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Unit 5 Management Accounting Assignment
Diploma in Business
Unit Number and Title
Unit 5 Management Accounting
1. Principles of management accounting
Management accounting is a profession that includes integration of financial and non-financial statements to provide useful information to the management so that the management can take effective decision for the organization. Management accounting plays a very major role in providing information to the people of management. The scope of management accounting is very wide as it contains all types of accounting information that are related to the particular organization. The principles of management accounting are as follows.
Communication provides insight that is influential. The role of management accounting begins as well as ends with communication. The utilization of management accounting is depending upon how well the information has been communicated so the major principle of management accounting is communication as the influence of management is depending upon the communication and better communication leads to good decision making so it is very necessary for every organization to focus on communication of management accounting information in proper way so that it can influence the management.
Information is relevant. Management accounting can lead to better decision making when the information provided to the management is relevant. Management accounting includes all type of information that is related to the organization whether they are financial or not, whether they are relating to the social and cultural issues of the organization. In other words all the information that are related to the organization and can affect the decision making must be included in the management accounting as all these information are relevant for the organization (Zaman & Akbar, 2013).
This principle is also known as value. Impact on value is analyzed. Management accounting helps the management to analysis the provided information properly so that management can evolve better decision making for the organization so right analysis is very necessary for every organization as analysis of the management accounting information reflects the decision making of the organization. Management should analysis the information properly so that they can understand the environment of the organization and can take better decisions.
Stewardship build trust. This principle focuses on the working of management accountants that these persons must be ethical and accountable to the organization. Management accountants must be trust worthy person that they should analysis the management accounting information in right ways so that they can take effective decisions for the organization. Management accountants must consider the trust of stakeholders and also they should be responsible for betterment of the organization through better decision making. They should fulfill all their responsibilities so that this could have a positive impact on the growth of the organization.
2. Role of management accounting and management accounting systems
Management accounting refers to the effective use of all those information which is related to management and which evolves the efficient decision making of the organization and management accounting systems refers to the process of collection of relevant data from the business operation and then converting them into management accounting information. Role of management accounting and management accounting system is as follows.
Planning is preparation for the achievement of the objectives in advance. Planning is done with a view to achieve short term as well as long term goals of the organization so management accounting helps in forecasting the budgets so that estimations for the expenses and incomes can be done in advances and through this management accounting systems helps in analyzing the relevant information so that goals of the organization can be achieved.
organizing refers to the proper organization of people in the organization so that a proper framework can be established and roles and responsibilities of each department can be assigned. Management accounting helps in taking those decisions in regard to assignment of roles and responsibilities so that a proper hierarchy of the work can be maintained in the organization and in this management accounting systems also plays a very major role in measuring the performance of the people of management so that operations of the organization can be adjusted in proper ways.
Control is the process of measuring the actual performance and then comparing it with estimated performance so that control can be established in the organizations so that the overall performance of the organization can be improved and this could be done through management accounting and management accounting systems as management accounting helps in providing relevant information to the organization so that measurement of performance can be done properly and management accounting systemhelps in defining the information which is relevant for this purpose (Yakshibaev, 2011).
d) Decision making:
The main role of management accounting and management accounting system is providing effective decision making to the organization so management accounting helps the management to take better decisions for the organization.
3. Use of techniques and methods used in management accounting
There is various type of management accounting systems such as cost accounting systems, inventory management systems, job costing systems, price-optimizing systems etc.
4 Calculation of income statements
a) Comparative absorption income statement
Variable production cost
Fixed production cost
Less: Selling and administration expenses
Marginal costing income statement
Less: Variable cost
Less: Fixed cost
b) The differences in the profits is due the method that is used for the costing as both the profits are calculated with different methods of costing as in absorption costing method all the expenses are segregated and then are deducted from sales so this leads to increase of expenses and thus it lowers the profits where in marginal costing method expenses are deducted into two categories which is into fixed and variable expenses. In this method first of all fixed costs are deducted from the sales which gives the contribution and then variable costs are divided from the contribution which provides the profit and through this the expenses are segregated into two heads (Schmidlin, 2014).
