20 Management Accounting

P.G. Padma Gowri

Introduction:

The management accounting is used to supply relevant information at appropriate time to the management to enable it to take decisions and effect control. According to Wilson and Chua 1993“Encompassing techniques and processes that are intended to provide financial and non-financial information to people within an organisation tomake better decisions and thereby achieve organisational control and enhance organisational effectiveness”.

Accounting is the Process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information”

Objectives:

Need for Management Accounting
To know about basics of management accounting statements
To understand analysis of management accounting

Need For Management accounting system:

The financial statements have the following laminations

1. Personal Judgement/Direction : The preparation of financial statement involve a degree of personal judgement or direction that may prevent presentation of facts in their true nature. Take the case of allocating the costs and incomes to a given accounting period. It is very difficult to set a uniform policy to cut off income and cost. It is true that the accounting department has considerable direction in this regard.

2. Replacement Cost is not Emphasised: The financial statements show the assets as per the book value and these seldom have relevance to the replacement costs. The financial statements are based on the historic cost prices but not o the prices.

3. Current Economic Realities Ignored: The financial statements present the accounts on cost concept. The cost of acquisition of the assets is taken as the basis to present the asset accounts. These may (be) far less than the current level of prices,particularly when there is a market decline in the value of currency and the economy shows up inflammatory trends. In other words, an increase in sales revenue may be in consequence to the fall in the rupee value and increase in the selling price. Ait may not be the direct result of improved performance of the firm.

4. Qualitative Factors Ignored: The financial statements do not reflect qualitative factors such as goodwill, credit rating, and so on. These factors have a profound impact on the financial conditions and operating results. However, there are a few companies such as Reliance showing up the quality of human factor in their financial statements

Management Accounting Statements –Key Words:

The following are the key words, which we come across while we scan through financial statements. Let us see what they mean to us.

Share Capital –This is the capital raised by issue of shares. Share capital may be raised by issue of (a) preference shares, (b) equity shares, or (c) both. Capital is liability for the company. It has to return this to the shareholders at any given time. A shareholder is the owner of the share capital of the company.

Preference share capital: This is capital raised by issue of preference shares. Preference shares carry fixed rate of divided (profit per share). They get dividend only if the company gets profits.

Equity shares: These are also called ordinary shares. Dividend is not fixed here. If the company gets profits, dividend is declared. Otherwise, no dividend.

Debentures: These refer to the borrowings by the company. When the company wants additional funds, it may issue debenture. A debenture is the acknowledgement of the loan taken be the company. These carry fixed rate of interest. Payment of interest involves a charge against the current year’s profits. Debenture holder is the long-term creditor of the company.

Retained profits: These are accumulated profits over a period of time. These are used for future needs of the business as expansion, mergers or acquisitions, and so on. Long-term loans : These are the loans from financial institutions such as banks.

Features of management accounting:

Internal parties – within an organisation (management accounting) Purpose of accounting is non routine reporting for Resource allocation decisions eg product and cost emphasis and pricing– internal routine reporting
Cost planning and control of operations and activities – internal routine reporting
Performance measurement and evaluation of people – internal non routine reporting
Meeting external regulatory and legal reporting requirements – External reporting

Analysis of accounting Statements

Analysis means examining something to know its contents in detail. It is the process of evaluating the relationship between different variables in the accounting statements. Analysis in accounting statements helps to identify the possible remedial measure to strengthen the weak areas of business. It provides an understanding of the financial matter of business such as the following:

How is the firm mobilising resources
How is the firm making profits/losses
How is the firm maintaining its assets and liabilities
How is the firm taking care of liquidity, solvency and profitability of the business etc In short, analysis facilities decision making.

Analysis of accounting statement involves an art by itself. It is always desirable that the people involved in the analysis should be conversant with the nature and limitations of the industry. This knowledge will help to identify the right type or approach of analysis. There are different approaches for the study of the accounting statements. The analysis of the study varies depending upon the users: internal or external.

TYPES OF ANALYSIS:

1.Horizontal Analysis vs. Vertical Analysis :

Horizontal Analysis refers to analysis of accounting statements presented in a horizontal format. Horizontal format of presentation of accounting statements has an advantage.

The data relating to different years or different firms for the same year can be given on a comparative basis. It is relatively easy to draw inferences about the relationship between related variables.

Vertical analysis refers to analysis of accounting statements presented in a vertical format. Vertical format restricts the freedom in presenting the data relating different firms or years for the same firm. The relationships can be drawn for the given period among the variables under study. The concept of common size statement is explained in the following section.

2. Internal Analysis

The management of the company is interested in finding out whether the performance of the company is satisfactory or not during a given period. So it carries out the financial analysis or sometimes the job is entrusted to the consultants or specialised agencies. The main objective of internal analysis is to identify the strong and weak areas of business. The strategy is to strengthen the weak areas and take advantage of the strengths. Conducting and using the results of financial analysis by the management for the purpose of forward planning and decision making is called internal analysis. The results of internal analysis are not available to the outsiders. The users of internal analysis include owners, management and employees.

Accounting Analysis Techniques:

The following are the techniques of financial analysis:

Ratio analysis
Funds flow and cash flow analysis
Common size statement analysis
Comparative statements analysis
Trend analysis

1. Ratio analysis: It is the process of analysing and interpreting the accounting statements to explain the issues of liquidity, solvency and profitability based on certain parameters with the help of ratios, proportions, percentages, etc. It is a valuable tool for decision making and forward planning. By using the ratios, the financial performance of a given firm can be analysed and compared from year to year, with that of other firms and even with that of the industry.

