BCOE-142

Management Accounting
Indira Gandhi National Open University
School of Management Studies
PROGRAMME DESIGN COMMITTEE B.COM (CBCS)
Prof. Madhu Tyagi Prof. D.P.S. Verma (Retd.) Prof. R. K. Grover (Retd.)
Former Director, SOMS, Department of Commerce School of Management
IGNOU University of Delhi, Delhi Studies IGNOU
Prof. R.P. Hooda Prof. K.V. Bhanumurthy (Retd.) Faculty Members
Former Vice-Chancellor Department of Commerce SOMS, IGNOU
MD University, Rohtak University of Delhi, Delhi Prof. N V Narasimham
Prof. B. R. Ananthan Prof. Kavita Sharma Prof. Nawal Kishor
Former Vice-Chancellor Department of Commerce Prof. M.S.S. Raju
Rani Chennamma University University of Delhi, Delhi Prof.. Sunil Kumar
Belgaon, Karnataka Prof. Khurshid Ahmad Batt Dr. Subodh Kesharwani
Prof. I. V. Trivedi Dean, Faculty of Commerce & Dr. Rashmi Bansal
Former Vice-Chancellor Management Dr. Madhulika P Sarkar
M. L. Sukhadia University, University of Kashmir, Srinagar Dr. Anupriya Pandey
Udaipur Prof. Debabrata Mitra
Prof. Purushotham Rao (Retd.) Department of Commerce
Department of Commerce University of North Bengal,
Osmania University, Darjeeling
Hyderabad
COURSE DESIGN COMMITTEE AND PREPARATION TEAM
Prof. BB Khanna, Director (I/C) Prof. Pradeep Aggarwal Faculty Members
SOMS, IGNOU, New Delhi Dean, Deptt. of Mgmt. Studies, SOMS, IGNOU
Prof. R B Solanki Sharda University, G. Noida Prof. N V Narasimham
Vice Chancellor Dr. Divya Verma, Faculty, Prof. Nawal Kishor
CRS University, Jind Deptt. of Mgmt. Studies, Prof. Madhu Tyagi
Prof. Pankaj Gupta GGSIP University, Delhi Prof. M.S.S. Raju
Centre for Management Studies Dr. Vikas Gupta, Faculty, Prof. Sunil Kumar
JMI, New Delhi Deptt. of Mgmt. Studies, Dr. Subodh Kesharwani
Prof. Ravinder Kumar, Dean Delhi Technical University, Dr. Rashmi Bansal
Deptt. of Commerce Delhi Dr. Madhulika P Sarkar
JMI, New Delhi (Unit 19) Dr. Anupriya Pandey
Prof. R K Sharma, Dean, Dr Sunil Kumar Course Coordinator
Bharati, Vidyapeeth University Associate Professor Prof. M. S. Senam Raju (E)
Paschim Vihar, New Delhi SOMS, IGNOU SOMS, IGNOU, New Delhi
Units 3-7, 9-16, and unit18 New Delhi Dr Rashmi Bansal (H)
adopted from MCO-05 (Units 1, 2, 8 and 17) SOMS, IGNOU, New Delhi
Dr. Vikas Gupta Content Editing
(Unit-19) Prof M S S Raju
(Proof Reading & Format
Editing)
Dr. Rashmi Bansal
SOMS, IGNOU, New Delhi

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February, 2022
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BCOE - 142 MANAGEMENT ACCOUNTING
Management Accounting covers the basic cost and accounting concepts that
are helpful in decision making and cost control. It provides a comprehensive
introduction to cost and accounting concepts.
When the objectives of an enterprise are defined, the management must
develop plans consistent with meeting those objectives. The efficiency of
the management is judged the extent to accomplish these defined objectives
with minimum effort and cost. For this purpose the management must
prepare its course of action in advance. A systamatic approach to facilitate
effective management performance is profit planning and control. A budget
is a quantified plan for future activities to coordinate and control the use of
resources for a specified period. Budgeting is a process which includes both
Budget and Budgetary Control.
Standard Costing is one of the most important tools which helps the
management to plan and control costs of business operations. It is a technique
of cost accounting which compares the standard cost of each product or
service with the actual cost, to determine the efficiency of the operation, so
that any remedial action may be taken immediately.
This course also provides the basic knowledge of Marginal Costing
and the necessity of Break-even Analysis and also Cost Volume Profit
Analysis for effective planning and evaluation of business operations. For
decision making it is very important to have an under of relevant cost,
pricing decisions, responsibility accounting and contemporary issues in
Management Accounting.
Management Accounting: Introduction and Basic
Techniques
Unit 1 : Management Accounting: An Introduction, outlines the need for
and objectives of accounting, accounting process and accounting equation.
It also discusses the basic accounting concepts to be observed both at
recording and reporting stages. It also explains the accounting standards to
he followed while preparing financial statements.
Unit 2 : Cost Control, Cost Reduction and Cost Management, deals with the
basic cost concepts, preparation of cost sheet and also explains different
methods and types of costing.
Unit 3 : Understanding Financial Statements, explains the preparation of
vertical format of corporate financial statements, concepts of reserves and
provisions, concepts relating to profit, capital employed, shareholders funds,
and debt funds. It further discusses the uses and limitations of financial
statements.
Budgeting and Budgetary Control
Unit 5: Budgeting: An Overview, It deals with the basic concepts of
budgeting and budgetary control. It also discusses establishment of a sound
system of budgeting and classification of various types of budgets.
Unit 6: Preparation of Budgets, It explains how various types of budgets
are prepared. It also includes the process of revising the budget under certain
circumstances such as budgeting errors and change in external factors.

