FINAL COURSE STUDY MATERIAL

PAPER

Advanced Management
Accounting
VOLUME I

BOARD OF STUDIES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

The Institute of Chartered Accountants of India

This study material has been prepared by the faculty of the Board of Studies. The objective of
the study material is to provide teaching material to the students to enable them to obtain
knowledge and skills in the subject. Students should also supplement their study by reference
to the recommended text books. In case students need any clarifications or have any
suggestions to make for further improvement of the material contained herein, they may write
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All care has been taken to provide interpretations and discussions in a manner useful for the
students. However, the study material has not been specifically discussed by the Council of
the Institute or any of its Committees and the views expressed herein may not be taken to
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Permission of the Institute is essential for reproduction of any portion of this material.
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Revised Edition
Updated Edition

:
:

January, 2013
July, 2013

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A WORD ABOUT STUDY MATERIAL

The Institute of Chartered Accountants of India develops the course curriculum for its students and
undertakes the periodic review of the course keeping in mind the developments in different
subjects world wide and the objective of equipping the students with necessary knowledge and skill
to serve the needs of Indian industry. The essence of successful management is decision making
with the help of relevant information. Management Accounting influence decision making capacity
and capabilities of a manager. The changes in business process across the globe and the
continuous research work have evolved various advanced tools and techniques in the field of
management accounting. The Institute has brought the modern techniques like Just in Time ( JIT),
Total Quality Management ( TQM), Life Cycle Costing, Value Analysis, Throughput Accounting etc
in the syllabus of Advanced Management Accounting. Equal importance has also been given in
traditional tools of management accounting like Standard Costing, Budgeting, CVP Analysis etc
which have great role to play in controlling and managing costs as well as decision making.
The Board of Studies which is instrumental in imparting theoretical education for the students of
Chartered Accountancy Course develops the Study Materials of all subjects with the objective of
developing the clear understanding of the concept of different topics covered in the subject among
the students. The Study Material on Advanced Management Accounting covers sixteen chapters
and topics included in each chapter are explained in details with explanation, examples and
illustrations. As Management Accounting builds on various cross functional areas, comprehensive
understanding of the subject is possible if only one covers all the topics of management
accounting. A real life problem relates a number of topics of management accounting which are
closely linked and its solution asks for clear understanding of all related topics. Thus, the students
are advised to go though the whole study material and are expected to supplement their studies by
referring to the recommended books of the subject in order to equip themselves with necessary
professional knowledge of the subject. If required, they are also advised to brush up their
knowledge of related topics of IPCC level.
The book attempts to elaborate and explain the conceptual basis of management accounting and
also covers all applicable areas in depth.
The Board of Studies has also developed Practice Manual of the subject to provide an effective
guidance material by providing clarification / solution to very important topics / issues, both
theoretical and practical, of different chapters. Moreover, it will serve as Revision Help book
towards preparing for Final Examination of the Institute and help the students in identifying the
gaps in the preparation of the examination and developing plan to make it up. It will also provide
standard of solutions to the questions which will act as a bench mark towards developing the skill
of students on framing standard answer to a question. For any further clarification/guidance,
students are requested to send their queries at bosnoida@icai.in

Happy Reading and Best Wishes!

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SIGNIFICANT CHANGES IN THE REVISED EDITION

Chapter
No.

Name of the
Chapter

Section/Sub-Sections wherein major

additions/deletions have been done

Developments in
The Business
Environment

1.2

Total Quality Management

1.3

1.3

Activity Based Costing, Activity Based

Management and Activity Based Budgeting

1.35

1.4

Target Costing

1.62

1.5

Life Cycle Costing

1.88

1.6

Value Chain Analysis

1.94

1.9

Just in Time

1.127

Decision Making
using Cost
Concepts and
CVP Analysis

Page
Numbers

1.10 Manufacturing Resources Planning (MRP I&II)

1.142

1.13 Theory of Constraints

1.147

Chapter 2 Cost Concepts in Decision making and

Chapter 3 CVP Analysis & Decision Making has been
merged into a single chapter.
2.2

