UNIT - I (10 Hours)
Meaning, nature and scope of Management Accounting; Difference between management
accounting and financial accounting,Cost concepts: , Cost Unit, Cost Control and Cost Reduction;
Components of total Cost, Cost Sheet, Classification of costs, Types and methods of costing,
Inventory Management, Labour Cost, Overheads, Activity based costing.
Meaning of Management Accounting
Management accounting is the process of preparing financial reports, analysis, and data to assist
internal management in decision-making, planning, and controlling business operations. It
focuses on using financial and non-financial information to improve efficiency, profitability, and
strategic planning within an organization. Unlike financial accounting, which is aimed at external
stakeholders, management accounting is used primarily for internal decision-making.
Example
A manufacturing company uses cost accounting, a branch of management accounting, to
determine the cost of producing each unit of a product. Suppose a textile company produces
shirts. Management accountants track costs like:
Raw materials – ₹200 per shirt
Labor costs – ₹100 per shirt
Overhead expenses (electricity, rent, etc.) – ₹50 per shirt
By analyzing these costs, management can:
1. Set the right price to ensure profitability.
2. Identify cost-cutting areas, such as negotiating better raw material prices.
3. Compare actual vs. budgeted costs to improve efficiency.
This helps the company make informed decisions, ensuring sustainable growth and
profitability.
Nature of Management Accounting
Management accounting has several key characteristics that define its role in decision-making
and business operations.
1. Future-Oriented
Unlike financial accounting, which focuses on past transactions, management accounting is
forward-looking. It helps in budgeting, forecasting, and strategic planning.
Example: A retail company uses sales forecasts to decide on inventory purchases for the next
quarter.
2. Decision-Making Tool
Management accounting provides relevant financial and non-financial data to support managerial
decisions.
Example: A company analyzing whether to continue or discontinue a product line based on
profitability reports.
3. Focus on Internal Users
It is designed for internal stakeholders like managers rather than external stakeholders like
investors or regulators.
Example: A factory manager uses cost reports to reduce wastage and improve efficiency in
production.
4. No Fixed Format
Unlike financial accounting, which follows standard formats (like balance sheets and income
statements), management accounting reports are customized based on business needs.
Example: A marketing manager receives a report comparing advertising costs with customer
acquisition rates.
5. Includes Both Financial & Non-Financial Data
Management accounting integrates financial data (sales, costs) with non-financial data (customer
satisfaction, employee productivity) for holistic decision-making.
Example: A hospital tracks both patient treatment costs and patient recovery rates to improve
healthcare efficiency.
6. Analytical and Interpretative
It involves analyzing data using techniques like variance analysis, break-even analysis, and ratio
analysis to provide actionable insights.
Example: A hotel chain analyzes room occupancy rates and pricing strategies to maximize
revenue.
7. Helps in Performance Measurement & Control
Management accounting evaluates employee performance, department efficiency, and overall
business performance.
Example: A logistics company tracks delivery times and cost per shipment to optimize fleet
management.
Scope of Management Accounting
Management accounting covers various areas of business operations, providing financial and
non-financial insights to help managers make informed decisions. The key areas of its scope
include:
1. Financial Planning and Control
It helps in preparing budgets, financial forecasts, and planning strategies to achieve business
objectives.
Example: A manufacturing company prepares an annual budget to allocate funds for raw
materials, salaries, and expansion plans.
2. Cost Accounting
Management accounting analyzes and controls costs to improve profitability.
Example: A textile company tracks material, labor, and overhead costs to determine the cost per
shirt and adjust pricing strategies accordingly.
3. Decision-Making
Provides data-driven insights to help managers make critical business decisions.
Example: A retail store uses sales data to decide whether to discontinue a slow-moving product
or offer discounts to boost sales.
4. Performance Measurement
Evaluates the efficiency of departments, employees, and business units.
Example: A call center tracks the number of customer complaints resolved per agent to assess
employee efficiency.
5. Budgeting and Forecasting
Estimates future revenue, expenses, and business trends to guide financial planning.
Example: A startup uses market trends to forecast sales and plan its marketing budget
accordingly.
6. Inventory Management
Helps in managing stock levels efficiently to reduce waste and optimize resources.
Example: A supermarket uses inventory management systems to track perishable goods and
minimize wastage.
7. Financial Reporting and Analysis
Analyzes financial statements to assess company performance and suggest improvements.