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 Unit 7: Approaches to Budgeting, It discusses different approaches
followed for the preparation of budgets. Besides highlighting the differences
between different approaches their advantages and disadvantages are also
described.
Unit 8: Budgetary Control, It explains essentials, objectives, advantages,
and limitations of budgetary control. It also includes details of programme
budgeting and performance budgeting.
Standard Costing and Variance Analysis
Unit 9: Standard Costing: An Overview, It describes basic concepts
of standard costing and its importance. It also deals with the pre-
requisites for the success of standard costing system in an organisation.
Unit 10: Material Variances, It explains the classification of variances
and the reasons for their occurrance. It also explains how one material costs
and their sub-variances calculated.
Unit 11: Labour Variances, It explains the concept of labour variances.
Different types of direct labour cost variances are described.
Unit 12: Overhead Variances, It deals with overhead and sales variances.
It also deals with the control ratios and how the variances are to be disposed
off.
Marginal Costing and Cost Volume Profit
Analysis
Unit 13: Marginal Costing, It deals with the basic concepts of marginal
costing and its significance in managerial decisions making.
Unit 14: Cost Volume Profit Analysis, It discusses the concept of break
even analysis, relationship between cost, volume and profit and its impact
on planning and evaluation of business operations.
Decision Making
Unit 15: Relevant Costs for Decision Making, It explains different types
of relevant costs and the importance of relevant costs in decision making.
Unit 16: Pricing Decisions , It explains the objectives and need of pricing
decisions. The various factors influencing the pricing decisions and methods
thereof are highlighted.
Unit 17: Responsibility Accounting, It explains the concept of
responsibility accounting. Different stages in the responsibility accounting
and the essentials of its success are described.
Unit 18:Contemporary Issues in Management Accounting – I: it explains
different challenges faced by the modern accountants. Scope and limitations
of conventional financial accounting are also described. It explains some
of the basic concepts of recent developments in financial and management
accounting.
Unit 19: Contemporary Issues in Management Accounting – II: This is
in continuation to the previous unit. It explains different types of costing
systems and various steps involved therein.

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 CONTENT

BLOCk-1 Management Accounting:

Introduction And Basic 7
Techniques
UNIT 1: Management Accounting: An Introduction 8

UNIT 2: Cost Control, Cost Reduction and Cost Management 22

UNIT 3: Understanding Financial Statements 34

UNIT 4: Techniques of Financial Analysis 70

BLOCK-2 Budgeting And Budgetary

Control
UNIT 5: Budgeting: An Overview 118

UNIT 6: Preparation of Budgets 131

UNIT 7: Approaches to Budgeting 157

UNIT 8: Budgetary Control 174

BLOCk-3 Standard Costing and

Variance Analysis
UNIT 9: Standard Costing: An Overview 187

UNIT 10: Material Variances 201

UNIT 11: Labour Variances 217

UNIT 12: Overhead Variances 232

BLOCK-4 Marginal Costing And Cost

Volume Profit Analysis
UNIT 13: Marginal Costing 254

UNIT 14: Cost Volume Profit Analysis 282

BLOCK-5 DECISION MAKING

UNIT 15: Relevant Costs for Decision Making 318

UNIT 16: Pricing Decisions 338

UNIT 17: Responsibility Accounting 350

UNIT 18: Contemporary Issues in Management Accounting - I 375

UNIT 19: Contemporary Issues in Management Accounting - II 395

5
Block

1
Management Accounting: Introduction and
Basic Techniques
UNIT 1
Management Accounting: An Introduction 12
UNIT 2
Cost Control, Cost reduction and
Cost Management 26
UNIT 3
Understanding Financial Statements 38
UNIT 4
Techniques of Financial Analysis 74

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 UNIT 1: MANAGEMENT ACCOUNTING:
AN INTRODUCTION
Structure
1.0 Objectives
1.1 Introduction
1.2 Meaning of Management Accounting
1.3 Objectives of Management Accounting
1.4 Nature of Management Accounting
1.5 Scope of Management Accounting
1.6 Difference between Cost Accounting and Management Accounting
1.7 Techniques of Management Accounting
1.8 Role of Management Accounting in an Organisation
1.9 Advantages of Management Accounting
1.10 Functions of Management Accounting
1.11 Let Us Sum Up
1.12 Key Words
1.13 Answers to Check Your Progress
1.14 Terminal Questions

1.0 OBJECTIVES
After studying this unit, you should be able to:
●● explain the meaning and definition of Management Accounting
●● identify the objectives of Management Accounting
●● explain the need for Management Accounting
●● understand the scope of Management Accounting
●● distinguish between Management Accounting and Cost accounting
●● identify different techniques used under Management Accounting
●● appraise the role and functions of Management Accounting
●● examine and illustrate the advantages of Management accounting in
an organization

1.1 INTRODUCTION
There are different objectives of a business enterprise, the most important one
being still profit maximization. To undertake this process of making profit,
a firm needs to use its available resources efficiently and perform certain
activities. In order to achieve these objectives, a firm needs to undertake
different transactions, such as purchases, sell in the market, make and receive
payments and perform different operational activities. All these events affect
the efficiency of an organization and can be measured in monetary terms.
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These activities need to be quantified, recorded, analyzed and reported to Management Accounting:
evaluate its impact on the organization. This is Management Accounting An Introduction
is concerned about. In this unit we will cover concept of Management
Accounting, its objectives and scope of Management Accounting. We
shall also discuss its basic difference from Financial Accounting and cost
accounting.

1.2 MEANING OF MANAGEMENT

ACCOUNTING
Till the 18th century, most of the business organizations were smaller in
size and mostly family run. As the family organizations started increasing
in size, scope and product line became more extended and complex. With
the further enhancement in technological changes and globalization, it
has become necessary to keep a track of information apart from financial
transactions. Management Accounting collects data from cost accounting
and Financial Accounting and provides all the information needed by
management to make decision.
Definition
Some important definitions of Management Accounting are as follows:
The Institute of Management Accountants USA has defined Management
Accounting as “A value-adding continuous improvement process of
planning, designing, measuring and operating both non-financialinformation
systems and financial information systems that guides management action,
motivates behavior, and supports and creates the cultural values necessary
to achieve an organization’s strategic, tactical and operating objectives”
As per American Accounting Association “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 making of rational decisions with a view towards
these objectives”.
As per International Federation of Accountants (IFAC): Management
Accounting may be defined as “The process of identification, measurement,
accumulation, analysis, preparation, interpretation, and communication
of information both financial and operating used by management to plan,
evaluate and control within an organization and to assure use of and
accountability for its resources”.
As per CIMA, London: “Management Accounting is an integral part
of management concerned with identifying, presenting and interpreting
information used for: (a) creating strategy; (b) planning and controlling
activities; (c) decision making; (d) optimizing the use of resources; (e)
disclosure to shareholders and others external to the entity; (f) disclosure to
employees; (g) safeguarding assets
The above involves participation in management to ensure that there is
effective:
(i) Formulation of plans to meet objectives;
(ii) Formulation of short-term operation plans;
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Management Accounting: (iii) Acquisition and use of finance and recording of transaction;
Introduction and Basic
Techniques (iv) Communicating financial and operating information;
(v) Corrective action to bring plans and results into line
(vi) Reviewing and reporting on systems and operations.”
Management Accounting is made up of two terms managing and accounting.
As all the above definitions explained, Management Accounting is the
process of identification, measurement, accumulation, analysis, preparation,
interpretation and communication of the information presented by Financial
Accounting and Cost Accounting. It helps the managers for planning,
executing and evaluating along with performance evaluation of management
functions.