Different Cost Concepts

2.1

2.2.1 Relevant Cost and Non Relevant Cost

2.1

2.2.2 Opportunity Costs

2.4

2.2.3 Notional Cost

2.5

2.2.4 Avoidable Costs

2.5

2.2.5 Historical Costs

2.5

2.2.6 Sunk Cost

2.5

2.2.7 Out of Pocket Cost

2.5

2.2.8 Discretionary Cost

2.6

2.2.9 Committed Cost

2.6

2.2.10 Shut Down Cost

2.6

2.2.11 Engineered Costs

2.6

2.2.12 Inventoriable Cost

2.6

2.2.13 Period Cost

2.6

2.2.15 Limiting Factor or Key Factor

2.7

2.5 Shut Down & Divestment Decision

2.49

2.7 Introduction to Marginal Costing

2.61

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Pricing Decisions

3.6 Pricing of Finished Product: Capacity Chart

3.6.1 Illustration- 4
3.8 Pareto Analysis: Pareto Chart

3.8
3.12
3.22

Budget &
Budgetary Control

4.3

The Preparation of Budgets

4.2

4.9

Miscellaneous Illustrations

4.18

Standard Costing

5.1

Relevant Terms

5.1

5.3
5.4
5.5
5.6

Computation of Variances
Reporting of Variances
Accounting Procedure For Standard Cost
Miscellaneous Illustrations

5.8
5.39
5.53
5.65

Transfer Pricing

Learning Objectives

7.1

7.1.2 Definition- Transfer Price

7.1

7.2

Objectives of transfer Pricing System

7.1

Solution to Illustration-3, a note has been inserted

7.9

7.4

Conflicts Between a Division and The Company

7.25

7.5

Multinational Transfer Pricing

7.26

Cost Sheet,
Profitability
Analysis and
Reporting

9.1

Introduction

9.1

10

Linear
Programming

10.4 The Simplex Method for Maximization Problems

10.9 Miscellaneous Illustrations

13

Critical Path
Analysis

13.4 Fundamentals of a CPA Network:

9.3.1 Direct Product Profitability

9.5

9.4

9.10

The Balanced Scorecard

Balanced Scorecard: Four Perspectives Figure

Activity

13.3

Events

13.5

13.4.4 Logical Sequencing and Connection of Activities

14

15

9.13
10.15
10.31

13.7

13.4.5 Errors in Logical Sequencing

13.8

Program
Evaluation and
Review
Technique

14.1 Introduction

14.1

14.6 Miscellaneous Illustrations

14.26

Simulation

15.2 What is Simulation?

15.1

15.2.1 Reasons for Using Simulation

15.1

15.3.2 Generation of Random Numbers

15.3

15.3.3 Advantages of Simulation

15.3

15.3.4 Disadvantages of Simulation

15.3

Illustration 5

15.11

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16

Learning Curve
Theory

Learning Objectives

16.1

16.2 Distinctive features of Learning Curve Theory in

Manufacturing Environment

16.2

16.6 Application of Learning Curve

16.6

16.7 Financial Costs Effected by Learning Curve

16.7

16.8 Important Consequences of Learning Curve in

Management Accounting

16.7

Illustration 3

16.9

16.9 Limitation of Learning Curve Theory

16.9

In order to make the study material error free, which is the prime concern of Board of Studies, all the
typing/printing errors have also been corrected in the updated edition. In addition, conceptual formulas
have also been improved through various presentable techniques to make the material more students
friendly

The Institute of Chartered Accountants of India

SYLLABUS
PAPER 5: ADVANCED MANAGEMENT ACCOUNTING
(One paper Three hours 100 marks)
Level of Knowledge: Advanced knowledge
Objective:
To apply various management accounting techniques to all types of organizations for
planning, decision making and control purposes in practical situations.
To develop ability to apply quantitative techniques to business problems
1.

