Purpose of financial accounting and management accounting
Differences between management accounting and financial accounting
Accounting is an organised and methodological process to collect, arranges, analyse, sort and make use of financial and other data. It is a huge area and involves great expertise in order to use the information so collected in a proper way. In order to simplify this area, accounting can be classified as financial and management accounting. Both these forms are important in decision making. But it is important to understand which form is to be used when. Let us understand what these are and differences between them. (Warren, Duchac and Reeve, 2014)
Financial accounting is the part of accounting which deal with the formation and presentation of accounting data along with other relevant data of the entity such as its management, CSR policies, pending litigations, etc. the final accounts are prepared in financial accounting which are laid before the stakeholders of the entity in order to inform them about the performance of the company. (Warren., 2015)
Management accounting is the part of accounting which deals with information both qualitative and quantitative which is used by the management in order to frame plans and policies and also take decisions for the company. It mainly comprises of managerial accounting and cost accounting. (Weygandt, Kimmel and Kieso, n.d.) This type of accounting is majorly used in entities involved in the business of manufacturing.
Let us now understand the differences between financial and management accounting:
Purpose: the main purpose of financial accounting is to provide the investors and the stakeholders the information about the well being and operations of the entity. Whereas management accounting is a tool which helps the management in decision making process.
Data used: the data used in financial accounting is mostly quantitative data and relates mainly related to the operations of the entity. The information used in management accounting is both qualitative and quantitative in nature.
End users of Reports: the end users of the reports of the reports of financial accounting are the investors and stakeholders and that of management are the mangers and board of directors. The financial reporting is mainly for external reporting purposes but management accounting is for internal reporting and decision making purpose. (Wild, Shaw and Chiappetta, n.d.)
Scope: financial accounting is used and implemented by all the entities. Even if they are not required to report to the investor’s financial accounting helps the owners understand the financial status of the entity. Scope of management accounting is much wider as compared to management accounting. It also takes into account the factors which are not monetary.
Analytically discuss the importance of break-even analysis with the help of a break-even chart.
Theoretically break even is the point at which total cost incurred is equal to the total revenue. The revenue earned over and above the break-even point is the profit for the entity. Break even analysis is the analytical tool which is used in order to evaluate the cost revenue relationship. This is the level at which the entity earns no profit and incurs no loss. If the break even is determined then it will help the entity to set a target of minimum number of units which will be required by it to sell in order to cover all the costs incurred during the process of production and other costs incurred which are incurred in assisting the production procedure. (Cafferky, 2014)
Data used in financial accounting and management accounting
Total fixed cost + Total variable cost = Total revenue
Fixed costs are the costs which do not change with the level of production. They are fixed in nature and do not vary with change in production level. These costs cannot be avoided; they vary with the time period. Variable expenses are the expenses which are incurred only when production takes place and they change with the level of production. (Harris, 1978)
The financials of an entity play a very important role in its growth and development. Using the financial data the managers can understand the profitability of the entity and also use the extra funds for development of the business. A proper study for this is required. Break even analysis is one of the tools to understand the financial position of the entity and learn more about entity’s profitability. (Kimmel, Weygandt and Kieso, 2011)
As already discussed break even analysis determines the level of break for the entity that is the level at which the entity incurs neither profit nor loss. Let us consider the following illustration:
An entity produces product x which is sold in the market for $ 10 per unit, the variable cost per unit is $ 5 and also the fixed costs which are incurred yearly amounts to $ 20,000. Now, we can calculate the breakeven point for product x using the following equation:
Breakeven Point (units) =Fixed Cost/ Contribution per unit,
In the given case fixed cost is $ 20,000 and contribution per unit is $ 5 (10-5), therefore the breakeven point in this case will be 4000 units. This means that the entity will have to sell a minimum of 4000 units per annum in order to recover all its expenses.