1.3 OBJECTIVES OF MANAGEMENT

ACCOUNTING
The basic objective of Management Accounting is to enable Management
to carry its duties efficiently that ultimately leads to maximization of profit
in an organization. It helps the Management in planning, organizing,
directing and controlling. With the help of creating budgets and formulating
strategies for organization as a whole, it helps to reduce the deviation
between budgeted and actual targets achieved. The main objectives of the
Management Accounting are as follows:
1) Helps in planning and formulating management policies:
Planning includes forecasting, setting objectives, creating strategies
for achieving them. It helps in preparation of statements on the basis
of past performance and data available for future forecast.
2) Interpretation of financial data available: Management Accounting
presents financial data in a simplified format. It includes charts, graphs
and diagrams to present it in an easy manner to be understandable by
the top management.
3) Helps in decision making: Management Accounting makes the
decision making scientific by using techniques. It uses the data from
cost accounting and Financial Accounting, analyses it for making a
sound decision. For Example, it helps in ascertaining the profitability
of a product, exercise effective control on it and implement cost
reduction programs.
4) Helps in controlling performance: Management Accounting helps
in controlling by using different techniques like standard costing
and budgetary control. It controls the cost of each department and
individual by different techniques. It defines each unit as responsibility
center and that unit is held responsible for deviation. It helps them
to understand the weak areas and take corrective action to improve
situation
5) Helps in organizing: It helps in creating effective and efficient
organizational framework. Management accountant uses budgeting
techniques and return on capital employed to control cost and
responsibility. It leads to decentralization to rationalization of
organizational structure
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6) Helps in reporting: Management Accounting informs the Management Accounting:
management about the current position of the organization from An Introduction
time to time through timely reposting. It helps the managers to take
the required actions timely and correctly. Performance of different
departments is reported regularly.
7) Helps in coordination of operations: Management Accounting
helps in evaluating the performance and coordinating the operations.
It helps management in coordinating activities by preparing functional
budgets and then coordinating by creating a master budget.

1.4 NATURE OF MANAGEMENT ACCOUNTING

It is a dynamic and forward-looking concept. Its nature can be explained as
follows:
1) Management Accounting is a basis for decision making:
Management Accounting helps the management to frame policies and
make day-to-day decision making. Management Accounting provides
the data to the top managers in a meaningful manner which helps
them to take a decision.
2) Management Accounting is futuristic concept: Focus of
Management Accounting is to deal with the future decisions. It
uses the historical data presented by Financial Accounting and cost
accounting and uses it for making future plans. It filters information
and provides the selective information for specific decision making.
3) Management Accounting is selective in nature: Management
accountant considers only the relevant data. It is analyzed and
presented to top managers in an effective manner.
4) Management Accounting is a systematic approach: Management
Accounting analyses different variables to identify the deviation
between the budgeted and actual by using the historical data. It is
systematic approach of planning and controlling.
5) No specific reporting standards: Management Accounting does not
follow any prescribed reporting standards. It can be presented in any
manner to make the relevant information available to the decision-
making authorities. Data can be presented in most suitable form for
the concerned person or issue.
Check Your Progress A
Identify whether the following statements are True or False.
1) Management Accounting follows the GAAP accounting standards.
2) Management Accounting is a forward-looking concept.
3) Management Accounting uses the data generated from Cost
Accounting and
Financial Accounting.
4) Management Accounting helps in strategy formulation.
5) Every organization needs to prepare Management Accounting report
every year.
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Management Accounting:
Introduction and Basic 1.5 SCOPE OF MANAGEMENT ACCOUNTING
Techniques
Management Accounting emphasises upon internal control in an organization.
It extends the analysis of Financial Accounting and cost accounting by using
different budgetary techniques. Its scope can be explained as follows:
1) Provides accounting information: Management Accounting is
based on data provided by financial and cost accountant. It provides
required information to managers at different levels. It provides the
information in a simplified manner to meet the dynamic needs of the
management.
2) Cost effect analysis: Other branches of accounting like Financial
Accounting and cost accounting provide only the final data but do
not consider responsibility centers. Management Accounting is more
focused on cause and effect relationship between variables.
3) Compilation of data for management planning: Management
Accounting presents and compiles the relevant historical data in such
a manner as it helps in identifying the trends in past period and to
assist in problem solving.
4) Assists in decision making: It helps in decision making first by
providing the relevant information to the management which can
be used for decision making. Secondly, by analyzing the impact of
all the possible decision is considered into account for taking a final
decision.
5) Achieving the objectives: Management Accounting helps in
creating the plans and setting the objectives. It compares the actual
performance with the standard performance, finds the deviations and
takes corrective actions.
6) Increase in efficiency: Management Accounting uses the accounting
information to identify efficiency within the organization. It ultimately
helps in improving the performance and making the organization
efficient.
7) Helps in forecasting and gaining feedback: Management Accounting
is a futuristic concept which helps in forecasting for future plan of
action. It helps in receiving feedback by identifying deviations and
setting responsibility accounting.