Cost Management
(a) Developments in the business environment; just in time; manufacturing
resources planning; (MRP); automated manufacturing; synchronous
manufacturing and back flush systems to reflect the importance of accurate
bills of material and routings; world class manufacturing; total quality
management.
(b) Activity based approaches to management and cost analysis
(c) Analysis of common costs in manufacturing and service industry
(d) Techniques for profit improvement, cost reduction, and value analysis
(e) Throughput accounting
(f)

Target costing; cost ascertainment and pricing of products and services

(g) Life cycle costing

2.

Cost Volume Profit Analysis

(a) Relevant cost
(b) Product sales pricing and mix
(c) Limiting factors
(d) Multiple scarce resource problems
(e) Decisions about alternatives such as make or buy, selection of products,
etc.
(f)

3.

Shut down and divestment.

Pricing Decisions
(a) Pricing of a finished product
(b) Theory of price
(c) Pricing policy

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(d) Principles of product pricing

(e) New product pricing
(f)

Pricing strategies

(g) Pricing of services

(h) Pareto analysis

4.

Budgets and Budgetary Control

The budget manual, Preparation and monitoring procedures, Budget variances,
Flexible budgets, Preparation of functional budget for operating and nonoperating functions, Cash budgets, Capital expenditure budget, Master budget,
Principal budget factors.

5.

Standard Costing and Variance Analysis

Types of standards and sources of standard cost information; evolution of
standards, continuous -improvement; keeping standards meaningful and
relevant; variance analysis; disposal of variances.
(a) Investigation and interpretation of variances and their inter relationship
(b) Behavioural considerations.

6.

Transfer pricing
(a) Objectives of transfer pricing
(b) Methods of transfer pricing
(c) Conflict between a division and a company
(d) Multi-national transfer pricing.

7.

Cost Management in Service Sector

8.

Uniform Costing and Inter firm comparison

9.

Profitability analysis - Product wise / segment wise / customer wise

10. Financial Decision Modeling

(a) Linear Programming
(b) Network analysis - PERT/CPM, resource allocation and resource leveling
(c) Transportation problems
(d) Assignment problems
(e)

Simulation

(f)

Learning Curve Theory

The Institute of Chartered Accountants of India

ADVANCED MANAGEMENT ACCOUNTING

CONTENTS
CHAPTER 1 DEVELOPMENTS IN THE BUSINESS ENVIRONMENT
1.1

The impact of changing environment on management accounting ........................... 1.2

1.2

Total Quality Management (TQM) ........................................................................... 1.3

1.3

Activity Based Costing, Activity Based Management and Activity Based Budgeting ......1.35

1.4

Target Costing ...................................................................................................... 1.62

1.5

Life Cycle Costing ................................................................................................ 1.88

1.6

Value Chain Analysis ............................................................................................ 1.94

1.7

Cost control and cost reduction ........................................................................... 1.122

1.8

Computer-aided manufacturing ........................................................................... 1.127

1.9

Just in Time (JIT) ................................................................................................ 1.127

1.10

Manufacturing Resources Planning (MRP I & II) ................................................. 1.142

1.11

Synchronous manufacturing ................................................................................ 1.146

1.12

Business Process Re-engineering....................................................................... 1.146

1.13

Theory of Constraints .......................................................................................... 1.147

Summary.. ....................................................................................................... 1.158

CHAPTER 2 DECISION MAKING USING COST CONCEPTS AND CVP ANALYSIS
2.1

Introduction ............................................................................................................ 2.1

2.2

Different Cost Concepts .......................................................................................... 2.1

2.3

Application of Cost Concepts in Decision Making .................................................... 2.7

2.4

Application of Incremental / Differential Cost Techniques in Managerial Decisions 2.39