c) FIFO refers to first in first out system of inventory valuation where the inventory is valued in such way that the first come inventory must be sold first and the records of inventory are made in such a way that inventory first come are recorded first and they are recorded for the sale first. The main focus of FIFO system is that the oldest inventory must be sol first without considering any other inventory. This method is the most used method of inventory valuation s it provides a clear picture of inventory. AVCO refers to Average cost or weighted cost method where inventory valuation is done by dividing the total cost of good that are available with sum of total purchases and inventory. This method is also applied in periodic inventory system and perpetual inventory system. Both the methods FIFO and AVCO are used for inventory valuation.
5. Integration of management accounting to the organization and its benefits.
Management accounting plays a very major role in an organization management accounting helps in supporting controlling, planning, organizing, decision making of the organization. Management accounting is a process of evaluating the information relating to the organization so that they can use that information in effective decision making of the business. Management accounting integrates in each and every level of the organization as all the information which are related to the organization whether they are financial or not, they are related to internal environment of the organization or external environment of the organization, whether the information are related to the social and cultural issues of the organization. In short all the information that is related to the organization and can affect the decision making is included in management accounting (Robnson. et al, 2012).
Management accounting is very useful for the organization as it impacts the decision making and decision making of the organization leads to the success of the organization so there is a direct link between management accounting and growth of the organization so the benefits of management accounting in an organization are as follows.
- Management accounting helps in increasing the efficiency of the functions of management.
- Management accounting helps in fixing the target, fixing the prices of the products.
- Management accounting helps in forecasting and preparing the budgets so organization can estimate its income and expenses.
- Management accounting helps in providing tools and techniques that increases the reliability of functions of business.
- Management accounting helps in establishing the planning and control in all the levels of organization.
- Management accounting helps in evolving better decision making for the business.
- Management accounting helps in finding ways to reduce the cost of production so that higher profits can be generated.
- Management accounting helps in establishing proper communication among all the levels of the organization.
- Management accounting helps in identifying the overall performance of the organization.
- Management accounting helps in cutting the extra costs of the organization so that the benefits could be earned by the organization.
- Management accounting helps in integrating the individual efforts of the people of the organization towards the achievement of organizational goals and objectives.
- Management accounting helps in implementing the expansion plans in the organization.
- Management accounting helps in defining the process for achieving the goals of the business.
There are several abovementioned benefits of management accounting in an organization so an organization needs to utilize its management information in right ways in order to achieve its long term as well as short term goals.
A) A budget is a forecast of what is expected to happen in a business during the next year.’
Budget is a statement which is prepared with a view to estimate the income and expenses of future year on the basis of present financial performance of any organization. One of the director of Nero Limited has raised a query with regard to this statement so this statement of director is partially right as the budget is prepared to estimate the income and expenses of Nero Limited for upcoming years but it cannot be determined what is expected to happen in next year as the budget only considers the financial values so the cash flows of Nero Limited can be forecasted so that the company can estimate its incomes and expenses but except financial terms what is doing to happen in next year cannot be forecasted through budget. The main purpose of preparing is the budget is to estimate the cash inflows and cash outflows of Nero Limited for next year.
b) ‘Activity-based budgeting is an approach that takes account of the planned volume of activity to .deduce the figures to go into the budget.’
Activity based budgeting is a type of budgeting where budgets are prepared on the basis of each activity. As the comment raised by the director of Nero Limited Activity-based budgeting is an approach that takes account of the planned volume of activity to deduce the figures to go into the budget is right as the main aim of activity based costing is to prepare budgets on the basis of the activities as well as the overall cost is also deducted from each activity. The approach which is used for activity based budgeting is that the planned volume of activity is deducted from the particular activity and through this the budget is prepared. In activity based budgeting overhead costs plays a significant role in total costs. In activity based budgeting activities and their costs are identified and then the cost from that particular activity is deducted (Morana, 2014).
Scenario 2 (i)
A. Cash budget is a plan that shows the inflows and outflows during the period for which it is calculated. It helps in evaluating if the business has sufficient cash to operate its day to day activities or not. It includes revenues and expenses paid by the business and reflects the position as surplus or deficit.
