Foundations Of Management Accounting

Difference between Financial Accounting and Management Accounting

Describe about the Foundations of Management Accounting.

Management accounting is the process which measures and reports information about economic activity within the organisation. The process of management accounting is helpful for managers, as it helps in planning, evaluating and exercise of operational control. Planning, evaluating and operational control, can be explained by the following sub-points:

Planning – Planning is required for deciding what to make, when to make and where to make it in regards to a product. Planning is also helpful for determining the materials, labour that is necessary to realise desired output.

Evaluation of performance – Performance evaluation is required to evaluate the profitability of the product and its product line. The contribution of managers of the organisation.

Operational control – Operational control is necessary to get an idea of how much work is in progress on the factory floor. Operational control is also helpful in maintaining a smooth flow of production.

The assignment attempts to evaluate the concept of financial accounting and its key facts. The study further determines on the system of product costing under activity-based costing (ABC). Moreover, a direct material budget plan and schedule of expected cash disbursement have been formulated to justify the research subject.

Difference between Financial Accounting and Management Accounting:

 Management accounting is explained according to Nixon and Burns (2012) as the preparation of management reports and accounts that provide accurate information, both financial and statistical, to the managers which help them take important day-to-day decisions.

Financial accounting can is defined as the process of summarising, reporting and recording the transactions of an organisation and its operations over a period. HalíÅ™ (2011) states that the summarization of financial statements includes the balance sheet, income statement and cash flow statement, which provides the company’s performance over a period.

Differences between Financial and Management accounting can be explained as follows:

Financial accounting is the branch of accounting, which deals with the financial aspects and information of the concerned business. On the other hand, management accounting is the branch of accounting that deals with both fiscal and non-financial aspects of the firm.

Financial accounting is viewed and assessed by both internal management and as well as external parties concerned. Management accounting, on the other hand, is determined and considered only by the internal administration of the business.

Financial accounting reports are meant for the public, for them to assess the businesses financial viability. Management accounting report is intended for the internal management and is treated confidentially.

Analysis of Fixed and variable Cost of Company X and Company Y

Financial accounting follows a predetermined format, whereas management accounting has no such prescribed format.

Financial accounting deals with providing information about the financial status to its shareholders. On the other hand, management accounting helps the managers in evaluating the business performance, which will help them make better-informed decisions in the future.

Financial accounting is done for a specified period (1 Year). On the contrary, management accounting is done when the managers are in need of it. (Quarterly, half yearly, etc.)

For the purpose of auditing, financial accounting is of paramount importance and is mandatory in any company. Whereas management accounting is not that necessary and is done voluntarily.

According to Eriotis et al. (2011), the case study states that Company X incurs less fixed cost compared to its variable cost and Company Y incurs less variable cost compared to its fixed cost. From this statement, an inference can be drawn that Company Y will realise a higher profit in case the sale increases. According to the appendix below, where the sales in units increase by 10%, for both company X and Y, it is seen that company Y will realise more profit. In other words, due to an increase of one percent of units of sales of company X, the profit of X increases by 1.429% and similarly due to an increase of one percent of units of sales of company Y, the profit of Y increases by 1.882%. From the appendix below it is also observed that the total contribution for company X and Y is 10%. It is because company Y incurs a small variable cost compared to its fixed cost. As a result company Y earns a profit of 18.82%. In the case of company X, it incurs a variable cost much higher than that of company Y. Thus, from the above context, it can be explained that company Y enjoys the benefit of operating leverage over company X.

Concluding the above explanation, company Y will realise the greatest increase in profit. It is due to two main factors that are; company Y enjoys the benefit of operating leverage over company X, and it incurs a less variable cost and more fixed cost compared to company X. As a result company, Y will earn more profit.

An accounting method that identifies the activities of a firm that performs and assigns indirect costs to products is known as activity-based costing. Activity-based costing (ABC) is majorly applied in the manufacturing industry, as it improves the dependability over cost data and provides a better classification of expenses incurred during the production process of a company.