Example: A CFO prepares a profitability analysis report to determine which business segments
generate the highest returns.
8. Working Capital Management
Ensures efficient management of cash flow, receivables, and payables to maintain liquidity.
Example: A car dealership tracks customer payments and supplier dues to maintain sufficient
cash flow for operations.
9. Risk Management
Identifies and mitigates financial and operational risks to safeguard business interests.
Example: A bank uses credit risk analysis to assess loan applicants' repayment capacity.
10. Tax Planning
Helps in optimizing tax liabilities by using legal tax-saving strategies.
Example: A company strategically invests in tax-saving instruments to reduce taxable income
and maximize profits.
Difference Between Management Accounting and Financial Accounting
Basis Management Accounting Financial Accounting
Helps in decision-making, planning, and Records and reports financial transactions
Objective
internal control. for external stakeholders.
Used by internal management (managers, Used by external parties (investors,
Users
executives). creditors, government, shareholders).
Past-oriented (records past financial
Time Focus Future-oriented (forecasting, budgeting).
transactions).
No fixed rules or standards (customized Follows accounting standards (GAAP, IFRS,
Regulations
reports). Ind AS).
Follows a standardized format (Balance
Format Flexible and customized reporting format.
Sheet, Income Statement, etc.).
Includes financial and non-financial data
Focuses only on financial data such as
Scope like customer satisfaction, employee
revenue, expenses, assets, and liabilities.
efficiency, etc.
Frequency of Reports are generated as needed (daily, Reports are prepared periodically
Reports weekly, monthly). (quarterly, annually).
Provides information for external
Decision- Helps managers make strategic and
stakeholders but does not focus on
Making operational decisions.
internal decisions.
Example
Management Accounting
A supermarket chain wants to optimize inventory levels. Management accountants analyze sales
trends, seasonal demand, and supplier costs to decide how much stock to order, reducing waste
and maximizing profits.
Financial Accounting
At the end of the financial year, the supermarket prepares a Profit & Loss Statement and
Balance Sheet to report its financial position to investors and tax authorities.
Cost Concepts
Cost concepts help businesses track, manage, and optimize their expenses.
Cost Unit
A cost unit is a measurable unit of a product or service for which costs are ascertained. It helps
in determining the cost per unit of production.
Example:
In a transport company, the cost unit is per kilometer per passenger.
2. Cost Control
Cost control refers to maintaining costs within a planned budget to improve efficiency and
profitability. It involves setting cost standards, comparing actual costs with budgeted costs, and
taking corrective actions.
Example:
A manufacturing company sets a budget of ₹500 per unit for raw materials but notices actual
spending has increased to ₹550 per unit. The company then negotiates with suppliers or finds
alternative materials to bring costs back within the budget.
Techniques of Cost Control:
Budgetary Control (setting and monitoring budgets)
Standard Costing (comparing actual vs. standard costs)
Variance Analysis (identifying deviations in costs)
Cost Reduction
Cost reduction is the process of permanently decreasing costs without compromising product
quality or operational efficiency. It focuses on continuous improvement, efficiency enhancement,
and waste minimization to increase profitability.
Key Features of Cost Reduction
Long-term impact – Aims for sustained savings.
Focus on efficiency – Uses better methods, materials, or technology.
Does not compromise quality – Ensures customer satisfaction remains intact.
Examples
1. Manufacturing Industry – Process Improvement
A car manufacturer adopts robotic automation in assembly lines, reducing labor costs by 20%
while increasing production speed.
2. Retail Industry – Bulk Purchasing
A supermarket chain negotiates with suppliers to buy products in bulk, reducing procurement
costs by 15%.
3. IT Sector – Cloud Computing
A software company shifts from expensive on-premise servers to cloud storage, cutting IT
infrastructure costs by 30%.
4. Logistics Industry – Route Optimization
A courier company uses AI-based route planning to reduce fuel consumption and delivery time,
saving ₹2 lakh per month.
5. Hotel Industry – Energy Efficiency
A hotel installs LED lights and energy-efficient appliances, reducing electricity bills by 25%.
Components of Total Cost
Total cost is the sum of all expenses incurred in producing goods or services. It consists of three
main components:
Prime Cost (Direct Costs)
Factory Cost (Works Cost)
Total Cost (Cost of Production)
1. Prime Cost (Direct Cost)
Definition: The sum of all direct costs involved in production.