1.6 DIFFERENCE BETWEEN COST

ACCOUNTING AND MANAGEMENT
ACCOUNTING
Management Accounting uses the reports of financial and cost accounting.
It interprets the data and formulates long term objectives and policies for the
company, whereas cost accounting maintains cost books for cost reduction
and ascertainment. Both the forms of accounting assist the management in
policy making but Management Accounting is broader in scope. The major
differences between Management Accounting and cost accounting are as
follow:
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 Management Accounting:
BASIS COST ACCOUNTING MANAGEMENT
An Introduction
ACCOUNTING
Focus The focus of Cost It considers the data from cost
Accounting is accounting to analyse the cost
ascertainment, allocation incurred and its impact.
and distribution of cost.
Objectives The primary objective Objective is to assist in
of Cost Accounting is to effective management process
control cost. and resolve the management
problems
Tools Cost Accounting uses Management Accounting uses
only quantitative data both quantitative as well as
which have a unit of qualitative data which cannot
measurement. It uses only be quantified in terms of
cost data money. It uses other financial
data as well apart from cost
data.
Emphasis Cost Accounting has Management Accounting
emphasis on collection of has emphasis on policy
data and its interpretation formulation by the top
for resolving the query and managers to make the
making decisions. organization efficient.
Users Cost Accounting is used Management Accounting is
by middle or lower level for top level management
management
Precedence Cost Accounting precedes Management Accounting uses
Management Accounting the data from cost accounting;
as Cost Accounting so it is done after Cost
does not use data from Accounting is complete.
Management Accounting
Vision Cost Accounting has Management Accounting
short term vision as it is is farsighted as it sets the
concerned with short term long-term objectives for the
goal of cost ascertainment organization
or reduction
Historic or Cost Accounting is Management Accounting
futuristic generally considered as is generally considered as
historic in nature as it futuristic in nature; as it
analyses the cost already considers the past data to
incurred by the form create policies for future.

Evaluation Cost Accounting only Management Accounting

assists the management is evaluative in nature it
by providing the current evaluates the performance
cost structure. It is not and is used for performance
evaluative in nature. judgement.
Statutory Cost Accounting and cost Management Accounting is
requirement audit are mandatory in not a statutory requirement for
some selected industries. company
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Management Accounting: Check Your Progress - B
Introduction and Basic
Techniques 1. Define the term Management Accounting.
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
2. What are the main objectives of Management Accounting?
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
3. How Management Accounting is different from Cost Accounting?
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
4. Explain the features of Management Accounting.
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
5. Fill in the blanks:
a) Management Accounting helps management in ………………
b) Management Accounting is generally used by ……………….
c) Management Accounting uses data from ……… and…………
d) …………………………………………. Branch of accounting
is compulsory for each kind of organization.
e) Management Accounting uses both…………………………….
and ………………………………………. data.

1.7 TECHNIQUES OF MANAGEMENT

ACCOUNTING
Management Accounting uses various special tools and techniques to make
data available in an understandable manner. As we read so far it uses the
data from Financial Accounting to make managerial decision making. The
techniques used under Management Accounting are Financial Planning,
Fund Flow Analysis, Standard Costing, Budgetary Control, Marginal
Costing, Ratio Analysis etc. Now we will read about these techniques in
detail.
Financial Planning:As we all know, planning is creating a plan for future
action; so financial planning is planning our financial activities of the
organization. An organization has different objectives - some are short term
others are long term. So it is the task of the top management to plan for
them accordingly. Financial policies may include determination of amount
of capital required, sources of funds distribution of the return of capital
structure of the company.
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Financial Statement Analysis: Financial Statements are the output of Management Accounting:
financial accounting. It provides us with the relevant data. It helps the An Introduction
management to know profitability and growth prospects of the organization.
Managers use comparative statements, common size statement and ratio
analysis.
Fund Flow Analysis:Fund Flow Analysis identifies the causes of change
in the financial position of an organization between two time periods. It
considers the change in working capital i.e. conversion of current assets to
fixed assets or long-term liabilities. It helps the organization to do financial
analysis and control its flow of funds.
Cash Flow Statement: Cash Flow Statement is different from fund flow
statement. Cash flow statement gives a detailed analysis of cash inflows and
outflows. As fund flow is more useful for long term planning, there may
be a situation when fund flow shows favorable results but it may be due to
accumulation of inventory and trade debtors.
Standard Costing: We will study the concept of standard costing in detail in
further chapters. It works as a control mechanism. Under standard costing,
we set a standard cost, measure the actual performance, compare it with
the standards and find the variances. It helps the organization to identify
the responsibility centers and take the remedial action to avoid the adverse
decisions taken in past.
Budgetary Control: It is often misinterpreted as similar to standard costing
as both are controlling techniques, but in budgetary control, we set a budget
for each unit of the organization and their performance is compared to the
budgeted values.
Marginal costing: Marginal Costing is another technique used by
management accountants for cost control and decision making. It helps to
decide selling price and proportion of units to be sold, to take, make or buy
decision. It divides the concerned cost in fixed and variable.
Ratio Analysis: There are different ratios as we have also studied in
financial accounting like liquidity, solvency profitability, etc. It helps the
management for internal decision making. It adds to the efficiency of the
management.
Cost Benefit Analysis: Management Accounting deals with cost benefit
analysis. It uses various techniques for comparing the cost with anticipated
results. Techniques like activity-based costing, differential costing are
used for analyzing cost and benefit of different decisions taken by the
organization.
Statistical Analysis: Accountants have access to data and they make
systematic and logical conclusions from it. Statistical analysis like sampling
theory helps to make reliable interpretation about population by using
sample data.

1.8 ROLE OF MANAGEMENT ACCOUNTING

IN AN ORGANISATION
Financial Accounting deals with documentation of company’s financial
transactions. It is a passive process while management accounting deals
15
Management Accounting: with future to make improvements that deal with better performance and
Introduction and Basic higher profits. Management accounting helps in shaping an organizational
Techniques
reporting system role performed by management accounting as follows:
Allocation of Resources: Resource allocation is to divide the limited
resources of the organization in most effective manner. Decision needs to be
made which projects need to be taken over management accountant divide
the resources and make a portfolio in best possible way. It considers factors
like availability of funds, selling price, demand, etc.
Measuring Performance: Management Accounting measures performance
within an organization on two fronts - first is to find responsibility center by
ensuring the performance of employees. Second performance management
is measure of efficiency. It analyses how efficiently resources have been
utilized.
Assessing Risk: An objective of management accounting is to measure the
risk involved with the decisions and to minimize risk while keeping the
profits low. It uses different tools and techniques.
To Coordinate and Administer: It is task of the management accounting to
provide control on operations. It uses cost standards, budgeting for expenses,
sales forecast, profit planning, etc. to improve the overall performance of
an organization.
Performance Comparison: To compare the performance of each level
with the predefined standards, identify the deviation to interpret the results.
It includes setting the financial policy as well.
Identify Different Forces and its Impact on Organisations: There are
different forces which impact an organization in terms of economic social
and governmental influence. It is the task of the management accounting to
identify their impact and take required corrective actions.
Preparation of Reports for Government Agencies: Every organization
has to fulfil the official requirements for submitting reports according to
reporting standards. Management accounting supervises and coordinates to
fulfill those mandatory requirements.
Check Your Progress C
Match the following:
A B
1) Activity Based Costing, Differential a) Ratio Analysis
Costing
2) Solvency, Liquidity and Profitability b) Cost Benefit Analysis
Ratios
3) Differentiates Between Variable and c) Budgetary Control
Fixed Cost
4) Setting up a Budget to Compare with d) Marginal Costing
Actual Performance