2.5

Shut Down & Divestment Decision ........................................................................ 2.49

2.6

Other Decision Making .......................................................................................... 2.56

2.7

Introduction to Marginal Costing ............................................................................ 2.61

2.8

Introduction of Cost-Volume-Profit (CVP) Analysis ............................................ 2.61

2.9

Important Factors in Marginal Costing Decisions ............................................... 2.63

2.10

Pricing Decisions under Special Circumstances................................................. 2.64

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2.11

Acceptance of an offer and submission of a tender ........................................... 2.66

2.12

Quotation for an Export Order ............................................................................. 2.71

2.13

Make or Buy Decision .......................................................................................... 2.73

2.14

Export Vs Local Sale Decision ............................................................................ 2.81

2.15

Expand Or Contract Decision .............................................................................. 2.83

2.16

Product Mix Decision ........................................................................................... 2.86

2.17

Price-Mix Decision ............................................................................................... 2.97

Summary..2.99
CHAPTER 3 PRICING DECISIONS
3.1

Introduction ............................................................................................................. 3.1

3.2

Theory of Price ....................................................................................................... 3.1

3.3

Pricing Policy .......................................................................................................... 3.3

3.4

Principles of Product Pricing ................................................................................... 3.5

3.5

New Product Pricing................................................................................................ 3.6

3.6

Pricing of Finished Product ..................................................................................... 3.7

3.7

Pricing Strategies .................................................................................................. 3.17

3.8

Pareto Analysis ..................................................................................................... 3.22

Summary..3.25
CHAPTER 4 BUDGET & BUDGETARY CONTROL
4.1

Introduction ............................................................................................................. 4.1

4.2

Strategic Planning, Budgetary Planning and Operational Planning .......................... 4.1

4.3

The Preparation of Budgets .................................................................................... 4.2

4.4

The Interrelationship of Budgets ........................................................................... 4.10

4.5

Using Spreadsheets in Budget Preparation ........................................................... 4.10

4.6

Zero Base Budgeting ............................................................................................ 4.10

4.7

Performance Budgeting (PB)................................................................................. 4.13

4.8

Budget Ratio ......................................................................................................... 4.16

4.9

Miscellaneous Illustrations .................................................................................... 4.18

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CHAPTER 5 STANDARD COSTING

5.1

Relevant Terms...................................................................................................... 5.1

5.2

Classification and Type of Variances .................................................................... 5.6

5.3

Computation of Variances ..................................................................................... 5.8

5.4

Reporting of Variances ........................................................................................ 5.39

5.5

Accounting Procedure For Standard Cost .......................................................... 5.53

5.6

Miscellaneous Illustrations .................................................................................. 5.65

5.7

Behavioural Aspects of Standard Costing ........................................................ 5.106

CHAPTER 6 COSTING OF SERVICE SECTOR

6.1

Introduction ............................................................................................................ 6.1

6.2

Main characteristics of service sector ...................................................................... 6.1

6.3

Collection of costing data in service sector.............................................................. 6.2

6.4

Costing methods used in service sector .................................................................. 6.3

6.5

Pricing by service sector ......................................................................................... 6.7

CHAPTER 7 TRANSFER PRICING

7.1

Introduction ............................................................................................................. 7.1

7.2

Objectives of transfer pricing system ....................................................................... 7.1

7.3

Methods of transfer pricing ...................................................................................... 7.1

7.4

Conflict between a division and the company ........................................................ 7.25

7.5

Multinational transfer pricing ................................................................................. 7.26

CHAPTER 8 UNIFORM COSTING AND INTER FIRM COMPARISON

8.1

Uniform costing ....................................................................................................... 8.1

8.2

Inter-firm comparison .............................................................................................. 8.3

Summary....8.5
CHAPTER 9 COST SHEET, PROFITABILITY ANALYSIS AND REPORTING
9.1

Introduction ............................................................................................................. 9.1