Cash budget is significant for a business.
- Opportunities – By evaluating the business’s liquidity position opportunities of expansion, acquisition or merger can be known.
- Strategy – If the business is planning launch of a new product or expansion but it has insufficient funds then it can make plans or strategies for borrowing money and the source as well.
- Decision making – It helps the management make decisions.
- Tax planning – It helps in estimating the profit that will be earned by the business for the period for which it is calculated thus making it easier to plan for taxes and penalties, fines and additional payment of tax can be stopped (Hall & Westerman, 2013).
b. The cash budget is as follows:
C .Information required by the banker for granting overdraft for further expansion:-
- The amount to be granted – The banker will consider the amount that is to be granted. In case a huge sum is involved it will affect the standing of the bank.
- Purpose – The banker will analyses the purpose for which the loan is to be granted and will further analyses if the expansion program to be carried out by the organization is profitable or not as that will affect the repayment of the loan amount.
- Security and mortgage –The banker will consider if the security that is offered or mortgaged is easily saleable or not and its worth is more than the loan amount or not.
- Repayment tenure – The banker will also consider the tenure of repayment as the bank would want the repayment in easy and quick installments.
Scenario 2 (ii)
- If the quantity of other two services cannot be expanded to use the spare capacity, the fixed costs allocated on the standards services will be a sunk cost and thus it is not relevant for decision making since even of the standard services are not offered, the fixed costs will be incurred. Hus the report prepared by accountant includes fixed cost which cannot be used for identifying the profit from standard service for decision making. There is a contribution of £15 (90 -75) from standard services and therefore it is advisable to offer these services next year also.
- If the spare capacity can be used to render a new service Nova, then standards services shall not be rendered net year since the contribution from Nova services will be £25 (85 – 60) which is higher than the contribution from standard services.
- In such case the opportunity cost of not offering the standard service will also be added to the variable cost. Thus, the minimum price acceptable will be £35 + £15 = £50.
- If a resource is scarce ad restricting sales then in such case profit can be maximized by utilizing the resource for selling only those products or services which results in maximum contribution. The ranking shall be given to each category on the basis of contribution per unit from each category since fixed cost is a sunk cost and therefore in this case highest contribution will result in maximum profits.
i) ‘Afavorable direct labor rate variance can only be caused by staff working more efficiently than budgeted.’
Direct laborrate variance includes elements of rate of labor wages and time consumed by labor. Thus a favorablelabor rate variance occurs when either he staff works more efficiently than planned or the staff is replaced with cheaper labor force with low wage rates. Thu the above statement is partially correct.
ii) ‘When calculating variances, we ignore differences of volume of output, between original budget and actual, by flexing the budget. If there were a volume difference, it is water under the bridge by the time that the variances come to be calculated.’
While calculating variances, the differences of volume of output are ignored between actual and budget by flexing the budget. The variances in the volume or output are calculated separately. Thus, this helps in the estimation of effect on the level of activity and is not the water under the bridge by the time variances are calculated.
iii)‘ Most businesses do not have feedforward controls of any type, just feedback controls through budgets.’
Feedback controls refer to as the implementation of controls after performance whereas feed forward controls are those which are implemented before the performance of business operations. Budgets are not the feedback controls but are feed forward controls since they help in controlling the business operations before their performance. However variance analysis is conducted afterwards to monitor the deviations.
a) Cash flows are used in the IRR, NPV and payback back period as all these theories includes the present value of cash. In all those theories cash is included and also during consideration of the expansion plans all these theories are to be considered as this provides a fair view of choosing any project as well as it calculates the present value for a future cash so through this the present value of the project is also considered.
These theories helps in selecting the project as the project with positive NPV is beneficial for the business and the project having negative NPV is not beneficial for the business so if a project has to choose any project on the basis of NPV then it should go with the project which is having higher NPV. IRR refers to the internal rate of return which helps in choosing the suitable project for the business on the basis of IRR so if a project is to be chosen on the basis of IRR then the project having higher IRR must be choose.Payback period refers to the present value of future cash. Profit flows of the business are circulated within the profit and loss statement of thee business and cash flows are used in these theories because these theories includes the value of cash.