2. Funds Flow and Cash Flow Analysis

Fund flow analysis deals with the change in the financial position based on ‘flow of funds’ for a given accounting period. Funds mean working capital. Cash flow analysis deals with the changes in the financial position on the basis of Cash inflows and cash outflows during a given period.

These statements provide information about the movement of funds or cash during a given period and this information is very valuable for ‘forward planning and decision making’. This is additional information that is not provided by the traditional statements such as profit and loss account and balance sheet.

3. Common-size Statement Analysis

Given the data or accounting statement of different organisations are different. It is difficult to compare them unless there is a common parameter. Common –size statements are those where in the contents of financial statements are converted in terms of a common parameter. In profit and loss statement, each item of income and expenditure is expressed as a percentage to sales. In balance sheet, each item of asset and liability is expressed as ratio to total assets and total liabilities respectively. Common size statement analysis facilitates inter-firm comparison.

4. Comparative Statements Analysis

Here are compare accounting statements of different years for a given firm to know whether the firm has made any progress over a period of time. This process is also called intra-firm comparison. To know whether the performance of the firm is better or not when compared to that of the firms in the same industry, we compare the accounting statements of a given firm with those of other firms. This process is called intra-firm comparison. The accounting statements become comparable only when they are arranged in a comparative form.

Comparison of accounting data:

Variances refer to differences between the actual figure and the forecast figure.

The comparison involves

Comparing actual figures with those forecast in the budgets produced by the business and calculating the variances.
Comparing this year’s figures (such as costs, sales or profits, etc.) with those from previous year(s)
Comparing figures (such as costs, sales or profits, etc.) From one business with those from another business in the same industry.

(a) Comparing actual with forecasts: Following is an extract from a sales budgetreport for a business, It includes sales for the current period and sales for the year so far.

Budget Control Report – Sales

Month : September 2003

Dated : 3 October 2003

This statement reveals that the variance for product X in the month of September has been positive and even the trend as on date in this year is favourable.

The variance for product Y in the month of September has been negative and the trend as on data n this year is adverse. It is exactly here, the management of the business would examine this report critically and investigate variances as to the reasons behind the product not doing well and probable solutions.

Year –to-Year Comparisons:

There is a common practice to show the year-to-year trends in the accounting data for example, the profit figures or sales figures. This enables the owners, managers, employees, shareholders and the public to see how the business is progressing. This year-to-year comparison results can be also presented through graphs or bar charts, and so on.

Inter-firm comparison It is often useful to compare the performance of a firm with that of other firms of the same industry. Such as a comparison help the owner of the business to see if their business is performing well in comparison to its competitions.

Trend Analysis: Trend refers to increase or decrease or no change in the performance of a given variable under study. For instance, to know whether the software companies are making profit we cannot draw any meaningful conclusion from the performance of a single company over a single year. It is necessary to study the financial performance of the software companies over the last five to six years to comment about the trend.

Financial accounting analyst

Financial analysts are one who analyses and interprets the financial statements. The main job of financial statements analysis. The job of the financial analyst starts where the job of accountant ends. In other works, unless the accountant provides the financial statements, the financial analyst cannot commence his work.

The analysis and observations made by financial analyst is very significant to the creditors, investors, management, government, and so on. The financial accounting analysis should possess a good knowledge of logical reasoning to build relationships between different variable. He should be capable of assessing the impact of different policies of management on the performance of business

Interpretation is the Logical End of Analysis

Analysis with no interpretation has no meaning. Analysis ends with interpretation. IT is necessary to focus on issues such as prospects for future earnings, ability to meet short-or long –term commitments, probability of a sound investment policy and so on. And this is possible only through analysis and interpretation of management accounting statements.

Accounting records:

Management accounting statement gives an account of recorded facts of business in a logical, meaningful way as per requirements of management. Recorded facts refer to information obtained from the accounting records.

The accounting records furnish the detailed account of

Debtors (debtors buy good from the firm on credit basis. So they have to pay the firm)
Creditors (creditors supply goods to the firm on credit basis. So the firm has to pay to the creditor).
Assets (asset may be a fixed asset like machinery or current asset such as cash in hand, and so on.)
Liability (liabilities may be long-term like debentures or short term such as bank overdraft)
Expenses (what the firm spends on goods, service such as advertising, insurance, wages, (and so on.)
Losses (the firm may suffer loss such as loss of stock in fire, etc.,)
Incomes (the firm earns interest on investments, receives rent, commissions, sand so on.)
Profits (the firm makes profit on sale of goods)
Gains (the firm makes a gain on sale of fixed assets such as plant or land and buildings, etc.)

Conclusion:

Management Accounting used to describes activities of managers in short run and long run planning and control of costs. It also includes the continuous reduction of costs. It is a key part of general management strategies and their implementation.

Management accounting formulate plans to different activities and coordinate plans into budget for business as a whole Controlling. It produces performance reports that compare actual outcomes with planned outcomes. Management accounting develops accounting reporting systems that are closely related to organisational structure. Management accounting provides guidance for decision making and problem solving in order to achieve optimal results or maximise profit over investments.

Finally it is used to aid communications functions by installing and main training an effective communication and reporting system (eg budget and performance reporting process).