16
 Management Accounting:
5) Comparative Statement, Common e) Cash Flow Analysis An Introduction
Size Statement, Ratio Analysis
6) Detailed Analysis of Cash Inflow f) Financial Statement
and Outflow Analysis
7) Change Between Two Time Periods g) Fund Flow Analysis

1.9 ADVANTAGES OF MANAGEMENT

ACCOUNTING
Basic advantage of Management Accounting is to take correct policy
decisions and improved efficiency of management. The prime objective is to
assist the management to increase the quality of the management decision.
The major advantages of management accounting are as follows:
Effective Decision Making:This is the prime objective or the basic purpose
of having management accounting. It uses different techniques from
different disciplines like charts, table and different accounting techniques.
It helps to justify the decisions taken by top management.
Future Planning: Management Accounting is a continuous process. It
collects and report data on the basis of need of the managers. So, managers
use the data for analysis and decision making on day-to-day basis.
Increase Efficiency of the Company:Management Accounting creates
accountability and improves efficiency of the company. It helps to identify
and remove deviations. It strives to increase the efficiency of the company.
Planning: Management Accounting provides the relevant information
to management on continuous basis in the form of budgets, forecast and
variance analysis. It helps management in decision making and business
activity.
Effective Control and Regulations: Management Accounting helps to
ensure effective control over the performance by providing efficient system
of planning and budgeting. It makes the comparison of actual with the
standards and makes the process easier and reliable.
Motivation to Employees: Management Accounting leads to overall
improved performance of an organization and thus it improves the image of
the company. It sets standards for the organization and employees as well
which keeps them motivated and improves their performance.
Optimal Utilization of Resources: Management Accounting helps in the
efficient utilization of resources. By creating different budgets and setting
standards, it helps in reducing the wastage of resources and efforts.
Keeps the Management Informed: Management Accounting helps the
management to remain informed about the progress from time to time. It
helps them to take the remedial actions simultaneously to remove deviations
and if necessary, to take corrective action.

17
Management Accounting:
Introduction and Basic 1.10 FUNCTIONS OF MANAGEMENT
Techniques ACCOUNTING
The basic objective of Management Accounting is to provide necessary
information to the management in a meaningful manner. To achieve
this objective, it has to undergo different activities. It helps in providing
accounting information to the management which assists in performing
management function. The major functions which add to the basic function
are as follows:
Planning and Forecasting: Planning is the first step in management process
which requires a strong system of decision making. Planning is done to
set the objectives and to achieve those objectives. Under this function, it
involves setting up the goals and formulating policies to reach those goals.
Techniques like budgeting forecasting, standard costing, etc. are part of this
step.
Analysis and Interpretation: Once the financial data is collected as per the
needs of the management and then comes the analysis of this data. Data is
collected from financial statements and cost accounting and then analyzed
as per the needs of the management. Analysis helps the management to do
future trend analysis as well.
Coordinating: Activities like budgeting, financial reporting and
interpretation are used to coordinate different activities of the organization.
The efficient control adds to the efficiency of the organization.
Communicating: Once Management Accountant has prepared various
budgets and reports, next task is to communicate these to the subordinates.
Publishing annual report is also the job of the management accountant.
Tax Administration: With modernization, it has become the task of the
management to submit necessary documents to the management and
return to the tax authority and supervision of all the matters related to tax
administration.
Decision Making: Management takes decision for day-to-day events.
Management Accounting provides information in terms of analytical
information, cost price and income etc. to make decisions and selecting the
best possible alternative.
Management Accounting assists the management to perform effectively.
It includes all the activities from collection of data processing analysis,
presentation of data and interpretation of data. All these functions can be
broadly categorized into two parts. One is related to only providing the
information another is assisting in management functions. This can be
explained through the diagram as follows:

18
 Management Accounting:
An Introduction

Check Your Progress D

Identify whether the following statements are True or False.
1) Management Accounting helps in effective Decision Making.
2) Management Accounting does not add to efficiency of the company.
3) Management Accounting leads to wastage of resources.
4) Management Accounting helps in enhancing employee’s motivation.
5) Management Accounting leads to coordination and communication
between different levels within an organisation.

1.11 LET US SUM UP

●● All the activities undertaken by an organization affects the
performance and efficiency of a company. These activities need to be
quantified, recorded, analyzed and reported to evaluate its impact on
an organization. This is Management Accounting is concerned about.
●● Management Accounting collects data from cost accounting and
Financial Accounting and provides all the information needed by the
management to make decision.
●● Management Accounting is the recent development after financial
and cost accounting.
●● Objectives of Management Accounting are that it helps in planning
and formulating management policies, interpretation of financial
data available, helping in decision making, controlling performance,
organizing, reporting and coordination of operations.
●● Management Accounting is a futuristic concept and it is the basis of
decision making, It is selective in nature but does not have specific
reporting standards.
●● It provides accounting information, gives cost effect analysis, assists
in decision making, increases the efficiency and helps in achieving
objectives.
19
Management Accounting: ●● Management account is different from cost accounting and Financial
Introduction and Basic Accounting. As its primary users are different and it does not follow
Techniques
any disclosure standards, it is not compulsory to be reported and does
not follow specific periodicity.
●● There are various techniques like Financial Planning, Financial
Statement Analysis, Fund Flow Analysis, Cash Flow Statement,
Standard Costing Budgetary Control, Marginal Costing, etc. which
helps in management accounting to analyze and make decisions
according to the need of business.
●● As we have studied so far, financial accounting provides relevant data
to managers but management accounting helps in using that data to
make a better decision. Roles that management accounting performs
in an organization are the Allocation of resources, measuring
performance, assessing the risk component, etc. It identifies different
forces and their impact on organization.
●● Management Accounting has many benefits to the organization as
it helps in future planning and effective decision making; it helps
in all the functions from planning, coordinating to motivation of
subordinates.
●● Management Accounting performs various functions. It helps in
planning and Forecasting, Analysis, Interpretation, Coordinating,
Communicating and Decision Making.

