MANAGEMENT ACCOUNTING

Introduction
Management Accounting: It is the process of identification, accumulation, analysis, preparation
and communication of information used by management to plan, evaluate, control and make
managerial decision.

Comparison between financial accounting and cost accounting

Similarities:
1. They are concerned with recording and representation of financial and cost data.
2. They apply the same principles of double entry when recording transaction.
3. They use the same documents i.e. the books of original entry
Differences
Financial accounting Cost accounting
1. The reports are submitted to 1. The reports are submitted to the management.
shareholders.

2. Preparation of the financial 2. Preparation of management accounting is a

accounting is a statutory voluntary exercise.
requirement.
3. Financial accounting statement are 3. Management accounting reports are
periodic. continuous.

4. The statement are prepared as per 4. The statement are prepared as per chartered
the international accounting institute of management accounts.
standards and international
financial reporting standards.
5. Financial statement are subject to 5 The managing accounting statement s are not
audit. subject audit.
6. Financial accounting is 6 Management accounting is dynamic it keeps on
conventional/static changing from one organisation to another.

7. Financial accounting emphasises on 7 Management accounting emphasises on cost

recording of the financial control.
transactions.
Objectives/Advantages of Cost Accounting/management accounting
1. Cost control
It enables an organisation to maintain the cost at desirable levels so as to minimise the wastage in
the production process.
2. Decision making
The managers are required to make internal decisions which are facilitated by the availability of
the cost data.
3. Planning
Cost accountant uses the budget generated from the past experience. They are prepared to
incorporate the future costs for the purpose of implementation.
4. Cost ascertainment/determination
It is important to determine the cost of producing a commodity or provision of service so as to
assist the manager in making optimal decisions.
5. Disclosure of waste
Past experience of cost data on how to determine the future cost is normally used to improve
efficiency so as to reduce or eliminate unnecessary expenditure. This will ensure that the costs
are minimised.
6. Measure of efficiency
For performance evaluation, the standards are set in advance which will be compared with the
actual performance to ascertain the difference.
The reason for the difference is also determined.
7. Setting the selling price
To come up with a realistic selling price an organisation must take into account the cost of
production plus the required profit margin.

Limitations of cost accounting/Management accounting

a) Cost accounting is not exact i.e. it involves inherent element of judgement
b) Cost accounting normally provide information for making optimal decisions in specific
circumstances. However, there is no best decisions in all circumstances.
c) It involves massive paper work i.e. cost items must be recorded separately.
d) It is expensive to maintain cost accounting department in an organisation.
e) Cost accounting only capture quantitative data and ignores qualitative data.
MANAGEMENT ACCOUNTING SYSTEM.
It is a combination of procedures and records designed to provide information required by the
management in-order to conduct the operation of the organisation.

Conditions for an effective cost accounting system

1. It must meet the needs of managers.
 2. It must be simple, economical and practical to use.
3. It must be supported by all the parties.
4. It must lead to co-operation between the managers and employees.
5. The wages and employment terms must be satisfactory.
6. Cost accounting department must be established.
7. Every cost item should have its own records.
8. The system put in place should be flexible so as to adjust for changes where necessary.

Difficulties in the installation

 Lack of support from the top management.
 Resistance to change by the employees especially from the accounting department.
 Cost accounting installation could be expensive to an organisation.
 Lack of adequate expertise to run the system.
 Forms or records might be inappropriate i.e. may not contain the adequate information
necessary.

Cost of classification
Costs are classified into different ways depending on the way they respond to the units of
production or any other external factors.
The following are the ways in which the costs are classified:
1. According to the behaviour
This is based on the way in which a particular cost item responds to the volume of output.
a) Variable costs
These are costs which changes with respect to the volume of production i.e. when the units
produced increase they also increase and vice versa.
 Costs

Units
b) Fixed costs
These are the costs which remain constant irrespective of the number of units produced i.e. they
are constant at all levels of production e.g. rent

Costs

Total fixed costs

Units
c) Semi variable costs
These are the costs which are partially fixed and partially variable. It has a combination of both
fixed and variable costs e.g. electricity bill.
*
2. According to controllability
These costs are based on the ability to be maintained at desirable level by the management.
a) Controllable costs/shut down costs
These are the costs, which may directly be regulated at a given level of management authority.
Variable costs are generally controllable by the departmental heads.
b) Uncontrollable costs
These are the costs which cannot be controlled or influenced by the manager concerned.
They remain the same irrespective of the decision taken e.g. rent.
c) Period costs
These are the costs which are controlled depending on the length or duration of consumption or
usage of that particular product.
To control these costs, the period in use should be reduced.
d) Product cost
These are the costs incurred in production and are controllable depending on the number of units
produced.

