Management Accounting is often called the language of business. The basic function of any language is to serve as a means of communication. In this context, the purpose of management accounting is to communicate or report the results of business operations and its various aspects. Though it has been defined in various ways- According to one commonly accepted definition. “Management Accounting Function is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least, of financial character and interpreting the results thereof’. Another definition which is less restrictive interprets as “The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of information” (Colin Drury, 1983)
The advent of management accounting was the next logical step in the developmental process. The practice of using accounting information as a direct aid to management is a phenomenon of the 20th century. The genesis of modern management with its emphasis on detailed information for decision-making provide a tremendous impetus to the development of management accounting.
Management accounting is concerned with the preparation and presentation of accounting and controlling information in a form which assists management in the formulation of policies and in decision-making on various matters connected with routine or non-routine operations of business enterprise. It is through the techniques of management accounting that the managers are supplied with information which they need for achieving objectives for which they are accountable. Management accounting has thus shifted the focus of accounting from recording and analyzing financial transactions to profitability reporting for organization, corporate planning, strategy and decision affecting the future. In this sense, management accounting has a vital role to play in extending the horizons of modern business. While the reports emanating from financial accounting are subject to the conceptual framework of accounting, internal reports-routine or non-routine are free from such constraints.
Accounting principles are man-made. They are accepted because they are believed to be useful. The general acceptance of an accounting principle usually depends on how well it meets the three criteria of relevance, objectivity, and feasibility. A principle is relevant to the extent that it results in meaningful or useful information to those who need to know about a certain business. A principle is objective to the extent that the information is not influenced by the personal bias or judgment of those who furnished it. Objectivity connotes reliability or trustworthiness which also means that the correctness of the information reported can be verified. A principle is feasible to the extent that it can be implemented without undue complexity or cost.
TRADITIONAL ACCOUNTING SYSTEM FUNCTION
Management accounting involves a series of activities linked with each other, beginning with the collecting, recording, analyzing and evaluating the data, and finally communicating information to its users. Information has no meaning unless it is linked with a certain purpose.
Accounting as a social science can be viewed as an information system since it has all the features of a system. It has its inputs (raw data), processes (men and equipment), and outputs (reports and information). Consider accounting as an information system, then some important observations may be noticed. First, the goal of the system is to provide information which meets the needs of its users. Once needs of the users are correctly identified, then the nature and character of the outputs of the system can be specified. Secondly, it is the output requirements that determine the type of data which would be selected as the inputs for processing into information output. (David Ashton, 2000)
There are several groups of people who have a stake in a business organization- managers, shareholders, creditors, employees, customers, etc. Additionally, the community at large has economic and social interest in the activities of such organizations.
The information needs of various users are:
Shareholders and Investors: Since shareholders and other investors have invested their wealth in a business enterprise, they are interested in knowing periodically about the profitability of the enterprise, the soundness of their investment and the growth prospects of the enterprise. Historically, business accounting was developed to supply information to those who had invested their funds in business enterprises. (Anthony J. Berry, Jane Broadbent and David Otley, 1998)
Creditors: Creditors may be short-term or long-term lenders. Short-term creditors include suppliers of materials, goods or services. They are normally known as trade creditors. Long-term creditors are those who have lent money for a long period, usually in the form of secured loans. The main concern of the creditors is focused on the credit worthiness of the firms and its ability to meet its financial obligations. In other words, it can also be stated that creditors are interested mainly in information which deals with solvency, liquidity and profitability so that they could assess the financial standing of the firms.
Employees: The view that business organizations exist to maximize the return to shareholders has been undergoing change as a result of social changes. A broader view is taken of economic and social role of management. The importance of harmonious industrial relations between management and employees cannot be overemphasized. That the employees have a stake in the outcomes of several managerial decisions is recognized. Greater emphasis on industrial democracy through employee participation in management decisions has important implications for the supply of information to employees. (Malcolm Smith, 2006)
Government: In a mixed economy it is considered to be the responsibility of the Government to direct the operation of the economic system in such a manner that it subserves the common good. Controls and regulations on the operations of organizations, enterprises are the hallmark of mixed economy. All this information is very important in evolving policies for managing the economy. It is clear that if accounting information is distorted due to manipulations and window-dressing in the presentation of annual accounts, it will have ill-effects on the measures the government intends to take and the policies it wishes to adopt.
Management: Organizations may or may not exist for the sole purpose of profit. However, information needs of the managers of both kinds of organizations are almost the same, because the managerial process i.e., planning, organizing and controlling is the same. All these functions have one thing in common and it is that they are all concerned with making decisions which have their own specific information requirements. The emphasis on efficient and effective management of organizations has considerably extended the demand for accounting information. (Robert Simons, 2003)
Consumers and others: Consumers’ organizations, media, welfare organizations and public at large are also interested in condensed accounting information in order to appraise the efficiency and social role of the enterprises in different sectors of the economy, that is, what levels of profits and outputs are being achieved, in what way the social responsibility is being discharged and in what manner the growth is being planned by the enterprises in accordance with the national priorities etc.