|
Level of units |
Total Variable Cost ($) |
Fixed Cost ($) |
Total Cost ($) |
Total Revenue($) |
|
– |
– |
20,000 |
20,000 |
– |
|
500 |
2,500 |
20,000 |
22,500 |
5,000 |
|
1,000 |
5,000 |
20,000 |
25,000 |
10,000 |
|
2,000 |
10,000 |
20,000 |
30,000 |
20,000 |
|
3,000 |
15,000 |
20,000 |
35,000 |
30,000 |
|
3,500 |
17,500 |
20,000 |
37,500 |
35,000 |
|
4,000 |
20,000 |
20,000 |
40,000 |
40,000 |
|
4,500 |
22,500 |
20,000 |
42,500 |
45,000 |
|
5,000 |
25,000 |
20,000 |
45,000 |
50,000 |
The graphical representation above shows clearly that the entities will profits only above the level of 40000 units. The revenue earned below that level will only be cost recovery. (Shim and Siegel, 2009)
Evaluate the importance of any six operational budgets for a limited company.
Budget is an estimate of quantitative data of an entity which serves as a basis for decision making procedure for the management. Budget is one of the most important tools of accounting. Investing proper time and resources in budget may provide great returns to the entity. (Balakrishnan, Sivaramakrishnan and Sprinkle, n.d.)
Let us now get an idea of different type of operational budgets and there importance:
- Sales Budget: A sales budget represents the estimated amount of revenue which is expected to be generated by the entity for the upcoming operational period. It not only presents in value the expected revenue, but it also gives the idea of the sales which can be made in units. It is not mere estimate of revenue, it is duly researched and calculated data based on the current period data along with changes which are to be made in future. It helps the entity get an idea of how much fund and resources are required to be allocated so that the demand supply chain is not harmed.
- Production budget: it helps the enmity get an idea of how much production is required to be made based on expected sales and the closing stock. Production budget help the management allocate the resources in the most efficient manner. It helps the managers move the resources smoothly in a cost effective manner so that the production cycle keeps moving. It is a lot more than allocation of resources; it helps the management save funds by buying materials and resources as per needs. It saves interest cost and also carrying amount for the resources.
- Financial budget: Financial budget is one of the most important budgets. Finance and liquidity is the blood of the organisation, lack of liquidity and finance and stop the whole operations of the entity. Financial budget helps the management decide the sources and collect funds for future operations. It gets them ready for future necessity of cash requirements. In case of cash crunch or sudden changes management needs to be prepared for sources of fund. Financial budget helps in such cases and saves the entity from harm which can be caused due to lack of financial stability and liquidity. (Barr and McClellan, 2011)
- Overheads budget: the overheads budget is the budget which gives the entity an estimate of indirect expenses which are to be incurred in the coming periods. This budget helps the entity plan the overhead expense for the expected budgeted production goals of the entity. Therefore, the overheads budget gives an estimate of factory, administration and other overheads to the management of the entity. It is basically made on a departmental basis in order to analyse the most efficient department and also to check which expenses are unnecessary. It helps in cost control and improves efficiency for the entity.
- Personnel Budget: as the name suggests the personnel budget makes an estimate of manpower to be required by the entity for the budgeted period. We all know manpower is the one of the most important resource without which no work can be carried out. The personnel budget involves all types of manpower like labour, administrative and others. It helps the administration decide whom to allocate what task. It also lets them arrange form contingencies. It helps them in recruitment and a long with management of resources. It helps in movement of manpower between departments for better results. (Davidson, 2009)
- Master budget: Master budget is the budget which is prepared by joining all the functional budgets mentioned above. It is the summary of all the budgets so that the top down view over the entity’s work can be seen. It gives the all in all information to the entity along with the expected profitability. It provides a comprehensive image of the proposed ideas along with expected results. This budget helps the entity in major decision making situations. It also serves as a basis of ratio analysis for the entity for future use. (Shim, Siegel and Shim, 2012)
These were the basic operational budgets along wit there importance.
Discuss analytically the importance of variance analysis as a cost controlling and decision making tool.