(I) Calculation of NPV, IRR and payback period
Payback period: There is no payback period in the projects as the payback period defines the time period in which the investment of the whole project will be recovered or can be said as the time period in which the amount that is invested in the project is equal to the inflows that are achieved from the project so in both these projects the cash inflows of the year 2 are negative that represents that both the projects have earned loss in this year and also both the projects have not earned much profits in the year so that the initial investment of the projects can be covered. So there is no payback period of both the projects.
ii) Selection of a project
If Nero limited want to choose one project on the basis of calculation of NPV and IRR then if Nero limited chooses a project on the basis of NPV then none of the project is profitable for the company as both the projects are having negative NPV but if Nero limited has to choose one project between both projects then Nero limited should go for the project 2 has it is having higher NPV in comparison to project 2 and if Nero limited has to choose a project between both the projects on the basis of IRR then Nero limited can choose both the projects as the IRR of both the projects are same so overall Nero limited should go for the project 2 on the basis of NPV and IRR.
Cost plus pricing is a strategic tool for determining the price of a product by adding fixed costs, variable costs and a markup percentage to arrive at a final cost of the product.
The drawbacks of using cost plus pricing approach are:-
- Limits innovation – This approach limits creativity or distinctive features that can be added to the product as keeping a low price is difficult.
- Low satisfaction to value for money –This pricing technique is quite unrealistic and the target group might not find the price of the product satisfactory or they may find it to be overpriced.
- Loss of revenue – By adopting cost plus pricing method, competitive aspect is lost.
- Decrease in gross profit – Suppose if the cost of a product is coming down to 40 per unit and after markup it comes to 50 per unit, gross profit of 10 per unit is earned, but if the material cost increases causing the product to cost 42 per unit then the gross margin will be significantly reduced.
- Overpricing- This method takes into consideration sunk cost and historical cost also which increases the price of the product thus makes it overpriced (Grimm, 2016).
B. It is important to hold inventories.
- To meet unexpected demand – The business is considered to be successful when the demand is easily met by the supply. In times of crises when the demand suddenly increases the supply can be made smoother if sufficient stock of inventory is held.
- Seasons – Holding inventory based on seasonal changes is generally followed in businesses which are on boom seasonally. For instance, holding inventory of woolens in winters, raincoats and umbrellas in rainy season.
- Discounts – When inventory is purchased in larger quantity more discounts is offered which is lucrative as it will have a direct impact on reduction of cost and rise in profit margin.
- Hedging –If rise in price is expected then more quantity of inventory is held for deriving benefits from increased price and in case taxes are to be levied in future those could be saved and hedging can also be done.
- Saving of freight and transportation expenses – If large quantities of inventories areordered at once, transportation cost can be saved.
c. (i) Calculation of ratios to measure efficiency of working capital management for two years
Current Ratio = Current assets/ current liabilities
2015 = 579/195 = 2.97
2014 = 732/225 = 3.25
Acid test ratio = Current assets – Prepaid expenses – inventory/ current liabilities
2015 = 579 - 200/195 = 1.94
2014 = 732 – 250/225 = 2.14
(ii) The method which can be used by the management of this company to exercise control over its inventories and receivables includes inventory management tools such as ABC method of Inventory Valuation, factoring of receivables, controlling bad debts etc.
(iii) Operating cycle provides the information to the management accountants about the period in which the funds invested in the business operations will be recovered from passing through all the stages of operating cycle. The operating cycle of the company for two years can be calculated as follows:
Operating cycle = Days Inventory outstanding + Days Sales Outstanding + Days Payable Outstanding
2015 = (200+160/2)/ (1,080/365) + (375/1,800)*365 – (195/1,120)*365
= 60.83 + 76.04 – 63.55 = 73.32
2014 = (200+250/2)/ (1,125/365) + (480/1,920)*365 – (225/1,175)*365
= 73 + 91.25 – 69.89 = 94.36
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