Role of Management Accounting

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 term Management Accounting refers to the process of identifying, analyzing, measuring as well as communicating information in concerned with organization’s goal and objective. The main purpose is to provide support to competitive decision making for the management by collection of information and processing information that would help in management planning, control and also to evaluate business process.

 1 Role of Management Accounting in Service Organization

As we all are aware that the objective of the management accounting to provide support to competitive decision making for the management by collection of information and processing information that would help in management planning, control and also to evaluate the business process. In the service organization, management accounting is broadly described as tools involving the use of quantitative data in the control. Also, it is provided that it has been observed that larger the organization is the greater will be the need for management’s/ management accounting for gathering information to identify and achieve organization’s goal and objective (Accountingtools,2015)

2. There are many classifications of costs & the same are not mutually exclusive:

Management Function–   It states that cost can be classified by the management Function

Operating Cost- it refers to the cost associated with production of goods or services

Example- purchase of material cost associated with the production of goods

Non Operating Cost- it refers to the cost associated in support to the production of goods or services.

Example- Cost incurred for borrowing money for the purchase of material would be considered as operating cost

Accounting Functions-  Accounting Functions, cost are classified as follows:

Financial Accounting Cost –   it is known as accounting cost refers to the measurement of the number of resources in the monetary terms for a certain purpose (Stede,2016).. If we see technically, cost means a value given to the goods as well as services and when the same expires, this cost becomes/treated as an expense.

Example- Historical cost arising from the financial statement is considered as an instant of accounting cost

Managerial Accounting Cost- refers to the present as well as future cost which helps management in decision making

Example- Cost which derived from budget is managerial cost (Accounting tools, 2015)

Traceability – it is provided that cost can be classified by traceability

Direct cost- it refers to the cost which can be directly traced to a department, product, service such as Labor and supplies. Example- during production of concrete, cost of cement, sand wages are direct cost

Indirect Cost- it means the cost which cannot be directly traced to a department, product and/or service for example- overhead cost, cost associated directly with heating and cooling or cost of insurance, depreciation, salary of supervisor incurred  in a concrete plant

Full cost it involves both direct and indirect cost.

Behavior –  it states that cost could be classified by behavior about the volume of products and services.

Fixed Cost- it refers to the cost which remains constant about changes in volume for example- rent charges for manufacturing space will be considered as fixed cost or depreciation since this is considered as gradual charging to the expense of tangible assets for a period over the useful life of an asset. For instance Rent, depreciation calculation using straight line method. It has been provided that fixed cost per unit decreases with the increase in production  (Accounting Tools, 2015).

Variable Cost- it refers to the cost directly proportionate to the change in quantity/volume. For instance – cost should be proportional to the volume. Therefore, the same is considered as a VC. It is provided that variable cost varies with the unit of production. As the number of unit increases, variable cost will also increase & vice verca.

Semi – Variable Cost- this cost varies incrementally to the changes in volume for example- there is no requirement to hire new housekeeper if patient volume increases by 1%. It have properties of both fixed as well as variable cost because of presence of both variable & fixed component (Accounting Tools, 2015)

Relevant for Decision Making

It is provided that cost can be classified by its relevancy

Controllable Cost- refers to the cost of the manager’s influence for example labor

Uncontrollable cost- it is not influenced by the management. For example utility cost

True Cost– it refers to the hypothetical cost which is considered as a most accurate representation of full cost that is easily determined by the managers/management.

Differentiate Cost- it refers to the cost arises due to a difference in the costs of two or more alternatives.

Opportunity Cost- it refers to the potential revenues forgone by rejecting an alternative, for example – amount spent in the purchase of fixed cost recovered as an interest income on leasing of machinery.

Sunken Cost- it refers to the cost already incurred and is consider that the same will not affect by and would not affect any future decision for instance- A person opens a new manufacturing factory with 1 million it is sunk cost. Another example can be advertisement expenses as an expense paid for the same cannot be recovered once made.

3. Variance Analysis refers to the quantitative investigation for the difference arises between the actual and planned figures. This is mainly done so as to maintain required control over a business. For instance- if planned for sale is £5000 and in actual it is £7,000, it means variance analysis yield difference of £2000.

Following are most commonly derived Variance analysis

1. Purchase Price Variance– it arises when actual amount paid for purchase is deducted from standard cost & then multiplied by the number of units used (Cost Accounting tools, 2015).

2. Variable Overhead Spending Variance– here, the standard variable overhead cost per unit will be deducted from the actual cost incurred & the result would be multiplied by the total quantity of output.

3. Material Yield Variance– it arises by subtracting the standard quantity of material which is supposed to be used from the actual level of use and then the result arises to be multiplied by standard price per unit.