Variance analysis in one of the tools of cost accounting which helps the entity to analyse and control costs and expenses. It is done my comparing the actual and budgeted figures. In case of huge variances, the reasons for them are studied and checked if they are favourable or not. (Glantz, Slinker and Neilands, n.d.)
- Material variances: under material variances the variance between the budgeted consumption of material the actual consumption is compared. This variance serves as an important tool in use and control of material usage. It helps the entity understand the area creating huge wastages and using unnecessary material. It helps in wastage control and helps improve the production by receiving maximum output with use of minimal resources. Material being the basis resource of production involves huge costs. Proper study of material variances helps in improving the product quality and cost reduction benefitting both the enterprise and the consumers. (Iversen and Norpoth, n.d.)
- Labour variances: These are the variances which are calculated by measuring the difference between the budgeted and actual overhead, negative variance is not considered favourable as it depicts that the entity spent more on labour than it had already planned for. It shows lower efficiency and increased cost burden. Positive labour variance on the other hand is considered and shows that the entity has planned its resources effectively.
- Variable overhead Variances: variable overhead expenses increase with increase in production. Therefore there should be variances in this head only if there are differences in the level of production. In case the budgeted and actual level of production is same and still there are variances then the management should look in to the reasons cause negative variances. Positive variances imply benefits of large scale production which also implies operating efficiency.(Scheffe?, 2010)
- Sales variance: sales variances are the variances between the budgeted and actual amount and level of sales made by the entity. In this case if the actual amount is greater than the budgeted amount them it is good for the entity. This shows that entity has achieved sales which are over and above the targeted revenue. Just achieving more sales is not enough, the entity should check for the profitability also. They should focus on major ratios and the efficiency in profitability ratios should be aimed for.
Just like other tools mentioned above, variance analysis is also a very important tool for cost accounting (Searle, Casella and McCulloch, 2006). It helps the entity to set a target and achieve efficiency in its procedure. It helps them to control costs and achieve goals with better alternatives. Variance analysis also helps the management understand the issues if any in the production process which are not easily identifiable. Therefore, we see that variance analysis is a very important tool.
References
Warren, C., Duchac, J. and Reeve, J. (2014). Financial and managerial accounting. 1st ed. Mason, Ohio: South-Western Cengage Learning.
Warren., (2015). Financial & Managerial Accounting. 1st ed. Cengage Learning.
Weygandt, J., Kimmel, P. and Kieso, D. (n.d.). Financial & managerial accounting. 1st ed.
Wild, J., Shaw, K. and Chiappetta, B. (n.d.). Financial and managerial accounting. 1st ed.
Cafferky, M. (2014). Breakeven analysis. 1st ed. New York: Business Expert Press.
Harris, C. (1978). The break-even handbook. 1st ed. Englewood Cliffs, N.J.: Prentice-Hall.
Kimmel, P., Weygandt, J. and Kieso, D. (2011). Accounting. 1st ed. Hoboken, N.J.: Wiley.
Shim, J. and Siegel, J. (2009). Modern cost management & analysis. 1st ed. Hauppauge: Barron’s.
Balakrishnan, R., Sivaramakrishnan, K. and Sprinkle, G. (n.d.). Managerial accounting. 1st ed.
Barr, M. and McClellan, G. (2011). Budgets and financial management in higher education. 1st ed. San Francisco: Jossey-Bass.
Davidson, I. (2009). Budgetary control in modern organisation. 1st ed. Saarbru?cken: VDM Verlag Dr. Muller.
Shim, J., Siegel, J. and Shim, A. (2012). Budgeting basics and beyond. 1st ed. Hoboken, N.J.: Wiley.
Glantz, S., Slinker, B. and Neilands, T. (n.d.). Primer of applied regression & analysis of variance. 1st ed.
Iversen, G. and Norpoth, H. (n.d.). Analysis of variance. 2nd ed. 1st ed.
Scheffe?, H. (2010). The analysis of variance. 1st ed. New York: Wiley-Interscience Publication.
Searle, S., Casella, G. and McCulloch, C. (2006). Variance components. 1st ed. Hoboken, NJ: Wiley.
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