Questions:
1. Discuss the importance of management accounting for your selected organisation and differentiate between management accounting and financial accounting?
2. Evaluate different classifications of costs (types, behaviour, function and relevance) with examples?
3. Explain the meaning of variance analysis and discuss the most commonly derived variances, outlining the problems and limitations?
4. Identify different operational budgets and explain the advantages of preparing different operational budgets?
Answers:
Introduction
The chosen industry is the service industry. The importance of management accounting in the hospitality sector is immense, and the chosen organization is Kingston hotels. Management accounting provides the managers of the above-mentioned organizations with particular internal information (like department accounting) since they are engaged in the direction and control of the operations in the hospitality industry (Elbanna 2016).
1. The internal information that is provided is used for long-term and short-term planning and decision-making (Davenport 2013). Management accounting is used mostly for cost center reporting, center profitability, product profitability and target customer profitability. It is also used to control costs, to monitor, plan and to make decisions mostly regarding beverages, bookings, and administration. In the hospital industry, management accounting plays an important role in the F&B segment (Cantallops and Salvi 2014). It is also useful in departments that are supposed to survive independently. Some of the important points are mentioned below:
To figure out if it is worthwhile to operate any specific part of the industry or not.
To affirm and evaluate the actual results against the estimated ones. This would help in analyzing the areas where the changes are required to be made.
To determine the prices of the products and services.
Pareto Analysis can be applied for finding the places where improvements can be made in the hotel.
Determination of the correct inventory order dates.
For expanding regarding adding new food outlets in the chain or services such as a spa or private pools.
Management accounting is internally present, but financial accounting is for the external users like the stakeholders (Eierle and Schultze 2013). Even though financial management is very useful for the present, and the potential investors, management accounting is essential for the managers for making the present and the future financial decisions (Brigham and Ehrhardt 2013). The approach of financial management is precise, and it must follow GAAP, but management accounting is mostly based on estimation, as the managers do not have the time mostly for the specific numbers when a judgment is to be made (Dichev et al. 2013).
2. According to types, costs can be divided into fixed and variable costs (Ostrom 2015). Those costs, which do not vary with the output, are known as fixed costs and are incurred even if there is no production. For example, fixed costs incurred by a company will be the same if it produces 1000 pieces of a product or 1 piece of the same product. Variable costs are those costs that are directly proportional to the volume of production, unlike the fixed costs (Hovenkamp 2015). It varies with the change in output. For example, the variable costs of producing 1000 pieces of a product will be more than producing 600 pieces of that product. There can be semi-variable costs too that are neither fixed nor variable. It is a combination of both fixed and variable costs (Rumble 2012). Some parts of it are fixed, and the other parts are variable. Costs can also be divided into direct and indirect costs (Greenleaf et al.2015). Directs costs are those costs that directly contribute to the production process as the cost of purchase of raw materials (DRURY 2013). Indirect costs are costs that are indirectly related to the volume of the output like the salaries of the supervisor’s, indirect labor, taxes, etc. Costs can be segregated into product and period costs too (Ryan 2012). Costs that the accounting system of the firm directly associates with the output and are used for inventory valuation are known as product costs (Demski 2013). Costs that are charged as expenses to the present period are known as period costs. There are some other types of costs too namely controllable and uncontrollable costs, out-of-pocket and sunk costs, incremental and opportunity costs and imputed costs. Costs that can be controlled by the management such as direct labor and material costs, direct expenses that are controllable by the level shop management, are referred to as controllable costs and costs that cannot be controlled are known as uncontrollable costs. For example, a supervisor in control of a particular department cannot be held responsible for the activities of another department, and it is uncontrollable by him. Out-of-pocket costs are costs that require the use of the present resources, mainly cash. Costs that have been already incurred are known as sunk costs. In evaluating if production should b increased or not, for example, the financial managers might consider the sunk costs involved in the tools and machinery as well as the out-of-pocket costs associated with the addition of more material and labor. The costs that show the sacrifice made when the factors of production are applied to a particular task rather than another one, or when capital is the time when capital have been used for investment rather than another. Imputed costs are those costs, which are not incurred but are involved with the internal transactions. For example, when an organization rents a building for its use, which it could have rented to another party, then the rent might be taken as an imputed cost.
Costs can be divided into fixed, variable and mixed according to behavior. Fixed costs are costs, which remain same with the activity level within the relevant range. For example, rent, depreciation, etc. Variable costs are costs that change directly with the production level, as the cost of direct materials, freight out, etc. Semi-variable costs are costs having properties of both fixed and variable costs since both the fixed and variable components are present in them. For example, telephone expenses where there are some fixed rental charges that must be incurred, and there are charges, which vary according to use and that, are the variable part.
According to function, cost can be divided into costs of production, costs of administration, selling and distribution costs, and research and development costs (Machlup 2014). Costs involved in the production process whether directly or indirectly, such as, direct raw material or labor can be termed as production costs. Administration costs are those costs that are incurred for the management of the business like the audit and legal fees. Selling costs are costs involved in the costs required for the sale of products and services, such as salaries of the sales people. Distribution costs are costs, which are spent for distribution of the products or services from the point of production to the consumers. For example, transportation costs, warehouse rent, etc. Costs, which comprise the cost of developments of a new product, or the up gradation of existing products.