4. Fixed overhead Spending Variance- it refers to the total amount resulted from the difference of fixed overhead costs and their total standard cost for the specified period (Accounting Tools,2015).

5. Labor rate Variance- this variance arises from the difference when actual price paid for the direct labor and standard cost then result would be multiplied by the number of units used.

6. Labor efficiency Variance- it arises, subtract the standard labor quantity consumed during the period from the actual amount then result would be multiplied by standard rate per hour (Cost Accounting tools, 2015).

7. Selling Price Variance– Number of unit sold to be multiplied with the difference airing from actual and standard cost (Cost Accounting tools, 2015).

It has been observed that there are many problems / limitation associated with variance analysis as follows:

• Delay in time– At the end of the month, accounting staff is required to compile the variances before issuing the result to the management (Van deer Steed, W. (2016). In the fast paced situation, management requires the result much faster than once a month and consequently relies upon other things that generated on the spot, generally in the   production area.
• Variance Source Information- It is provided as well as observed that most of the reason of variances have not been located in the accounting record and then need arises for the staff to sort out the reason through information like bills of material, labor routing, overtime records etc so as to determine the causes of issue. This extra work may be cost effective only of management able to extract the required information
• Setting of Standard- as we all are aware that variance analysis is essential a comparison of actual result with a standard set/ derived from political bargaining. Consequently, variance arises as a result would not yield any useful information (Accounting Tools,2015).

At the end, it is provided that it not essential to track all the mentioned variances by an organization. In much organization, it is sufficient to review just two or more variances in order to arrive at a desired result. Moreover, it has been seen that most of the companies prefer to use horizontal analysis rather than variance analysis in order to interpret their financial result. Using this approach, one can find multiple periods result to be listed at one side.

4. Operating budget is considered as a forecast and analysis of the projected income as well as expenses of an organization, for a specified period of time. It is also provided that in order to arrive a clear picture, operating budget must account for various factors such as production, sales, labor cost material cost administrative expenses, etc. it is usually prepared on weekly, monthly or sometime yearly basis. It is provided that maintaining operational budget helps business to track as well as manage their resources efficiently. Please find below different operation budget:

1. Sales Budget– For the sale budget, sale forecast is important by which entity can predict the production and also to budgeting variable and costs. It comprises of various item such as no. of units expected to be sell, revenue expected to be generated, impact of credit sales etc. (Accounting Tools, 2015). This budget helps the entity to estimate the sale to be made during the specified period
2. Production and finished goods inventory Budget– Primary objective of preparing this budget is to provide the clear picture of the number of inventory assets which is appearing in the budgeted balance sheet by which decision will be taken regarding the cash requirement for the investment in assets. It consists of three main items as direct material, direct labor, and overhead allocation. This budget helps to estimate the inventory level to be maintained so as to protect them the situation of nil inventory at the time of sale.

3. Production Budget– This statement of budget shows the number of units that must be produced. For preparing production budget, three factors must be considered 1. The Number of units to be sold 2. The Level of inventory at year ends 3. Number of units in the beginning inventory (Accounting Tools, 2015). This budget helps to estimate the production volume so as to achieve the turnover and to prevent misuse.

4. Manufacturing Overhead Budget– This budget is prepared to include all the cost of manufacturing excluding the direct material & labor expenses. This budget includes variable production overhead and, fixed production overhead expenses also. It is also provided that most of the information mentioned in this budget may be estimated from the historical results in case the type of volume as well as product to be manufactured is not varied from the prior period. Through this budget, one can estimate the all expenses to arrive at a decision of sale price etc.

5. Direct Material Budget– This budget determines the number of units to be purchased in order to fulfill the sale expectation during the period. To calculate this budget, it involves the number of the units to be produced from the production budget, require level of ending inventory, and also the number of units in beginning inventory (Accounting Tools, 2015). This budget helps to esteem the material to be purchased to meet the sales requirement.

6. Direct Labor Budget– This budget shows the number of direct labor hours and the cost of the labor per hour to determine the total cost. For example it takes one‐half hour of labor to put together one pickup truck and each labor hour costs $14.00. The total direct labor budget is for 50,000 (100,000 unit’s × .5 hours per unit) hours at a cost of £7,00,000 (£ 00 per hour × 50,000 hours) (Accounting Tools, 2015). This budget helps to estimate the one of the essential expenses which entity is required to incur while manufacturing the product.

Conclusion

By above discussion, it is advisable that every organization should adhere to the management Accounting so as to keep the records accurate as well help the managers for decision making by gathering of information. Moreover, Variance Analysis refers to the quantitative investigation for the difference arises between the actual and planned figures. This is mainly done so as to maintain required control over a business helps to analyze the variance at the right time so that required decision can be taken accordingly. So it is necessary that budget as well variance analyses should be done periodically it can be monthly, quarterly etc.

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