Explanation of processes of product costing under an Activity Based Costing

This system targets product costing, product line profitability analysis, service pricing, etc. According to Fei and Isa (2010), the system can be used for reduction of overhead cost. A complex environment is best for application for ABC.

The following steps can further explain Activity-based costing:

Cost Identification – Identifying the costs that need to be allocated, is the first and the most important step in the total process. As wastage of time is not preferred with a large project scope. For proper allocation of time and cost right factors need to be identified to avoid wastage of time.

Secondary cost pools – Cost pools are created for those costs which are incurred to provide services.

Primary cost pools – Primary cost pools are designed for those costs which are directly connected to the production of goods and services. A separate cost pool for each line of product is beneficial as costs are likely to arise at this level. A separate cost pool should be allocated for marketing and distribution of the product.

Activity cost driver – The factor that contributes to the expense of business operations is known as activity cost drivers. Few of the cost drivers are labour cost, maintenance cost and other variable expenses. On the other hand more technical activity cost drivers are machine hours, customer contact base, inspections, etc.

Management chooses cost drivers as the base for distributing manufacturing overhead. It is not mandatory for the management to select cost driver. Management selects cost driver at its discretion. The selection is made by verifying the variables relating to the expense incurred.

The methodology of product costing is associated with managerial accounting. The analytical recourses have made product costing a regular feature of manufacturing operations. In recent years product costing is involved with activity-based costing. ABC is based on the presumption that costs occur in various activities. According to the (Prates, 2014), ABC is based on the principle that production of products does not generate costs. The resources that are necessary to support the business activity generate costs. The activities generated from production consume costs.

Preparation of company’s direct materials budget and schedule of expected cash disbursements for purchases of materials for each quarter in the upcoming fiscal year:

The schedule of expected cash disbursement for the purchase of raw materials in each quarter is depicted in the table below:

Here it is assumed that the depreciation is not included in the fixed manufacturing overhead of $84,000 per quarter.

Conclusion:

From the above content, it can be inferred that the assignment differentiates between the key properties of financial accounting and management accounting. The study also shows the effect of profit due to the change in variable cost and fixed cost of company X and Y. The assignment explains the process of product costing under the ABC system. The calculation of direct material budget, cash disbursements, direct labour budget and manufacturing budget tries to justify General Corporations forecasted profitability and viability for the upcoming fiscal year 2017.

References:

 Eriotis, N.P., Frangouli, Z. and Ventoura-Neokosmides, Z. (2011) ‘Profit margin and capital structure: An empirical relationship’, Journal of Applied Business Research (JABR), 18(2).

Fei, Z.Y. and Isa, C.R. (2010) ‘Factors influencing activity-based costing success: A research framework’, International Journal of Trade, Economics and Finance, 1(2), pp. 144–150.

Ghaemi, M.H. and Nematollahi, M. (2012) ‘Study on the behavior of materials, labor, and overhead costs in manufacturing companies listed in Tehran stock exchange’, International Journal of Trade, Economics and Finance, , pp. 19–24.

HalíÅ™, Z. (2011) ‘Accounting system and financial performance measurements’, European Financial and Accounting Journal, 2011(3), pp. 38–65.

Iwai, N. and Thompson, S.R. (2012) ‘Foreign direct investment and labor quality in developing countries’, Review of Development Economics, 16(2), pp. 276–290.

Nissen, B. and Smith, R. (2015) ‘A novel way to represent and Reframe the interests of workers: The people’s budget review in st. Petersburg, Florida’, Labor Studies Journal, 40(1), pp. 84–102.

Nixon, B. and Burns, J. (2012) ‘Strategic management accounting’, Management Accounting Research, 23(4), pp. 225–228.

Prates, G.A. (2014) ‘METHODS OF COSTING – TARGET (TARGET COSTING) AND KAIZEN (KAIZEN COSTING) SUPPORTED BY QFD (quality function deployment) AS A TOOL FOR COST REDUCTION IN DEVELOPMENT PRODUCT AND PRODUCTION’, Nucleus, 11(1), pp. 7–20.

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