According to relevance, costs can be classified into relevant and irrelevant costs. Costs, which are affected by a decision made by the management in a specific business situation. For example, costs incurred when the management is determining whether to sell or keep a business unit. Irrelevant costs are those costs that are not affected by the decisions taken by the management. For example, salary of an investor relations officer.
3. The quantitative analysis of the variances in between the actual and the estimated behavior is termed as variance analysis. The analysis so made is used for maintenance of control of a particular business. For example, if the budgeted sales are $100000 and the actual sales are $80000, the analysis of variance gives a difference in the value of $20000. It is especially useful when the variance amount is reviewed on a trend line such that abrupt changes in the variance levels are more apparent from month to month. The investigations of the differences are also involved in variance analysis such that the result is different from the expectations, in the form of a statement, and the explanation for the occurrence of the variation. For example, a completed sales variance analysis would be like:
“During the month of January, sales stood at $2000 lower than the budgeted amount of $10000. The cause of this variance was caused mainly by losing a particular consumer at the end of December, who buys $1800 each month from the organization. The customer was lost due to late deliveries continually for some months.”
The detailed analysis helped the management in understanding the reason for the occurrence of fluctuations in the business and the required steps that can be undertaken for changing the situation.
The most commonly derived used variances used in the analysis of variances are discussed below:
Purchase price variance
It is calculated by subtracting the price paid for the materials that were applied in the process of production of standard costs, and the number of units that are used then multiplies it.
Labor rate variance
It is calculated by subtracting the amount paid for the use of direct labor that was applied for production with the standard cost and the number of units that are used then multiplies it.
Variance overhead spending variance
The standard variable per unit overhead cost forms the cost incurred. The reminder is then multiplied by the total unit amount of output.
Fixed overhead spending variance
The amount of difference between the fixed overhead costs and the standard costs in total for the particular period.
Selling price variance
The difference between the actual and the standard selling price, which is then multiplied by the number of, sold units.
Material yield variance
The amount of difference between the total standard amount of materials which were thought to be used and the level of actual use ad then the remnant is multiplied by the per unit standard price.
Labor efficiency variance
The standard quantity of the labor used is subtracted from the actual amount, and the remainder is then multiplied by the per hour standard labor rate.
Variable overhead efficiency variance
The estimated activity units on which the variable overhead is charged is subtracted from the actual activity units, and the remainder that is left is then multiplied by the per unit standard variable overhead cost.
Problems with variance analysis:
Delay in time
The variances are complied by the accounting staff at the month end before the outcome is provided to the management. However, in recent times, feedback must be given to the management sooner than on a monthly basis.
Variance source information
The reasons that are responsible for the variances are absent in the accounting records; hence, the accountant has to locate the information from different sources for determining the causes.
Standard setting
The derivation of variation is done by matching the actual results with a random estimate, which might have been after getting influenced by political bargaining. Hence, the result might not give proper results.
4. The different types of operational budgets and their advantages are mentioned below:
Master Budget
The average of the individual budgets of a company, which was made for presenting a total picture of its financial health and activity is known as a master budget (Hofstede 2012). It is a combination of different factors like operating expenses, sales, assets and the income streams for allowing the organizations to make their goals and to measure their total performance and that of the cost centers too within the company. This type of budget is used in bigger organizations for keeping the managers aligned.
Master budget can give an idea of the objectives of an organization and what must be done for achieving them. It helps the organization in present the cash flows of the future in a realistic manner thereby helping the organization to get particular financing types.
Operating Budget
The forecasting and analyzing the projected incomes and the expenditures of a particular period is known as an operating budget (Brewer and Pedersen 2013). For the creation of a proper picture, certain factors must be included in the operating budget like production, material and labor costs, administrative expenses and overhead. It is created prepared either per week, per month or year. The reports should be compared on a monthly basis for checking whether the organization is spending more than its allocated amount of the supplies or not.
Operating budget helps in the management of the current expenses, projection of the future expenses, building the reserves and it increases the tendency of sticking to the budget.
Cash Flow Budget
The projection of the process and the time when cash comes in and goes out of a particular business in a particular time-period is known as a cash flow budget (Simons, R., 2013). It helps an organization to make sure that the cash is wisely managed. The cash budget is easy to be followed since it is quite simple and it raises the financial awareness too.
Financial Budget
The presentation of the strategies of the company for the management of its assets, cash flows, incomes, and expenditures. It is used for establishing a picture showing the health of the organization financially and presenting a detailed picture of its expenses that are relative from its core operations.
It provides financial awareness of the incomes and expenses incurred in the business.
Static Budget
The budget that remains fixed and unaltered even if there are alterations in the factors like the volume of sales or revenue.
It helps in prioritizing and creating a clear difference between the things they that are needed and the things that are wanted.
Conclusion and Recommendations
In the given report, different types of costs in management accounting have been accomplished. Management accounting plays a key role in business enterprises. For example, a cash flow statement takes into consideration many factors like accounts payable and receivable for assessing if the organization has sufficient cash in its hand for continuing its operations and the degree to which the cash is used by it effectively and the possibility of generation of cash in the future.
References
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