3 ACCORDING TO TIME
a) Historical costs: They are costs that are ascertained after they have been incurred they are
actual costs of the organisation.
b) Predetermined costs – They are future costs which are ascertained in advance of the
specification of all factors affecting the operations of the organisation.
4 ACCORDING TO IDENTIFICATION WITH THE COST UNITS
a) Direct costs – They are costs incurred and can conveniently identified with a particular
cost unit/product, process or a department. Therefore, all direct costs are prime costs.
b) Indirect costs- They are costs, which cannot conveniently be identified with a particular
cost unit, process or department.

Terms used in cost accounting

1. Cost
These are expenses incurred in producing one unit or providing services. They are normally
expressed in monetary terms.
2. Cost unit
This is a unit of measurement of production of the smallest value. It is normally expressed in kgs,
litres or any other relevant quantity.
3. Unit cost
This is the smallest amount incurred to produce one unit of a particular item. It is also known as
cost per unit.
4. Cost centre
This is a section of an organisation which consumes costs and * to a manager. This section is
normally assigned a manager who is responsible for its expenditure e.g. production department.
 5. Revenue centre
This is a section of an organisation where the revenue is generated but the cost of making that
revenue is not incurred in the section e.g. sales department
6. Profit centre
This is a section of an organisation which generates revenue and incurs the cost of making that
revenue. The manager is normally assessed based on the profit generated.
7. Responsibility centre
This is a section of an organisation where a manager is assigned to be in charge. All the activities
within that section are controlled by the manager.
8. Investment centre
This is a section of an organisation where the manager is responsible for the revenue collected,
costs incurred and other incomes from different sources such as dividends from shares. The
manager here has got the power to acquire non-current assets.

Other types of costs

1. Out of pocket costs
These are the costs incurred and require cash payment within the accounting period. They are
normally incurred when running the business. Depreciation does not require cash payment and
therefore is not an example of out of pocket costs.
2. Normal costs
These are the costs incurred in the normal operations of the business e.g. salaries and wages
3. Abnormal costs
These are the costs incurred out of the normal business operations e.g. shut down costs of the
factory, development costs etc.
4. Capital costs/capital expenditure/expenditure costs
These are the costs incurred in the acquisition of the capital items e.g. the cost of purchasing land
and machinery
5. Revenue costs
These are the costs incurred in the day to day running of the business. They are normally incurred
for the benefit of the ordinary transactions.
6. Imputed/notional costs
These are the costs incurred but does not require cash payment e.g. notional rent
7. Standard costs
These are estimated costs used by an organisation for budgeting purposes. They are always on per
unit basis.
8. Actual costs
These are the costs incurred when the time which is budgeted for has come. It is the cost which is
actually paid.
9. Sunk costs/historical costs
These are the costs which have already been incurred in the past and are not used for decision
making.
10. Relevant costs
This is the extra costs incurred or avoided as a consequence of the decision made.
 11. Marginal costs
This is the variable cost of production or transportation or marketing.
12. Incremental costs
This is the cost which increases as a consequence of the change in the decision made. They are
normally used for decision making.

The scope of management accounting

The management accountants interpret the results and reports to the management and provides
analysis, which assists in decision making in the following departments:
 Production department
In this department the personnel measure and report the manufacturing costs. The efficiency of the
production department in transforming the materials in to the final products is evaluated for
improvement.
 Engineering department
Cost accountants and engineers translates specification for the new products into estimated costs
by comparing estimated costs and the projected sales. This will help the management to decide
whether manufacturing a product will be profitable.
 System design department
Cost accountants are becoming more involved in designing computer integrated manufacturing
system and the data base corresponding to the cost accounting needs.
This idea for the cost accountants, engineers and the system designers to develop a flexible
production process which responds to the market needs is becoming popular.
 Treasury department
The treasurer uses budgets and related accounting reports developed by the cost accountants to
forecast the cash flows and capital requirements.
Detailed cash reports indicate where there is excess funds to invest or where there is cash deficit
which needs to be funded.
 Financial accounting department
The cost accountants work closely with the financial accountants who use the cost data to value
inventory for external reporting.
 Marketing department
Marketing involves the cost accountants during the product innovation stage, manufacturing and
the sales process. The marketing department develop the sales forecast to facilitate preparation of
the product manufacturing schedule.
Cost estimates competition, supply, demand and the states of technology becoming the selling
price that the product will be offered and command in the market.
 Personal department
This department administers the wage rate and the pay methods. This will ensure that the
employees receive the correct dues. The department also maintains adequate labour records for
legal and cost analysis purposes.