Information needs of the various users may not necessarily be the same. Sometimes, they may even conflict and compete with each other. In any case, the objective of accounting information is to enable information users to make optimum decisions.
MODERN ACCOUNTING BUSINESS -ADVANCED TECHNOLOGIES
Any activity that is performed is facilitated if one has a set of rules to guide. Further, these rules are of more value to if they are standardized. A similar principle applies to accounting which has evolved over a period of several hundred years, and during this time certain rules and conventions have come to be accepted as useful. If one is to understand and use accounting reports-the end-product of an accounting system-one must be familiar with the rules and conventions behind these reports. (Kenneth A. Merchant and Wim A. Van der Stede, 2004)
The rules and conventions of accounting are commonly referred to as the conceptual framework of accounting. As with any discipline or body of knowledge, some underlying theoretical structure is required if a logical and useful set off practices and procedures are to be developed for reaching the goals of the profession and for expanding knowledge in that field. Such a body of principles is needed to help answer new questions that arise. No profession can thrive in the absence of a theoretical frame. Accounting theory may be defined as logical reasoning in the form of a set of broad principles that (i) provide a general frame of reference by which accounting practice can be evaluated, and (ii) guide the development of new practices and procedures. Accounting theory may also be used to explain existing practices to obtain a better understanding of them. But the most important goal of accounting theory should be to provide a coherent set of logical principles that form the general frame of reference for the evaluation and development of sound accounting practices.
Financial statements are the product of process in which a large volume of data about aspects of the economic activities of an enterprise are accumulated, analyzed, and reported. This process should be carried out in accordance with generally accepted accounting principles. The word ‘principles’ is used to mean a “general law or rule adopted or professed as a guide to action, a settled ground or basis of conduct or practice”. This describes a principle as a general law or rule that is to be used as a guide to action. This implies that accounting principles do not prescribe exactly how each detailed event occurring in business should be recorded. Consequently, there are several matters in accounting practice that may differ from one company to another.
Accounting principles are man-made. They are accepted because they are believed to be useful. The general acceptance of an accounting principle usually depends on how well it meets the three criteria of relevance, objectivity, and feasibility. A principle is relevant to the extent that it results in meaningful or useful information to those who need to know about a certain business. A principle is objective to the extent that the information is not influenced by the personal bias or judgment of those who furnished it. (Peter Atrill and Eddie McLeaney, 2005)
As with language, accounting has many dialects. A number of words and terms have been used by different writes to express and explain the same idea or notion. The various terms used for describing the basic ideas are: concepts, postulates, propositions, basic assumptions, underlying principles, fundamentals, conventions, doctrines, rules, etc. Although each of these terms is capable of precise definition general usage by the profession of accounting has served to give them loose and overlapping meanings. Fundamental accounting concepts are broad general assumptions with underlie the periodic financial accounts of business enterprises. The alteration of any of the basic concepts would change the entire nature of financial accounting.
BUSINESS ENTITY CONCEPT- GE Electricals, USA
In accounting we make a distinction between business and the owner. All the records are kept from the viewpoint of the business rather than from that of the owner. An enterprise is an economic unit separate and apart from the owner or owners. As such, transactions of the business and those of the owners should be accounted for and reported separately. This distinction can be easily maintained in the case of a limited company because a company has a legal entity of its own. Like a natural person it can engage itself in economic activities of producing, owning, managing, storing, transferring, lending, borrowing and consuming commodities and services. Nevertheless, accounting still maintains separation of business and owner.
MONEY MATERIAL MEASUREMENT
As money is accepted not only as a medium of exchange but also as a store of value, it has a very important advantage since a number of widely different assets and equities can be expressed in terms of a common denominator. Money is probably the only practical common denominator and a yardstick.
In the accounts, money is expressed in terms of its value at the time an event is recorded. Subsequent changes in the purchasing power of money do not affect this amount. In fact, one of the major problem of accounting today is to find means of solving the measurement problem, that is, how to extend the quality and the coverage of meaningful information
COST ACCOUNTING IN REQUIEMENT PLANNING
Accounting assumes that the business i.e., an accounting entity will continue to operate for a long time in the future unless there is good evidence to the contrary. The enterprise is viewed as a going concern, that is, as continuing in operation, at least in the foreseeable future. The owners have no intention nor have they the necessity to wind up or liquidate its operations.
This assumption is of considerable importance for it means that the business is viewed as a mechanism for adding value to resources it uses. The success of the business can be measured by the difference between output values, sales or revenues and input values or expenses. Therefore, all unused resources can be reported at cost rather than at market values.
ACCOUNTING NEEDS OF MRP SYSTEM
The resources, land, buildings, machinery, property rights, etc the money values that are assigned to assets are derived from the cost concept. This concept states that an asset is worth the price paid for or cost incurred to acquire it. Thus, assets are recorded at their original purchase price and this cost is the basis for all subsequent accounting for the assets. The assets shown on the financial statements do not necessarily indicate their present market worth or market values. The term ‘book value’ is used for amount shown in the accounting records.