Formula:
Prime Cost=Direct Material Cost+Direct Labor Cost+Direct Expenses
Example (Car Manufacturing):
Component Cost (₹)
Direct Material (Steel, Plastic) 10,00,000
Direct Labor (Wages for workers) 2,00,000
Direct Expenses (Machine Maintenance) 50,000
Total Prime Cost 12,50,000
2. Factory Cost (Works Cost)
Factory Cost= Prime Cost + Factory Overheads (Indirect costs in production).
Example (Car Manufacturing):
Component Cost (₹)
Prime Cost 12,50,000
Factory Overheads (Electricity, Depreciation) 1,00,000
Total Factory Cost 13,50,000
3. Total Cost (Cost of Production)
Total Cost = Factory Cost + Administration, Selling & Distribution Costs.
Example (Car Manufacturing):
Component Cost (₹)
Factory Cost 13,50,000
Administrative Overheads (Office Salaries) 1,00,000
Selling & Distribution Costs (Advertising, Transport) 50,000
Total Cost 15,00,000
Cost Sheet
A Cost Sheet is a statement that shows the total cost incurred in the production of goods or
services. It helps in cost control, pricing decisions, and profit analysis.
Format of a Cost Sheet
Particulars Amount (₹)
Direct Costs (Prime Cost)
Direct Material XXXXX
Direct Labor XXXXX
Direct Expenses XXXXX
Total Prime Cost XXXXX
Particulars Amount (₹)
Factory Overheads
Factory Indirect Expenses (Rent, Power, etc.) XXXXX
Factory/Works Cost XXXXX
Office & Administrative Overheads XXXXX
Total Cost of Production XXXXX
Selling & Distribution Overheads XXXXX
Total Cost (or Cost of Sales) XXXXX
Profit XXXXX
Selling Price XXXXX
Example
Company: XYZ Ltd. (Manufacturing 1,000 units of a product)
Particulars Amount (₹)
Direct Costs (Prime Cost)
Direct Material 5,00,000
Direct Labor 2,00,000
Direct Expenses 50,000
Total Prime Cost 7,50,000
Factory Overheads
Factory Rent & Electricity 1,00,000
Depreciation on Machinery 50,000
Factory/Works Cost 9,00,000
Office & Administrative Overheads 1,00,000
Total Cost of Production 10,00,000
Particulars Amount (₹)
Selling & Distribution Overheads 1,50,000
Total Cost (or Cost of Sales) 11,50,000
Profit (10%) 1,15,000
Selling Price 12,65,000
Selling Price per Unit: ₹12,65,000 ÷ 1,000 = ₹1,265 per unit
Classification of Costs
Costs can be classified based on different factors such as behavior, function, controllability, and
traceability.
1. Classification Based on Behavior
Fixed Cost – Costs that remain constant regardless of production levels.
Example: Rent of a factory (₹50,000 per month, whether 100 or 1,000 units are produced).
Variable Cost – Costs that change with the level of production.
Example: Raw materials cost (if one unit requires ₹500 of material, then for 10 units, it's
₹5,000).
Semi-Variable Cost – Costs that have both fixed and variable components.
Example: Electricity bill (fixed component of ₹5,000 + variable charge based on usage).
2. Classification Based on Function
Production Cost – Costs related to manufacturing goods.
Example: Direct materials, labor, factory rent, and machine depreciation.
Administration Cost – Expenses incurred for business operations.
Example: Salaries of managers, office rent, and stationery.
Selling & Distribution Cost – Costs related to marketing and delivery.
Example: Advertisement expenses, transportation, and sales commissions.
Finance Cost – Expenses related to borrowing funds.
Example: Interest on loans and bank charges.
3. Classification Based on Controllability
Controllable Cost – Costs that can be managed by decision-makers.
Example: Employee bonuses (management can decide the amount).
Uncontrollable Cost – Costs that cannot be changed in the short term.
Example: Depreciation on machinery (cannot be avoided).
4. Classification Based on Traceability
Direct Cost – Costs that can be directly attributed to a specific product.
Example: Raw materials used for a car’s production.
Indirect Cost – Costs that cannot be directly linked to a specific product.
Example: Factory supervisor's salary (oversees multiple products).
5. Classification Based on Time Period
Historical Cost – Actual costs incurred in the past.
