of management. All business managers need accurate and timely information and more complex
accounting and many other types of divisions. Multidivisional corporations and larger amounts
of information and more complex accounting and reporting systems than do small businesses.
Management accounting information helps organization make better decisions. Such decisions
make all organizations become more cost effective and help manufacturing, retail and service
organizations becomes more profitable.

1.2.3 Objectives of Managerial accounting activity

The four major objectives of managerial accounting activity are:
A. Providing managers with information for decision making and planning
B. Assisting managers in directing and controlling operational activities
C. Motivating managers and other employees toward the organizational goals

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 D. Measuring the performance of subunits, managers and other employees within the
organization.

The management accountant not only providing financial information but also a strong trend
toward the presentation of substantial non financial information managerial accountants supply
all kinds of information to management and act as strategic business partners in support of
management’s role in decision making and managing the organization’s activities. Measuring
managing and continuously improving operational activities is critical to be organization’s
success.

1.2.4 Role of the Management accountant’s in Decision making:

To understand the managerial accountant’s role in an organization, we must know how
organizations are structured.

Line and staff positions

Apart from top management position the other positions in the organization structure are of two
types: Line position and staff position. Managers in line positions are directly involved in the
operation of the organization.
Manager in staff positions supervise activities that support the organization but they are
indirectly involve in the operation.

Controller: In most organizations, the controller is the chief managerial and financial
accountant. The controller usually is responsible for supervising the personnel in the accounting
department and for preparing the information and reports used in both managerial and financial
accounting. As the organization’s chief managerial accountant, the controller often interprets
accounting information for line managers and serves as a consultant when decisions and plans
are made. Most controllers are involved in planning and decision making at all levels and across
all functional areas of the enterprise. This broad role has enabled many managerial accountants
to rise to the top of their organizations.
Treasurer. The Treasurer is responsible for raising capital and safeguarding the organization
assets.
Internal Auditor: An organization’s internal auditor is responsible for reviewing the accounting
procedures, records and reports in both the controller’s and the treasurer’s areas of responsibility.

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Auditor: The auditor expresses an opinion to top management regarding the effectiveness of the
organization’s accounting system. In some organizations, the internal auditor also makes a broad
performance evaluation of middle and lower management.

1.2.5 Advantages of Management accounting:

Management accounting providing invaluable services to management in all of its function.
Planning: Management accounting makes an important contribution in performance of the
planning function. It makes available the relevant data after pruning and analyzing them suitably
for effective planning and decision-making.
Controlling: It involves evaluation of performance keeping in view that the actual performance
coincides with the planned one and remedial measures are taken in the event of variation
between the two.
Coordinating: It involves interlinking of different divisions of the business enterprise in a way
so as to achieve the objectives of the organization as a whole.
Organizing: A sound system of internal control and internal audit for each of the cost or profit
centers helps in organizing and establishment of a sound business structure.
Motivating: It involves maintenance of a high degree of morale in the organization. The
superiors should be in a position to find out whom to demote or promote and to reward or
penalize.
Communicating: Communicating involves transmission of data, results etc. both to the insiders
as well as outsiders. The management owes a duty to the creditors, prospective investors,
shareholders etc to communicate to them about the progress, financial position etc of the
enterprise. Management accounting helps the management in performance of their function by
developing a suitable system of reporting.
Thus, Management accounting is helpful to the management in every field of activity.

8 Distinctions between: Management Accounting and Financial Accounting

Links between Management accounting, financial accounting and the management

information system:
Management accounting and financial accounting are linked by their responsibilities for
summarizing and reporting information for interested parties, yet the two differ in many ways.
Financial accounting includes all the principles that regulate the accounting for and reporting of
financial information that must be disclosed to people outside a company, such as shareholder,

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creditors etc. On the other hand, management accounting exists primarily for the benefit of
managers inside a company, the people who are responsible for day-to-day operations.

Financial accounting and management accounting are part of and use data from a company’s
management information system. Much of the financial data generated by a company’s events
activities and actions are used for both financial and management accounting purposes.
The financial accountant concentrates on using the data for external reporting and the
management accountant is interested in developing reports and analyses for internal use. One of
the most important links between financial and management accounting involves the cost of
inventories. The cost of goods a company produces and holds in inventory are developed through
product costing systems within the management accounting function. Such amounts enable the
financial accountant to report accurate inventory costs on the company’s balance sheet. The
interaction between the two parts of the accounting discipline is greatest in the area of inventory
costing.

A management information system (MIS) is a system that gathers comprehensive data, organizes
and summarizes them into a form that is of value to functional managers and then provides those
into a form that is of value to functional managers and then provides those same managers with
the information that they need to do their work. An organizations database feeds information
through the MIS to several information systems operating concurrently within the firm. Much of
the information is non financial in nature and is not disclosed in the financial statements, so
financial accountants deal primarily with the financial information system when developing
external reports and financial statements.

On the other hand management accountant interacts with all the different information systems to
supply managers with the information necessary for their work. The management accountant is
also responsible for interpreting financial information as it pertains to other functions within the
company. For such analyses, the management accountant deals with both financial and non-
financial data.

In short, both management accounting and financial accounting

(i) Provide an information system crucial to reporting and analyses
(ii) Provide reports used by individuals to analyze and make decision and
(iii) Develop relevant, objective product cost information for valuing inventories
included in the balance sheet.
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 Comparison between Financial and Management accounting.