The cost concept does not mean that all assets remain on the accounting records at their original cost for all time to come. The cost of an asset that has a long but limited life is systematically reduced during its life by ‘depreciation’ Deprecation is a process by which the cost of the asset is gradually reduced by allocating a part of it to expense in each accounting period. This will have the effect of reducing the profit of each period. (Paul Collier, 1998)
The accrual concept makes a distinction between the receipt of cash and the right to receive it, and the payment of cash and the legal obligation to pay it. In actual business operations, the obligation to pay and the actual movement of cash may not coincide. The accrual concept recognizes this distinction. In connection with the sale of goods, revenue may be received (i)before the right to receive arises, or (ii) after the right to receive has been created. The accrual concept provides a guideline as to how one should treat the cash receipt and the rights related thereto. In the former case the receipt will not be recognized as the revenue of the period for the reason that the right to receive the same has not yet arisen. In the latter case the revenue will be recognized even though the amount is received in the subsequent period.
This concept, also known as the concept of prudence, is often stated as “anticipate no profit, provide for all possible losses”. This means one should follow a cautious approach. He should record lowest possible value for assets and revenues, and the highest possible value for liabilities and expenses. According to this concept, revenues or gains should be recognized only when they are realized in the form of cash or assets the ultimate cash realization of which can be assessed with reasonable certainty. Further, provision must be made for all known liabilities, expenses and losses whether the amount of these is known with certainty or is at best an estimate in the light of the information available. Probable losses in respect of all contingencies should also be provided for.
There are many events in business which are trivial or insignificant in nature. The cost of recording and reporting such events will not be justified by the usefulness of the information derived. Materiality concept holds that items of small significance need not be given strict theoretically correct treatment.
Where to draw the line between material and immaterial events is a matter of judgement and common sense. There are no hard and fast rules in this respect. Whether a particular item or occurrence is material or not, should be determined by considering its relationship to other items and the surrounding circumstances.
There are several ways to record an event or a transaction in the books of account. The trade discount on raw material purchased may be deducted from the cost of goods and net amount entered in the books, or alternatively trade discount may be shown as the income with full cost of raw material purchased entered in the books. Similarly, there are several methods to charge depreciation on an asset or of valuing inventory. The consistency concept requires that once a company has decided on one method and has used it for some time, it should continue to follow the same method or procedure for all subsequent events of the same character unless it has a sound reason to do otherwise. (S. Mark Young, 1998)
Although the results of operations of a specific enterprise can be known precisely only after the business has ceased to operate, its assets have been sold off and liabilities paid off, the knowledge of the results periodically is also necessary. Those who are interested in the operating results of business obviously cannot wait till the end. These time periods in actual practice vary, though a year is the most common interval as a result of established business practice, tradition and government requirements. More and more firms are changing to the ‘natural’ business year the end of which is marked by relatively lower or lowest volume of business activity in the twelve-month period.
Management accounting as a field of study in its developmental process has evolved a theoretical framework consisting of principles or concepts over period of time. These concepts enjoy a wide measure of support of the accounting profession.
The accounting functions are broad guidelines for general application, they permit a wide variety of methods and practices. The lack of uniformity in accounting practice makes it difficult to compare the financial reports of different companies. Moreover, the multiplicity of accounting practices makes it possible for management to conceal economic realities by selecting those alternative presentations of financial result which allow earnings to be manipulated. The financial statements prepared under such conditions, therefore, may have limited usefulness for several users of information. Such professional bodies, in fact, first look at the practices used by practicing accountants
Accounting information function addresses itself to three important business related problems, namely, score-keeping, attention-directing and problem-solving. Accounting information acquires relevance only in the context of an organization. In this context accounting is closely related to control. Accounting helps in the process of guiding actions of the organization into desired directions. In the process of initiating control actions, it helps the whole gamut of activities involving planning, organizing and controlling.
The earnings information is useful for several purposes. It helps in measuring achievement of business and its management. It provides a basis for appropriation decisions and for determining the market value of the firm. It helps to identify the problems currently faced by the enterprise. A proper analysis of the information contained in the balance sheet can enable them to draw conclusions which in turn help them in making decisions.
Colin Drury, 1983, Management and Cost Accounting, 6th Value Media Edition, Thomson Learning.
S. Mark Young, 1998, Readings in Management Accounting 4th edition, Pearson Education.
Peter Atrill and Eddie McLeaney, 2005, Management Accounting for Decision Makers 5th edition. Viking: New York.
4. Performance Measurement and Control Systems for Implementing Strategy by Robert Simons, 2003, Journal of Accounting Research.
5. Management Accounting: Theories, Issues and Performance by Anthony J. Berry, Jane Broadbent and David Otley, 1998 (8), 231; Journal of Business Finance & Accounting.
Issues in Management Accounting by David Ashton, 2000 (5), 51; Advances In Quantitative Analysis Of Finance And Accounting.
Management Control Systems: Performance Measurement, and Evaluation Kenneth A. Merchant and Wim A. Van der Stede 2004 (6), 156; Accounting, Organizations and Society.
Performance Measurement and Management: A Strategic Approach to Management Accounting by Malcolm Smith reprinted, 2006 (2), 56; Accounting Education.
Paul Collier, Accounting for Managers: Interpreting Accounting 1998 (8), 231; Accounting Review.