Example: Last year's production cost report.
Future (Predetermined) Cost – Estimated costs for planning purposes.
Example: Budgeted cost for the next quarter.
Types and Methods of Costing
Costing refers to the process of determining the cost of production or services. Different
industries use various types and methods of costing depending on the nature of their operations.
1. Types of Costing
1.1 Job Costing
Used when products are made as per customer specifications.
Example: A furniture manufacturer calculates the cost separately for each custom-made sofa.
1.2 Batch Costing
Costs are accumulated for a batch of identical products.
Example: A pharmaceutical company produces a batch of 1,000 tablets and calculates the cost
per batch.
1.3 Process Costing
Used in industries where production is continuous, and costs are assigned to different stages.
Example: Oil refineries, where the cost is calculated for each stage (crude processing, refining,
packaging).
1.4 Contract Costing
Used for large projects and contracts that take a long time to complete.
Example: A construction company tracks costs separately for each highway project.
1.5 Operating Costing (Service Costing)
Used in service industries where costs are calculated per unit of service.
Example: A transport company calculates the cost per kilometer per bus.
1.6 Uniform Costing
A standardized costing system used by multiple companies in the same industry.
Example: Textile manufacturers following a uniform costing method to compare efficiency.
1.7 Marginal Costing
Considers only variable costs for decision-making, ignoring fixed costs.
Example: A company pricing a new product based on variable costs alone to penetrate the
market.
2. Methods of Costing
2.1 Specific Order Costing Methods
Used for unique products or services.
Examples:
Job Costing (Printing press, shipbuilding)
Batch Costing (Pharmaceuticals, bakery)
Contract Costing (Construction, infrastructure projects)
2.2 Continuous Operation Costing Methods
Used when production is continuous.
Examples:
Process Costing (Chemicals, petroleum)
Operation Costing (Automobile assembly)
Operating Costing (Hospitals, railways)
2.3 Activity-Based Costing (ABC)
Allocates costs based on activities rather than traditional cost centers.
Example: A manufacturing company uses ABC to assign costs based on machine usage, labor,
and overhead.
Meaning of Activity-Based Costing (ABC)
Activity-Based Costing (ABC) is a costing method that allocates overhead costs based on
activities that drive costs rather than simply using labor or machine hours. This method
provides a more accurate way to assign indirect costs to products or services based on their
actual resource consumption.
Features of ABC:
Focuses on activities as cost drivers
Helps in precise cost allocation
Used in complex and multi-product businesses
Useful for cost control and decision-making
Example
A company manufactures two products: Product X and Product Y. The company incurs
₹5,00,000 in total overhead costs, which are distributed across two activities:
Activity Total Cost (₹) Cost Driver Usage by Product X Usage by Product Y
Machine Setup 2,00,000 Number of Setups 10 setups 40 setups
Quality Control 3,00,000 Number of Inspections 20 inspections 30 inspections
Activity Cost Rates
Machine Setup Cost per Setup = ₹2,00,000 ÷ (10 + 40) = ₹4,000 per setup
Quality Control Cost per Inspection = ₹3,00,000 ÷ (20 + 30) = ₹6,000 per inspection
Allocation of Costs to Products
Activity Product X Cost (₹) Product Y Cost (₹)
Machine Setup 10 × ₹4,000 = ₹40,000 40 × ₹4,000 = ₹1,60,000
Quality Control 20 × ₹6,000 = ₹1,20,000 30 × ₹6,000 = ₹1,80,000
Total Overhead Cost ₹1,60,000 ₹3,40,000
Thus, under ABC, Product X gets ₹1,60,000 of overhead costs, and Product Y gets ₹3,40,000,
reflecting their actual usage of resources.
USES OF ABC
More accurate costing than traditional methods
Helps in identifying expensive activities
Aids in better pricing and cost control
Improves profitability analysis
Cost sheet
Question 2.3
Question
Solution
Raw materials consumed = Rs 15,000
Direct wages = Rs 9,000
Machine hours worked = 900
Machine hours rate = Rs 5
Administrative overheads = 20% on works cost
Selling overheads = Rs 0.50 per unit
Units produced = 17,100
Units sold = 16,000
Selling price per unit = Rs 4
Prime Cost=Raw Materials Consumed+Direct Wages
= 15,000+9,000
=24,000
Question
Solution:
