Management accounting

Discuss about the Collectively Management Accounting for Responsive Decision Making.

Management accounting is used by the members of the organisation for the purpose of decision making at various levels of management  so that management can exercise its control over costs as well as regulate the use of its resources and reduce their wastage, to reap its benefits in the long term. Management accounting might not be legally binding like financial accounting but its increasing popularity in the management world has helped it climb through various ladders of success. Management accounting is a process which uses varied techniques like budgetary control, marginal costing and standard costing and processes the data furnished by these techniques via communication, and hence leaving no ambiguity in setting standards for the employees and therefore motivating them to achieve the desired results. The report gives the understanding of management accounting and its importance in the Victor Reactor Inc.

Management accounting as a part of process of management focuses on the aspects of an organisation which adds value to its processes by achieving the effective utilization of resources of an organization in dynamic, flexible and in context to competitiveness within and outside the organization. It comprises of both accounting of costs and measurement of performance. It contains all the data which is collected to help in arriving at the decision to be made in production.

Importance of management accounting in manufacturing entity

For a manufacturing entity, firstly it provides the relevant Information for making decision related to production and aids in planning the manufacturing process, secondly it assists the management in formulating operational activities, thirdly it synchronizes and motivates the managers and other employees towards achievement of organizational goals, fourthly it helps in measuring the performance of activities, managers and employees within the organization and lastly it assess the company’s competitive position and provides direction to managers in achieving competitiveness for long run in the Industry.

Classifications of costs (types, behaviour, function and relevance) with examples.                                                

Classification of costs in terms of types

Direct costs: These are the costs which are incurred for the benefit of one specific cost object. This type of cost is directly traceable to a product, service or department. Examples of direct costs are material cost and labour costs.

Indirect costs: These are the costs which are incurred for the benefit of more than one cost objects. This type of cost cannot be directly traceable to a product, service or department. These are also known as overheads cost. Examples of indirect costs are: electricity, maintenance costs, rent etc which are benefiting two or more departments or products/services.

Importance of management accounting in manufacturing entity

Classification of costs in terms of behaviour  

Cost behaviour means how a cost will change with changes in the level of manufacturing activity. Following are the types:

Fixed Costs: These are the costs which in total will remain the constant for a specific period of time and over a relevant range of output of production. Fixed costs per unit keeps on declining as the production output increases. Examples of fixed costs are: Rent, rates, insurance and depreciation etc.

Variable Costs: These are the costs which in total will tend to change as the output varies. These costs are directly proportional to volume of production. Variable cost per unit remains constant while the total of variable cost keeps on increasing with the increase in production volume. Examples of variable costs are: direct material cost, direct labour costs etc.

Classification of costs in terms of function

Classification of costs by function which are categorized in accordance to activity which is performed in each function. All such costs of a manufacturing entity may be classified into manufacturing costs, marketing costs, administrative costs, and financing costs which are defined below:

Manufacturing costs: These are the costs which are associated with the production of a product. These are the total of direct materials costs, direct labour costs, and costs of factory overhead.

Marketing costs: These are the costs which are incurred in advertising, promoting and marketing a product or service which in turn contributes to selling efficiency of the product/service.

Administrative costs: These are the costs which are incurred for administration of several departments within the organization. These includes costs incurred in directing, monitoring, and in conduct of operation of an entity and also costs like remuneration paid to managers and employees.

Financing costs: These are the costs which are incurred in acquiring funds for the operation of an entity. This primarily comprises the interest costs which the company pays on acquired funds. It also includes the cost of credit which is extended by an entity to its customers

Classification of costs in terms of relevance

Classification of costs in terms of its relevance to planning, monitoring, and contribution to decision-making can be briefly illustrated as below:

Relevant costs: These are the costs which serve as a pertinent factor in making a relative decision. A cost is relevant for the decision if the cost in question is respondent to the decision under consideration. These costs are appropriate to a specific management decision. These costs are estimated future costs and differ under alternative course of action for a specific decision. A relevant cost can be fixed or variable in nature.

Differences between management accounting and financial accounting

For example: Suppose for a company which is in a process to decide on production of a product either manually or through machines, relevant costs would be cost of labour and  machine cost respectively.

Irrelevant costs: These are the costs which are not affected by the actions of management. These costs are called as irrelevant costs as these do not influence the decision of management and hence should not be considered in a decision-making analysis. A good example of such type of cost is sunk costs, these costs are the costs which have already been incurred and are now irrevocable like cost of survey which has already been made to judge if the product has a market in the industry or not.

Variance can be termed as a deviation of actual cost from the cost which is set as a standard also known as the standard cost while the standard costing act as a measurement benchmark for determination of variances which helps in evaluating the performances  

Variance analysis means the process of analysing variances so as to determine the causes behind the deviations. The variances can be favourable or unfavourable, when the actual performance is better than the standard performance, it is termed as a favourable variance and when the actual performance is below the standard performance, we call it a unfavourable variance.

The variances are measured broadly keeping in mind the various types of costs and the revenue.

