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MANAGEMENT

ACCOUNTING

Semester – VI

Student Workbook

Edition: 2018

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Edition: 2018

NOTE:

THE WORKBOOK IS ONLY A DIRECTIVE FOR STUDENTS AND NOT

EXHAUSTIVE TOWARDS THE COURSE. THE STUDENTS MUST REFER

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JAIN UNIVERSITY

SYLLABUS

Subject: Management Accounting

Total Lecture Hours: 60 Credits: 04

Objective To familiarize the students with various principles of Management Accounting and to enable them acquire skills needed to understand, analyze, Interpret and present accounting information to Management for decision-making.

Module I: Introduction to Management Accounting and Analysis and Interpretation of Financial Statements 8 hours Introduction, Meaning & Nature of Management Accounting, Scope, Objectives, Functions of Management Accounting, Relationship between Financial Accounting, Management Accounting & Cost Accounting, Tools & Techniques of Management Accounting, Limitations of Management Accounting, Techniques of Financial Analysis, Comparative Financial Statements - Comparative Balance Sheets - Comparative Income Statements - Common size statements - Common size Balance Sheets - Common size Income statements - Trend percentages

Module II: Ratio Analysis 12hour s Introduction, Meaning of Ratio, Nature of Ratio analysis, Interpretation of the Ratios, Guidelines for use of Ratios, Significance of Ratio analysis, Limitations of Ratio analysis, Classification of Ratios, Calculation and interpretation of short term and long term financial position ratios, Profitability ratios and capital structure leverage ratios. Activity & turn over ratios, Preparation of financial statements using ratios, DuPont control chart

Module III: Cash Flow Analysis 11 hours Introduction, Meaning of Cash Flow statement, Classification of Cash Flows, Uses and significance of cash flow statement, Limitations of cash flow statement, Preparation of cash flow statement in accordance with Accounting standard 3 (Revised) issued By ICAI (only indirect method)

Module IV: Marginal Costing & Standard Costing 20 hours Introduction, Meaning, Features of Marginal Costing , Advantages and Disadvantages, Marginal Cost Equation, CVP Analysis and Break Even Analysis, PV Ratio and Marginal Safety, Introduction & Meaning of Standard Costing, Standard Cost and Estimated Cost Comparison, Advantages & Disadvantages of Standard Costing, Variance Analysis, Favorable and Unfavorable Variances, Classification of Variances - Material Variance- Labour Variance - Overhead Variance - Variable overhead Variance - Fixed overhead Variance

Module V: Budgetary Control & Reporting 9 hours Meaning, Objectives & Essentials of Budgeting, Advantages and Limitations of Budgetary Control, Classification of Budgets, On the basis of Time - On the basis of Function - On the basis of Flexibility, Cash Budget Introduction, Meaning of Report, Reporting to different levels, Methods of Reporting, Kinds of Reports, Principles of good Reporting System, Process of Report writing (Specimens)

Module – 1

Introduction to Management Accounting and Analysis and

Interpretation of Financial Statements

Structure: 1.1 Introduction 1.2 Meaning and Emergence of Management Accounting 1.3 Scope of Management Accounting 1.4 Objectives of Management Accounting 1.5 Functions of Management Accounting 1.6 Relationship of Management Accounting with Financial Accounting 1.7 Relationship between Cost and Management Accounting 1.8 Tools and Techniques used in Management Accounting 1.9 Limitations of Management Accounting 1.10 Meaning of Financial Analysis 1.11 Comparative Financial Statements 1.12 Comparative Income Statement 1.13 Common-size Financial Statements 1.14 Common-size Balance Sheet 1.15 Common-size Income Statement 1.16 Trend Analysis, Trend Percentage or Trend Ratio Analysis 1.17 Terminal Questions

Learning Objectives  To learn how Management accounting as a discipline emerged.  To understand the nature, scope, purpose and limitations of Management accounting.  To learn how Management Accounting is different from Financial Accounting and cost Accounting.  To know the convention established in Management Accounting.  To learn the tools of Management Accounting.

1.1 Introduction:

The term “management accounting” is the modern concept of accounts as a tool of management. It is broad term and is concerned with all such accounting information that is useful to the management. In simple words, the term management accounting is applied to the provision of accounting information for management activities such as planning, controlling, decision making, etc.

1.2 Meaning and Emergence of Management Accounting:

Management Accounting is comprised of two words ‘Management’ and ‘Accounting’. It is the study of managerial aspect of accounting. The emphasis of management accounting is to redesign accounting in such a way that it is helpful to the management in formation of

policy, control of execution and appreciation of effectiveness. It is that system of accounting which helps management in carrying out its functions more efficiently.

Definitions of Management Accounting “Management Accounting is the presentation of accounting information in such a ways as to assist management in the creation of policy and the day-to-day operation of an undertaking.” – Anglo-American Council on Productivity

Nature of Management Accounting:

1. Providing Accounting Information: Management accounting involves the presentation of information in such a way to suit the managerial needs. The accounting data is used for reviewing various policy decisions. 2. Cause and Effect Analysis: The ‘cause and effect’ relationship is discussed in management accounting. If there is loss, the reasons for the loss are probed. If there is a profit, the factors directly influencing the profitability are also studied. 3. Use of Special Techniques and Concepts: Management accounting uses special techniques and concepts to make accounting data more useful. The techniques usually used include financial planning and analysis, standard costing, budgetary control, marginal costing, project appraisal, control accounting, etc. 4. Taking Important Decisions: Management accounting helps in taking various important decisions. It supplies necessary information to the management which may base its decisions on it. 5. Achieving of Objectives: In management accounting, the accounting information is used in such a way that it helps in achieving organizational objectives. 6. No Fixed Norms Followed: No specific rules are followed in management accounting. Though the tools of management accounting are the same, but their use differs from concern to concern.

1.3 Scope of Management Accounting:

1. Financial Accounting: Financial accounting deals with the historical data. The recorded facts about an organization are useful for planning the future course of action. So management accounting is closely related to financial accounting. 2. Cost Accounting: Cost Accounting uses financial data for finding out cost of various jobs, products or processes. The system of standards costing, marginal costing, differential costing and opportunity costing are all helpful to the management for planning various business activities. 3. Financial management: Financial management is concerned with the planning and controlling of the financial resources of the firm. Although, financial management has emerged as a separate subject, management accounting includes and extends to the operation of financial management also. 4. Budgeting and Forecasting: Budgeting means expressing the plans, policies and goals of the enterprises for a definite period in future. Forecasting, on the other hand, is a prediction of what will happen as a result of a given set of circumstances. Both budgeting and forecasting are useful for management accountant in planning various activities.

3. Financial Analysis and Interpretation: Management accountant analyses and interprets financial data in a simple way and presents it in a non-technical language. He gives his opinion about various alternative courses of action so that it becomes easy for the management to take a decision. 4. Facilities Managerial Control: Management accounting is very useful in controlling performance. Performance evaluation is possible through standard costing and budgetary control which are an integral part of management accounting. 5. Communication: The management accountant prepares reports for the benefit of different levels of management and employees. The activities of the concern are communicated to outsiders such as bankers, investors, creditors, government agencies, etc. 6. Use of Qualitative information: The field of management accounting is not restricted to the use of monetary data only. It collects and uses qualitative information also.

1.6 Relationship of Management Accounting with Financial Accounting:

Sl. No Basis Financial Accounting Management Accounting

1. External and internal users

Financial accounting information is mainly intended for external users - investors, shareholders, creditors, Govt. authorities, etc.

Management accounting information is mainly meant for internal user, i.e., management.

2. Accounting method

It is based on double entry system for recording business transactions.

It is not based on double entry system

3. Statutory requirements

Under company law and tax laws, financial accounting is obligatory to satisfy various statutory provisions.

Management accounting is optional though its utility makes it highly desirable to adopt it

4. Analysis of cost and profit

Financial accounting shows the profit/loss of the business as a whole. It does not show the cost and profit for individual products, processes or departments etc.

Management accounting provides detailed information about individual products. Plants, departments or any other responsibility centre.

5. Past and future data

It is concerned with recording transactions which have already taken place, i.e., it represents past or historical records.

It is future oriented and concentrates on what is likely to happen in future through it may use past data for future projections.

6. Periodic and continuous reporting

Financial reports, i.e., Profit and Loss Account and Balance Sheet are prepared usually on a year to year basis.

Management accounting reports are prepared frequently, i.e., these may be monthly, weekly or even daily depending on managerial

requirements.

7. Accounting standards

Companies are required to prepare financial accounts to Accounting Standards issued by the Institute of Chartered Accountants of India.

Management accounting is not bound by accounting standards. It may use any practice which generates useful information to management.

8. Types of statements prepared

Financial accounting prepares general purpose statements - Profits and Loss Account and Balance Sheet which are used by external users.

In management accounting special purpose reports are prepared, e.g, performance report of sales manager or any other department manager which are used by top level management.

9. Publication and audit

Financial statements, i.e., P&L A/c and Balance Sheet are published for general public use and also sent to shareholders. These are required to be audited by the Chartered Accountants.

Management accounting statements are for internal use and thus neither published for general public use nor are these required to be audited by Chartered Accountants.

10. Monetary and non-monetary measurements

Financial accounting provides information in terms of money only.

Management accounting may apply monetary or non- monetary units of measurements. For example information may be expressed in terms of Rs. or units of quantity, machine hours, labour hours, etc.

1.7 Relationship between Cost and Management Accounting:

Sl. No

Basis Cost Accounting Management Accounting

1. Scope Scope of cost accounting is limited to providing cost information for managerial uses.

Scope of management accounting is broader than that of cost accounting as it provides all types of information, i.e., cost accounting as well as financial accounting information for managerial uses.

2. Emphasis Main emphasis is on cost ascertainment and cost control to ensure maximum profit.

Main emphasis is on planning, controlling and decision- making to maximize profit.

5. Comparative financial statements.
6. Differential cost analysis.
7. Funds flow statements.
8. Cash flow statement.
9. Responsibility accounting.
10. Accounting for price level changes.
11. Statistical and graphical techniques.
12. Discounted cash flow. Etc.

1.9 Limitations of Management Accounting:

1. Based on Accounting Information: Management accounting is based on data supplied by financial and cost accounting. The correctness and effectiveness of managerial decisions will depend upon the quality of data on which these decisions are based. 2. Lack of Knowledge: Management should be conversant with accounting principles, statistics, economics, principles of management, etc., and only then management accounting can be effectively utilized. Deficiency in knowledge of any of these subjects limits the use of management accounting. 3. Intuitive Decisions: Though management accounting provides scientific analysis of various situations and enables decision making based on facts and figures, there is a tendency to make decisions intuitively. Intuitive decisions limit the usefulness of management accounting. 4. Not an Alternative to Administration: Management accounting does not provide an alternative to administration. The tools and techniques of management accounting provide only information and not decisions. 5. Top Heavy Structure: Introduction of management accounting system is a costly affair and can be used by big concerns only, smaller units cannot afford to use this system because of heavy cost. 6. Evolutionary Stage: Management accounting is only in a developmental stage. It will take some time before management accounting takes a final shape.

1.10 Meaning of Financial Analysis:

In the words of Myers, “Financial statement analysis is largely a study of relationship among the various financial factors in a business as disclosed by a single set-of statement, and a study of the trend of these factors as shown in a series of statements.”

Techniques/Types of Financial Analysis: We can classify various types of financial analysis into different categories depending upon (i) The material used and (ii) The method of operation followed in the analysis or the modus operandi of analysis.

(i) On the basis of material used. According to the material used, financial analysis can be of two types:

a. External Analysis: This analysis is done by outsiders who do not have access to the detailed internal accounting records of the business firm. These outsiders include investors, potential investors, creditors, potential creditors, government agencies credit agencies, and the general public. For financial analysis, these external parties to the firm depend almost entirely on the published financial statements.

b. Internal Analysis: The analysis conducted by persons who have access to the internal accounting records of a business firm is known as internal analysis. Such an analysis can, therefore, be performed by executives and employees of the organization as well as government agencies which have statutory powers vested in them.

(ii) On the basis of modus operandi : According to the method of operation followed in the analysis, financial analysis can also be of two types: a. Horizontal Analysis: Horizontal analysis refers to the comparison of financial data of a company for several years. The figures for this type of analysis are presented horizontally over a number of columns. The figures of the various years are compared with standard or base year. Comparative statements and Trend percentages are two tools employed in Horizontal analysis.

b. Vertical Analysis: Vertical analysis refers to the study of relationship of the various items in the financial statements of one accounting period. In this type of analysis the figures from financial statement of a year are compared with a base selected from the same year’s statement. Common-size financial statements and financial ratios are the two tools employed in vertical analysis.

TYPES OF FINANCIAL ANALYSIS

ON THE BASIS OF MATERIAL USED ON THE BASIS OF MODUS OPSRAND

EXTERNAL ANALYSIS

INTERNAL ANALYSIS

HORIZONATAL ANALYSIS

VERTICAL ANALYSIS

Comparative Balance Sheet as on 31- 12 - 2017 and 31- 12 - 2018.

Particulars

As on 31 - 12 - 2017

As on 31 - 12 - 2018

Absolute Increase or decrease in 2018

Percentage of increase or decrease in 20 18

Capital and Liabilities: Equity share capital 10% Preference Share Capital Reserve fund Profit and Loss Account Owner’s Funds Long-term Liabilities Long-terms loans Current Liabilities Creditors

Assets: Fixed Assets (Gross block less depreciation, i.e., net): Investments Current Assets: Inventories Accounts Receivable Cash

Rs.

6,00, 5,00, 4,00, 2,00,

Rs.

12,00, 9,00, 5,00, 3,00,

Rs.

• 6,00,
• 4,00,
• 1,00,
• 1,00,

Conclusion drawn from the comparative balance sheet analysis on financial position of the company: a) There has been an increase of Rs.10,00,000 in fixed assets. The increase in fixed assets has been financed through additional equity share capital of Rs.6,00,000 and additional preference share capital of Rs.4,00,000. Financing the increase in fixed assets through additional equity share capital and preference share capital is a sound financial policy. b) There has been a substantial in long-term loans. It has to be seen whether the long-term loans have been used productively or not. c) Investments are treated as long-term investments. There has been an increase of Rs.1, 00,000 in investments. The increase in investments in appreciable. d) There is an increase of 44.4% in inventories. This increase in not very high. That means, much working capital is not locked up in inventories. e) There is a very high increase of 300% in accounts receivables. That means, steps taken for the collection of debts require scrutiny.

f) There has been an increase of 200% in cash. Cash is an idle asset. That means, a huge cash balance is kept idle. g) There is an overall increase of Rs.6,00,000 in current assets. There is also an overall increase of Rs.2,00,000 in current liabilities. The percentage of increase in current assets, viz., and 100% is less than the percentage of increase in current liabilities, viz., 200%. That means, there is a slight decrease in the current ratio. But the current ratio of the concern is quite good. h) There is an increase of Rs.1,00,000 in reserve fund and Rs1,00,000 in profit and loss account balance. This suggests that the profitability of the concern is good. To conclude, the overall financial position of the concern seems to be good.

1.12 Comparative Income Statement:

A comparative income statement is a statement prepared to compare the various items of the income statements of the different periods and to ascertain the changes (i.e., the increases or decrease) that have taken place in the items of income statements from one period to another. As such, a mere reading of the comparative Income statement helps one to derive a meaningful conclusion about the performance and efficiency of the business from year to year.

Illustration 2:

1. From the following data, prepare comparative profit and loss A/c showing increase or decrease in individual incomes and expenses together with percentage of such increase or decrease.

PARTICULARS 31 st^ Dec 2017 31 st^ Dec 2018 Sales Cost of goods sold

Gross profits Operating expenses: Office expenses Selling expenses Distribution expenses

Net operating profit Financial expenses

Net profit before tax Income tax

Net profit after tax 2,00,000 6,00,

amount. Generally, in the common-size income statement, the net sales figure is taken as 100%, and all other items of the income statement are expressed as a percentage of net sales. Similarly, in the common-size balance sheet, the total of assets, or the total of liabilities and capital is taken as 100% and all the items in the balance sheet are expressed as a percentage of this total.

Common-size financial statements are known as component percentage statements or 100 percent statements , because each statement is reduced to the total of 100% and each individual item is expressed as a percentage of the total of 100.

Common-size financial statements mainly include (1) Common-size balance sheet. (2) Common size income statement and

1.14 Common-size Balance Sheet:

A common-size balance sheet is a statement in which the total of the assets or the total of liabilities and capital is taken as 100%, and all the items of the balance sheet (i.e., each of the assets and each of the liabilities) are expressed as a percentage of the total assets, or the total of liabilities and capital.

Illustration 3:

1. Prepare Common Size Balance Sheets of A Ltd, and B Ltd, as on 31st^ March 2018 from the following balance sheets of the two companies. Liabilities A Ltd. Rs

B Ltd. Rs Equity Share Capital Pref Share Capital General Reserve Profit and Loss A/c

Current Liabilities: Proposed dividend Sundry creditors Bills payable Outstanding salary Provision for taxation

Assets A Ltd. Rs

B Ltd. Rs Investments Discount on issue of shares

Factory Building Machinery Fixed Deposits Preliminary expenses Current assets: Sundry debtors Stock Bank Cash

Solution:

Common Size Balance Sheets For the year ending 313- 2018 A. Ltd. B Ltd.

Rs. % of total Rs. % of total

Fixed Assets; Investments Discount on issue of shares Building Machinery Fixed deposits Preliminary expenses

Total Fixed Assets 6,27,200 59.80 7,75,200 60. Current Assets: Sundry debtors Stocks Bank Cash

Total current Assets 4,21,600 40.20 5,13,600 39. Total Assets (Fixed + Current) 10,48,800 100.00 12,88,800 100. Capital and Reserves: Equity capital Preference shares capital General reserves Profit and loss account

Total capital and reserves 7,88,000 75.13 9,76,800 75. Current Liabilities: Proposed dividend Sundry creditors Bills payable