Areas of comparison Management Accounting Financial Accounting

Report format Flexible format, driven by Based on generally accepted
user’s accounting principles
Purposes of reports Provide information for Report on past performance
planning, control, performance
measurement and decision
making
Primary users As a whole business or Division, product wise owners,
aggregate employees, lenders, customers,
Managers suppliers government agencies
Units of measurement Historical or future dollars, Historical dollars
physical measure in time or
names of objects, or non
monitory events technical
innovation
Nature of information Future oriented, objective for Historical objective
decision making, more
subjective for planning relies
on estimates
Frequency of reports Prepared as needed, may or Prepared on a regular basis
may not be a regular basis or a (minimum of once) a year
regular basis minimum of once
Legal compulsion As the discretion of Compulsory
management

1.4 Cost accounting and Management accounting

Cost accounting refers to the accounting procedures relating to recording of all incomes and
expenditure and the preparation of periodical statements and reports with the object of

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ascertaining and controlling costs. It is thus the formal mechanism by means of which the cost of
products or services are ascertained and controlled.

On the other hand Management accounting involves collecting, analyzing, interpreting and
presenting all accounting information, which is useful to the management. It is closely associated
with management control, which comprises planning, executing, measuring and evaluating, the
performances of an organization. Thus, Management accounting draws heavily on cost data and
other information derived from Cost accounting. Today cost accounting is generally in
distinguishable from the so-called Management accounting or internal accounting because it
serves multiple purposes.
Management accounting has a wider scope as compared to cost accounting. Cost accounting
primarily deals with cost data while management accounting involves the considerations of both
cost and revenue. Management accounting is an all-inclusive accounting information system,
which covers Financial accounting, Cost accounting and all aspects of Financial Management.
But it is not substitute for other accounting functions. The main thrust in Management
Accounting is towards determining policy and formulating plans to achieve desired objective of
management. Management accountancy makes corporate planning and strategy effective and
meaningful.

1.5 Management accounting guidelines

Three important guidelines help management accountants provide the most value in performing
their functions. They are: -
(a) Cost-benefit approach
(b) Behavioral and technical considerations and
(c) Different costs for different purposes.

(a) Cost benefit approach

Management accountants continually face resource allocation decisions. A cost benefit approach
should be used in these decisions-resources should be spent if they promote decision making that
better attains organizational goals in relation to the costs of those resources. The expected
benefits from spending those resources should exceed their expected costs.

(b) Behavioral and Technical considerations:

A management accounting system should have two simultaneous missions for providing
information:
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 (a) to help managers make wise economic decisions, and
(b) to motivate managers and other employees to aim and strive for goals of the organization.

Do not underestimate the role of individuals and groups in management planning and control
systems. Both accountants and managers should always remember that management system are
not confined exclusively to technical matters such as the type of computer software systems used
and the frequency with which reports are prepared.

Management is primarily a human activity that focus on how to help individuals do their jobs
better. For example it is often better for managers to personally discuss how to improve
performance with under performing workers rather than just sending these workers a report
highlighting their underperformance.

c) Different costs for different purposes.

The different costs for different purposes theme is the management accountant’s version of the
“one shoe does not fit all size” nation. A cost concept used for the external reporting purpose
may not be an appropriate concept for internal routine reporting to managers. Consider the
advertising costs associated with launching a major new product. For external reporting to
shareholders, television-advertising costs are fully expensed in the income statement in the year
they are incurred. In contrast, for evaluating management performance (internal reporting
purpose), the television advertisement costs could be capitalized and then written off as expenses
one several years,
There are multiple external parties and multiple internal parties for which financial reports are
prepared. Any specific accounting method is unlikely to be the preferred method for all external
parties or all internal parties. Indeed, even an individual manager may prefer accounting method
A for one decision and accounting method B for another decision.
A management accountant following these three guidelines operates within a given
organizational structure.

1.6 Management Philosophies of Continuous improvement

Several significant management philosophies evolved to deal with expanding global competition:
They are:
A. Just in time operating Technique (JIT)
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 B. Total quality management (TQM)
C. Activity Based Management (ABM) and
D. Theory of Constraints (TOC)

Just in time operating Technique (JIT)

The JIT requires that all resources including materials, personnel and facilities be acquired and
used only as needed. Its objectives are to improve productivity and eliminate waste. All employer
are encouraged to continuously look for ways to improve processes and save time.

Adopting the JIT operating philosophy results in reduced production time, reduced investment in
raw materials inventory, reduced material wastage, higher quality goods and reduced production
costs. Funds that are no longer invested in inventory can be redirected according to the goals of
the strategic plan.

Total Quality Management (TQM)

Total Quality management (TQM) is a philosophy that required that all functions work together
to build quality into the organization product or service, TQM focuses on improving product
quality by identifying and reducing or eliminating the waste of resources caused by poor product
or service quality. Emphasis is placed on using resources efficiently and effectively to prevent
poor quality and on examining current operations to spot possible causes of poor quality.
Improved quality of both work environment and the product or service is the goal of TQM.

To determine the impact of quality on profits management uses accounting information about
the magnitude and classification of the cost of quality.

Activity Based Management (ABM)

ABM is an approach to managing an organizations that identifies all major operating activities,
determines what resources are consumed by each activity, identifies what causes resource, usage
way of each activity, and categorizes the activities as either adding value to a product or service
or not adding value.
Activities that add value to a product or service improve product or service quality and customer
satisfaction. All other activities are called non-value activities. They add cost to a product or
service but do not increase its market value.

Theory of Constraints:
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According to the theory of constraints (TOC), limiting factors or bottlenecks, occur during the
production of any product or service.

Once managers identify such a limitation or constraint, they can focus attention and resources on
it and thus achieve significant improvements. TOC helps managers set priorities for how they
spend their time and other resource.

Each of these management tools can be used as an individual system, or parts of them can be
combined to create a new operating environment. Some aspects of them can be employed in
service industries, such as banking, as well as in manufacturing. By continuously trying to
improve and fine- tune operations, these management tools contribute to the same basic results
for any organization: product or service costs and delivery time are reduced and the quality of the
product or service and customer satisfaction is increased.

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