1.12 KEY WORDS

Management Accounting: It is concerned with the supply of information
which is useful to the management in planning, controlling and decision
making within the organization.
Cost Accounting: A branch of accounting concerned with measurement
and control of cost.
Financial Accounting: It is primarily concerned with record keeping
directed towards preparation of financial statements and other accounting
reports for external users.
Cost control: Controlling the cost to attain a predetermined standard.
Cost ascertainment: Collection analysis and measurement at different
stages of production.
Cost reduction: Permanent reduction in cost without impairing the quality
of goods and services.
Budgetary control: budgets are prepared for different future period then
actual is compared with budgets prepared to find and rectify deviations.
Cash flow statement: it provides details of cash inflow and outflow during
a given period of time.
Marginal costing: Costing technique where variable cost is charged to unit
cost

1.13 ANSWERS TO CHECK YOUR PROGRESS

A. i) False ii) True iii) True iv) True v) False
20
B. 6. a) Formulating Management Policy Management Accounting:
An Introduction
b) Upper Level Management
c) Financial Accounting and Cost Accounting
d) Financial Accounting
e) Quantitative and Qualitative
C. 1) B 2) A 3) D 4) C 5) F
6) E 7) G
D. i) True ii) False iii) False iv) True v) True

1.14 TERMINAL QUESTIONS

1. DefineManagement Accounting and briefly describe its objectives.
2. Discuss the nature and scope of Management Accounting.
3. Differentiate between Management Accounting and Cost Accounting.
4. Write a short note on the following:
1. Financial Accounting
2. Cost Accounting
5. Explain the functions performed by Management Accounting.
6. What are the roles performed by Management Accounting in an
organization?
7. Explain various advantages of Management Accounting.

21
 UNIT 2: COST CONTROL, COST
REDUCTION AND COST
MANAGEMENT
Structure
2.0 Objectives
2.1 Introduction
2.2 Cost Control
2.2.1 Concept of Cost Control
2.2.2 Features of Cost Control
2.2.3 Advantages of Cost Control
2.2.4 Disadvantages of Cost Control
2.2.5 Techniques of Cost Control
2.2.6 Characteristics of a Good Cost Control System
2.3 Cost Reduction
2.2.1 Concept of Cost Reduction
2.2.2 Features of Cost Reduction
2.3.3 Advantages of Cost Reduction
2.3.4 Disadvantages of Cost Reduction
2.3.5 Techniques of Cost Reduction
2.3.6 Essential requisites for the successful implementation of Cost Reduction
Programme
2.4 Difference between Cost Control and Cost Reduction
2.5 Cost Management
2.5.1 Concept of Cost Management
2.5.2 Objectives of Cost Management
2.5.3 Types of Cost Management
2.5.4 Techniques of Cost Management
2.5.5 Advantages of Cost Management
2.6 Let Us Sum Up
2.7 Key Words
2.8 Answers to Check Your Progress
2.9 Terminal Questions

2.0 OBJECTIVES
After studying this unit, you should be able to:
●● explain the concept of cost control and cost reduction
●● identify the need of cost control and cost reduction
●● enumerate the techniques of cost control and cost reduction
●● differentiate between cost control and cost reduction
●● explain the concept of cost management
22
 Cost Control, Cost Reduction
2.1 INTRODUCTION and Cost Management
Most of the enterprises want to maximize the profit, which is possible by
decreasing the production cost. For this purpose, management uses two efficient
tools, i.e. cost control and cost reduction. Cost Control is a technique which
makes available the necessary information to the management that actual costs
are aligned with the budgeted costs or not. Cost Reduction is a technique which
we use to save the unit cost of the product without compromising its quality.
The main objective of the organization is to earn maximum profit and to
achieve this objective, firm needs either to increase the revenue or reduce
the cost of production. Different concepts are used in cost accounting which
deals with minimizing the cost. Let us discuss these concepts in detail to
have better understanding and how these concepts enable the management
to achieve the main objective of earning maximum profit.

2.2 COST CONTOL

Cost Control is a process in which we focus on controlling the total cost
through competitive analysis. It ensures that the cost incurred on production
should not go beyond the pre-determined cost. Cost Control involves a
chain of various activities, which starts with the preparation of the budget in
relation to production. Thereafter we evaluate the actual performance. After
that we compute the variances between the actual cost and the budgeted cost
and further, we find out the reasons for the same. Finally, we implement the
necessary actions for correcting discrepancies
2.2.1 Concept of Cost Control
Cost control is prime function of cost accounting. Under cost control, cost
accountant measures actual costs, compare it with the standards and find the
deviations. Then redial actions are taken to reduce the variances. It involves
various actions taken to keep the cost within budgeted standards and not
rising beyond the limit. Cost Control focuses on decreasing the total cost of
production.
2.2.2 Features of Cost Control
Cost control has following features:
i) It is an attempt to keep the expenses within the control.
ii) It is a continuous process which includes formulating standards and
preparing budgets to set a target and then continuously comparing the
actual with these standards.
iii) It requires a continuous cost control report to identify the variances to
be resolved.
iv) It works as motivational and encouragement to the employees to
achieve the budgetary goals and keep the cost, controlled.
v) It is not only focused on reducing the cost, it also focusses on the
effective utilization of the resources to get better results with the same
available resources.