9.2

Cost Sheets (Contentious issues) ........................................................................... 9.1

9.3

Profitability statements ............................................................................................ 9.5

9.4

The Balanced Scorecard ....................................................................................... 9.10

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CHAPTER 10 LINEAR PROGRAMMING

10.1

Introduction ........................................................................................................... 10.1

10.2

Graphical Method .................................................................................................. 10.3

10.3

Trial & Error method of solving Linear Programming Problem ............................. 10.12

10.4

The Simplex method for maximization problems ................................................. 10.15

10.5

Simplex method for minimization problems ......................................................... 10.22

10.6

Marginal value of a resource ............................................................................... 10.27

10.7

Some remarks ..................................................................................................... 10.28

10.8

Practical applications of linear programming ....................................................... 10.29

10.9

Miscellaneous Illustrations .................................................................................. 10.31

10.10

Limitations of linear programming ....................................................................... 10.65

CHAPTER 11 THE TRANSPORTATION PROBLEM

11.1

Introduction ........................................................................................................... 11.1

11.2

Methods of finding initial solution to transportation problems................................. 11.3

11.3

Optimality test ..................................................................................................... 11.10

11.4

Special cases ...................................................................................................... 11.16

11.5

Maximization transportation problems ................................................................. 11.20

11.6

Prohibited routes ................................................................................................. 11.23

11.7

Miscellaneous illustrations .................................................................................. 11.28

Summary

...11.45

CHAPTER 12 THE ASSIGNMENT PROBLEM

12.1

Introduction ........................................................................................................... 12.1

12.2

The Assignment algorithm ..................................................................................... 12.1

12.3

Unbalanced assignment problems ........................................................................ 12.7

CHAPTER 13 CRITICAL PATH ANALYSIS

13.1

Introduction ........................................................................................................... 13.1

13.2

General framework of PERT/CPM ......................................................................... 13.2

13.3

Advantages of critical path analysis ...................................................................... 13.2

13.4

Fundamentals of a CPA network ........................................................................... 13.3

13.5

Critical path analysis ........................................................................................... 13.20

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13.6

Distinction Between PERT & CPM .................................................................... 13.31

Summary...13.32
CHAPTER 14 PROGRAM EVALUATION AND REVIEW TECHNIQUE
14.1

Introduction ........................................................................................................... 14.1

14.2

Updating the network ............................................................................................ 14.9

14.3

Project crashing .................................................................................................. 14.11

14.4

Resource smoothing ........................................................................................... 14.22

14.5

Resource levelling............................................................................................... 14.26

14.6

Miscellaneous Illustrations .................................................................................. 14.26

14.7

A few comments on assumptions of PERT & CPM .............................................. 14.42

14.8

Distinction between PERT & CPM ....................................................................... 14.43

CHAPTER 15 SIMULATION
15.1

Introduction ........................................................................................................... 15.1

15.2

What is simulation? ............................................................................................... 15.1

15.3

Monte Carlo simulation ......................................................................................... 15.2

15.4

Simulation and inventory control ......................................................................... 15.14

15.5

Miscellaneous illustrations .................................................................................. 15.16

15.6

Random numbers table ....................................................................................... 15.24

CHAPTER 16 LEARNING CURVE THEORY

16.1

Introduction ........................................................................................................... 16.1

16.2

Distinctive features of learning curve theory in manufacturing environment ........... 16.2

16.3

The learning curve ratio ........................................................................................ 16.2

16.4

Learning curve equation ........................................................................................ 16.4

16.5

Learning curve application .................................................................................... 16.4

16.6

Application of Learning Curve ............................................................................... 16.6

16.7

Financial Costs effected by Learning Curve .......................................................... 16.7

16.8

Important Consequences of learning curve in Management Accounting ................ 16.7

16.9

Limitations of learning curve theory ....................................................................... 16.7

Summary

...................................................................................................................... 16.10

APPENDIX

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