On the basis of costs: Variances are measured for the following cost categories:

Direct costs i.e. the Direct Material and Direct Labour costs and the Indirect costs i.e. the variable and fixed overheads

Direct Material Variances and Direct Labour Variances could occur due to price at which material is procured or the labour is employed and the quantity usage of material and labour in production of the product.

Variances measuring the price differences in material and labour costs are termed as Direct Material and Direct labour price variances. While the variances measuring the usage variances in material and labour quantity are termed as Direct Material and labour usage or efficiency variances. While analysing the variances, the commonly measured variances also include labour idle time variance which measures the idle time labour cost deviation from the estimated standard.

Similarly to measure the deviation in fixed and variable overhead similar concept is used. Variances measuring the price differences in spending of variable and fixed overheads are termed as Variable and fixed overhead price variances while the variances measuring the efficiency of these overheads are termed as variable and fixed overhead efficiency variances. While the calculation of indirect cost variance is similar to that of direct cost variances, the interpretations of these variances differ.

Classification of costs (types, behavior, function, and relevance) with examples

Deviation in sales revenue are interpreted using the sales price variance which measures the deviation in actual and standard price of the product and the sales volume variance which measures the deviation in actual and standard volume of the product sold.

Problems and limitations that need to be kept in mind while conducting a variance analysis. While the variance indicates the deviations from a standard which is an expected estimate, it does not indicate management on what actually went wrong. There could be various possible reasons for the occurrence of variances. For instance, an unfavourable direct materials efficiency variance could be a result of poor design of the finished product and/or process of manufacturing, problems associated with the materials supplied in terms quality or availability, carelessness by employees owing to improper training etc.

Another factor that further complicates the analysis is the inter-relationship among the variances. For instance, due to purchase of inferior quality of materials, a favourable materials price variance would occur along with an adverse materials efficiency variance. It could also result in an adverse labour efficiency variance as it may slow down workers.

Finally, variance analysis tells management if the entity has performed better or worse than the planned performance, but it does not indicate on the intensity of the situation. For example, suppose the material price variance for a material was adverse, it may be possible that if the procurement department had not taken various measures such as placing larger order to curtail the adversity of rising material costs, the situation could have been much worse.

Operational budgets and its advantages

Budget is a statement formally prepared to set aside the financial resources in conduct of specific activities for a given frame of time.

An operational budget is the statement which sets aside the estimated financial resources for various operations in an entity. Following could be the various types of operational budgets:

Production Budget: This budget as a control tool helps in providing the details about what should be the quantity of production for a particular and when should the quantity be produced. Since inability to meet customers’ demand could have adverse impact on revenue while keeping excess inventory would cost an extra carrying cost, so the production budget helps in maintaining the balance.

Raw Material Purchase Budget: It states the quantity of raw material to be purchased in order to meet the production needs and the timings on which the prescribed quantity is purchases and also to strike a balance between supply and demand.

Variance analysis

The Direct Labour Budget: It provides details about the production hours which would be required along with the wage rates commensurate to the skills of the type of labour in order to produce the desired units of output. This will also include all other labour related costs and helps to monitor the efficiency and cost effectiveness of labour cost.

The Overhead Budget: It summarizes the cost and timing of overhead expenditure that will be required during a particular frame of time for which the budget is being prepared. This budget will help to control and monitor the spend of various fixed and variable overheads and thus helps in enhancing the profitability of the product.

The Cash receipts and disbursement budget: The receipt budget which would depend upon the timing of sales and collection from debtors. It is prepared considering the credit period in case of credit sales while cash is received immediately in case of cash sale, it also considers other sources that may generate cash receipts during the period of budget

The disbursement budget like the receipt budget depends upon the timing of purchases and payment to creditors. It is prepared considering the credit period in case of credit purchases while cash is paid immediately in case of cash purchase, it also considers other sources that may require outflow of cash during the period of budget

These cash budgets help us determine the expected inflow, outflow and balance of cash and which would further enable the management to determine its cash needs.

The Profit Plan or pro-forma income statement and the pro-forma Balance sheet: It provides an indication of the level of income that can be expected while the balance sheet provides managers with an idea of financial position of the entity

Other advantages of budgeting

Budgeting process with specified business timelines tends managers to focus their attention in operating in a more disciplined and controlled environment.

Budgeting enhances important principles of how an entity would communicate and coordinating among various operations and departments of an organization.

Budgets provide a roadmap for future actions.

Conclusion and Recommendation

It can be concluded that collectively management accounting serves as a tool for prompt and responsive decision making, through its various tools and techniques as discussed in the assignment above it helps the senior level of management in decision making. While we classify costs on the basis of our requirement, it can be in terms of their behaviour, relevance or interconnectivity to various operations and departments. Standard costing and Variance analysis further assists in analyzing the results to aid decision making. Budgeting also serves as a control tool which helps the management to further take and compare outputs of variance analysis, it also provides data inputs to conduct variance analysis and estimating the budgeted income position and asset position of the entity.

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