23
Management Accounting: For example:
Introduction and Basic
Techniques If current cost of producing a unit is Rs. 100 per unit, then under cost control
attempt will be made to reduce the cots in such a manner that it does not
go beyond Rs. 100. Organization will attempt to achieve this target. If it is
found that actual cost comes at Rs. 120, it will find the deviation which is
Rs. 20. Then attempt will be made to find the method to reduce the cost to
Rs. 100 This is known as cost control.
2.2.3 Advantages of Cost Control
The advantages of cost control are mainly as follows:
i) Cost control helps to achieve expected return on the capital invested
in a company, by resolving deviations between actual and expected
standards.
ii) Cost control leads to improved standards of production with the
limited resources of the company.
iii) Cost control reduces the prices or tries to maintain it by reducing the
cost.
iv) Cost control leads to economic use of resources.
v) It increases profitability and competitive position of a company.
vi) It enhances credit worthiness of the company.
vii) It prospers and increases economic stability of the industry.
viii) It increases the sales of the company and maintains the level of
employment.
2.2.4 Disadvantages of Cost Control
The disadvantages of cost control are mainly as follows:
i) It reduces the flexibility and process improvement in a company.
ii) It restricts innovation by emphasizing to reaching the preset standards
iii) It requires skilled personnel to set standards.
iv) It lacks creativity as it is concerned with following the current
standards
v) It does not lead to improvement in standards
2.2.5 Techniques of Cost Control
1. Budgetary control: The budgetary control is process of continuous
comparison. It works with creating budgets and continuous comparison
of these budgets with the actual. It is finding the reasons for deviations
and revising the budgets with needs. It helps in planning coordination
and controlling.
2. Standard costing: Standard costing is setting a standard cost and
using this standard cost with actual and analyze the variances. It helps
in identifying the causes of variances and cost estimation.
3. Inventory control: Inventory control is regulating purchase, and
usage of material to maintain the production without blocking the
extra funds into it. It tries to reduce the wastage of the material and
leads to effective utilization of it.
24
4. Ratio analysis: Ratio analysis identifies the relationship among Cost Control, Cost Reduction
different variables. It helps to identify the trends in an organization. and Cost Management
Ratio analysis is also used for comparison of different organizations
on different aspects. It is mainly used for comparing the performance
with other organizations and external standards.
5. Variance analysis: Variance analysis is a method of cost control. It
involves the identification of the amount of variance and to analyze
the reasons of these variances. A variance is which varies from the
standards set. It can be favourable or unfavourable.
2.2.6 Characteristics of a Good Cost Control System
According to Backer and Jacobson, effective cost control should have the
following characteristics:
(a) Delineation of center’s responsibility, i.e., deciding responsibility
centers;
(b) The delegation of prescribed authority;
(c) Various cost standards;
(d) The relevance of controllable cost;
(e) Cost reporting; and
(f) Cost reduction
Check Your Progress - A
1. What do you mean by cost control?
………………………………………………………………………
………………………………………………………………………
2. What are the steps involved in cost control?
………………………………………………………………………
………………………………………………………………………
3. Name any two techniques of cost control.
i) ………………….
ii) ………………….
4. What is meant by budgetary control?
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………

2.3 COST REDUCTION

Cost reduction ensures savings in cost per unit and maximization of profits
of the enterprise. Cost reduction aims at cutting off the unnecessary expenses
which occur during the production process like storage, selling and distribution
of the product. In order to identify cost reduction, we should mainly focus on
the following major elements: savings in per unit production cost, the quality
of the product should not be affected and savings should be non-volatile in
nature.
25
Management Accounting: 2.3.1 Concept of Cost Reduction
Introduction and Basic
Techniques Cost reduction is real and permanent reduction in unit cost of goods and
services provided by the organization with effecting their quality and
efficiency. There are different techniques used for cost reduction which can
be budgetary control, standard costing, material control, labour control and
overhead control. Cost reduction focuses on decreasing per unit cost of a
product. Cost reduction is a continuous process. It has no visible end.
2.3.2 Features of Cost Reduction
Cost control has following features:
i) Cost reduction is genuine cost reduction which can be implemented
by lowering the cost of production.
ii) Cost reduction includes permanent reduction in cost. It is more due to
internal factors. For example, Reduction in government taxes is not
considered as cost reduction as it is not permanent nature.
iii) Cost reduction doesn’t decline the quality of production. It remains
the same.
iv) Unit cost is reduced either by decreasing the expenditure at a given
level of output.
v) Cost reduction can also be done by increasing the quantity produced.
It means reducing the expenditure will remain the same but the output
will increase
2.3.3 Advantages of Cost Reduction
i) Cost reduction increases the profitability of an organization.
ii) Cost reduction enhances the cash flow of the company.
iii) Cost reduction program helps in achieving the goals of the company.
iv) It is permanent in nature which affects the organizational performance
in the long run.
v) Cost reduction does not impair the quality of the production while
reducing the cost.
2.3.4 Disadvantages of Cost Reduction
There are problems with cost reduction which are generally do faced. These
are as follows:
1. Workers and employees of an organization generally do not like to
implement cost reduction program and they try to resist it. These are
considered as difficult to be implemented.
2. Cost reduction programs are continuous in nature. It is a continuous
attempt to lower the cost. But in most of the organizations, they are
implemented on adhoc basis.
3. The cost reduction technique cannot be applied in all the cases.
4. Cost reduction technique requires a lot of research which adds on to
the cost of the company
5. Cost reduction technique needs to be implemented in a planned
manner.
26
There can be two ways to achieve the goal of the cost reduction Cost Control, Cost Reduction
and Cost Management
●● By reducing the cost of that particular product and
●● By increasing the efficiency so that we can increase the productivity
of the production unit which lowers per unit cost.
2.3.5 Techniques of Cost Reduction
Cost reduction results from reduction of wastage, improvement in efficiency,
identifying alternatives, and continuous reduction of the cost. There can be
different methods for cost reduction which can be as follows:
1) Value analysis and value engineering.
2) Job evaluation and merit rating
3) Quality control
4) Economic order quantity
5) Standardization and simplification
6) Inventory management
7) Bench marking
8) Business process reengineering
9) Job Study, Works Study and Motion Study;
10) Job Evaluation and Merit Rating;
11) Value Analysis.
2.3.6 Essentials for success of cost reduction programme
Cost reduction programme aims at improvements of human efforts at
all levels of the organization, which help in reducing costs. It may be a
short-term or long-term program. A short-term programmer is undertaken
for sorting out immediate problems, e.g. a problem involving controlling
wastages and inefficiencies in certain departments, which are likely to push
up the cost and may also require capital expenditure. It involves setting
up the target return on capital employed and developing a scheme for its
achievement through various cost reduction measures.
The following are the essential requisites for successful implementation
of a cost reduction programme. Let us understand them in detail.
a. There should be a separate cost reduction cell responsible for proper
planning and implementation of the cost reduction programme.
b. There should be an efficient system of management reporting at all
levels of management.
c. The programme should have support from the top management.
It is a continuous process and, therefore, should not be allowed to
degenerate into a routine affair.
d. There should be an operation and research procedure.
e. There should be close co-operation amongst different executives
concerned with the programme. Each departmental head should be
given a list of the areas where he is expected to affect economies in
cost. Moreover, he should also be encouraged to put forward his own
suggestions for improvement.
27
Management Accounting: f. There should be regular follow-up to the plan and continuous
Introduction and Basic appraisal of the programme performed with the actual cost reduction
Techniques
performance.
g. The plan should not be confined only to reducing costs but should also
examine whether expenditure is really required or not. In other words,
there should be efforts to eliminate uneconomic and unnecessary
activities.
Check Your Progress B
1. State whether each of the following statements is True or False:
a. Cost reduction includes permanent reduction in cost. It is more
due to internal factors.
b. Cost reduction declines the quality of production. It should
remain the same.
c. Cost reduction increases the profitability of an organization.
d. Inventory management is a method of cost reduction.
e. Cost reduction is substitute of cost control.

2.4 DIFFERENCE BETWEEN COST CONTROL

AND COST REDUCTION
Cost control and cost reduction are two different concepts under cost
accounting. In cost control, we try to reduce the cost to achieve the
predefined target. In cost reduction we try to reduce the cost further to
lower the budgeted cost. It is an attempt to improve the standards itself.
Cost control ends once the standards are reached, on the other hand, there
is no limit to cost reduction as there can be improvement in the standards.
It is an ongoing process. We can say that cost reduction is much broader as
compared to cost control, it starts where control, ends cost. The difference
between the two concepts can be explained as follows:
BASIS COST CONTROL COST REDUCTION
Steps Cost Control process Cost Reduction is critical
involved involves defining the analysis of existing
standards, measuring actual standards to improve
performance, comparing the standards rather than
actuals with standards, creating the standards.
estimating variances and
taking corrective actions.
Techniques Cost Control uses Cost Reduction uses
techniques like budgetary tools like simplification,
control and standard costing standardization, value
engineering, ABC analysis,
etc.
Focus Cost Control focuses on Cost Reduction is
maintaining the standards challenging all the
and achieving the predefined standards and
established standards brings cost down further.

28
 Cost Control, Cost Reduction
Time period Cost Control is not a Cost Reduction is a and Cost Management
dynamic function; it tries to continuous process. It is
reach to the minimum cost not a period based concept
at a given point of time but it analyses new ways to
reduce cost.
Orientation Cost Control is focused on Cost Reduction is a future
the past and present cost oriented concept.
data.
Nature Cost Control can be Cost Reduction is a
regarded as a preventive corrective measure. It tries
to improve the efficiency
function as it attempts to
maintain the cost at the of the existing control
mechanism. It assumes that
required pre-set standards
there is always scope of
reduction.
Permanency Cost Control is temporary Cost Reduction is
in nature. It is just a permanent reduction in cost
measure to reduce variances of a good or a service
between actual and
budgeted.
Cost Cost Control focuses on Cost Reduction is an
concerned reducing the overall cost. attempt to reduce the per
unit cost
Quality Cost Control does not talk Cost Reduction is reducing
concerns of quality of the product; it the cost whole maintain the
focusses on reduction only. quality of the product.
Frequency Cost Control is more of a Cost Reduction is research
routine activity. It requires oriented; it is a form of
close monitoring. improvement so it demands
creativity.
Both the cost reduction and cost control are different concepts; they do not
overlap each other and cannot be substituted with each other. They both
perform different functions in an organization having their own importance.

2.5 COST MANAGEMENT

Cost management involves different cost accounting methods that have the
goal of improving business cost efficiency by reducing costs or at least having
measures in place to restrict the growth of costs. Cost management system is
helpful in identifying, collecting, classifying and collating information that
can be used by managers in planning, controlling and taking right decisions
to keep the costs in the desirable limits. Cost manangement can be defined
as the process of planning and controlling the budget of the business. It
helps in predicting the expenses of the business.
2.5.1 Concept of Cost Management
Cost management is method of collecting, analyzing and presentation of
data to plan, monitor and control cost. Cost management techniques identify
how an organizational resource needs to be allocated to different projects
29
Management Accounting: while comparing its worth or outcome. Under cost management, we identify,
Introduction and Basic collect and do reporting of the information required by managers and other
Techniques
users. Its main objective is to make the information available to the internal
users of an organization. Efficient cost management helps the organization
to improve its potential of the business. It provides information to managers
for cost optimization and improving cost effectiveness.
2.5.2 Objectives of Cost Management
The main objective of cost management is to reduce the costs expended by
an organization while strengthening the strategic position of the firm. There
are many ways to apply the techniques of cost management. Some of them
are as follows:
a) Establish systems to streamline the transactions between corporate
support departments and the operating units.
b) Devise transfer pricing systems to coordinate the buyer-supplier
interactions between decentralized organizational operating units.
c) Use pseudo profit centers to create profit maximizing behavior in
what were formerly cost centers.
2.5.3 Types of Cost Management
There are three types of cost management which are as follow:
1. Those that strengthen the organization’s competitive position.
An example of a cost management technique that strengthens an
organization’s position is illustrated as follows. A hospital redesigns
its patient admission procedure so it becomes more efficient and easier
for patients. The hospital will become known for its easy admission
procedure so more people will come to that hospital if the patient has
a choice. The strategic position of the hospital has just been increased
over its competitors.
2. Those that have no impact on the organization’s position. An
example of a cost management technique that has no impact on the
organization’s competitive position is illustrated as follows. An
insurance company decides to reevaluate its accounts payable system
to make it more efficient. The evaluation has no positive benefits to
the insurance company in the external market. The objective of the
change is to make the organization more profitable.
3. Those that weaken the organization’s position. An example of a
cost management technique that will weaken the organization’s
competitive position is illustrated as follows. A large airline company
only has two desks for administering and selling tickets. This set-
up induces long lines for the airline customers which can ultimately
result in high dissatisfaction and a bad reputation for the airline.
This may reduce the amount of ticket sales when compared with the
airline’s competitors. Even though having only two desks available
for customers may initially be cost effective, in the long run, it harms
the company.
As a general rule, an organization should never undertake any practices that
are predicted to weaken the position of the organization.
30