Importance Of Management Accounting: Cost Structures, Break-even Analysis And Variance Analysis

Importance of Management Accounting

Indicate the main purposes of management accounting and its relevance to the management of organisations.

Evaluate the main cost structures of organisations and methods of their calculation.

Determine appropriate methods of calculating break-even, profitability and capital input costs.

Introduction

Any form of accounting which assists business in making decisions efficiently can be termed as

Management accounting. It processes the data furnished by financial statements as well as cost

Statement. The data is analyzed using various techniques like budgetary control, standard costing and marginal costing and hence presented before the top level management for decision making. Further the top management assigns responsibility to the executives at all the levels of management and sets standard target performance for them. At the end of the specific period the performances are reviewed and deviations from standard targets are measured, and policies are revised to achieve desired results. The below report discuss the importance of  management accounting in  Vihaan Engineering Inc which is in manufacturing of Pressure Vessel machine.

Importance of Management Accounting

Management accounting is any form of accounting in which techniques and concepts are applied to process economic data which could be historical and projected data of an undertaking to help the managers for creating policies and thereby helping them to arrive at reasonable decisions for the fulfillment of the objectives. (Civilserviceindia.com,n.d.)

It is an invaluable help to the managers for discharging the basic duties in the service industry- in the field of drafting a plan, executing it and lastly controlling the actions. It is done by-

Furnishing data to management to enable its plan effectively and maintaining facilitation of services without any hindrance and thus increasing the competence of employees at all levels.

Measuring and reporting the actual performance to all the management at all levels to reflect the efficiency of the organizational techniques used.

Providing services at reasonable prices to its customers by using cost control techniques.

Computing the deviations from the standards set and interpreting the same to assist management to have “Management by Exception” and take actions for future policies.

Difference between Management accounting and financial accounting

(Megha M, n.d.),( Ducu C,Enache T,Stefan P,2016)

Basis	Financial Accounting	Management Accounting
Audience	Primarily provides information to the external parties as well as internal parties	Primarily provides information to the managers and employees
Focus	Its focus is on historical data dealing with past events and prepares statements for the prior financial year.	Its focus is on past as well as future events and forecasts for the future.
Intent	To calculate profit and financial status of business.	To analyse and interpret financial data to draw conclusions and enable management in decision making.
Voluntary	It is not voluntary but legally binding to prepare financial statements.	It is completely optional and is left up to the choice of management.
Data	It deals with transactions expressed in financial terms	It deals with transactions expressed in financial terms as well as non-financial transactions like credit standing of business

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

Classification of costs on the basis of types

Direct Material cost – It refers to the cost of material that can be traced with each cost center and forms a part of finished output. For example for a fast food joint if a cheese sandwich is the finished product then the cost of onion, cheese used in that burger is the direct material cost since these are costs which can be distributed over each unit of product.

Difference between Management accounting and financial accounting

Indirect Material cost – It refers to the cost of material which cannot be traced with individual cost center. For example: store rent, telephone expenses etc.

Direct Labour cost – It signifies that labour cost that can be traced with each cost center and is spent for the employees who are employed in providing services like the server who assembles the cheese sandwich and serves it to the customers in a fast food joint.

Indirect Labor cost – It comprises that labour cost which cannot be traced with each cost center and is spent for the employees who are not employed in providing services but assist in the same like the restaurant manager who looks after the visitors’ grievances and manages the staff.

Overheads – It consists of all the indirect costs like the costs incurred for overheads that relates to office and administration and overheads that relates to selling and distribution activities. For example cost of advertisement, discounts offered to customers etc.

Classification of costs on the basis of behavior

Fixed cost – It refers to that part of total cost that remains stable at all levels of output inspite of any alteration in the cost. As the output shoots up, fixed cost per unit might reduce, but the total fixed cost remain constant. Example- in case of a hospital – rent, administrator’s salary etc.

Variable cost – It refers to that part of total cost that changes in proportion to the change in level of production, though variable cost per unit remains same at all levels of production like the patient examination fees charged by a specific doctor remains same irrespective of the number of patients.

Semi-variable or Semi-fixed cost – These costs refers to that part of total cost which is partly fixed and partly variable in relation to level of output. For example electricity charges are fixed up to specified unit consumption and tend to increase with the increase in electricity consumption.

(microbuspub.com, 2016)

Classification of costs on the basis of function

Production costs – These are associated to production of services be it direct or indirect. Example supervisor’s salary, outlet expenses etc.

Administration costs – These are the costs which are incurred for the overall management of business like printing and stationery, rent, rates, taxes.

Selling costs – These are the costs which are associated with achieving desired sales of services. Like salesman’s salary, discounts and commission etc.

Classification of Costs

Research and development costs – These are the costs which are related to any cost related to improvisation of existing services or development of new services like salaries for hiring experts.

(microbuspub.com, 2016)

Classification of costs on the basis of relevance

Relevant costs – Relevant costs are those which are affected by the managerial decision in a specific business situation. They are relevant for a specific managerial alternative and can be avoided in another alternative. For example make or buy decisions, pricing decisions.

Irrelevant costs – Irrelevant costs are those which remain unaffected in any alternative being considered for a business situation and is incurred in case of all of them. Like the sunk costs which cannot be recovered or refunded and are retrospective in nature. For example cost of training the sales force to use special electronic devices to take orders and later these devices are discontinued due to technical faults, therefore cost incurred on training is a sunk cost and should not be considered in any decisions regarding the usage of electronic devices.

(microbuspub.com, 2016)

VARIANCE ANALYSIS

Variance is the result of deviation of actual cost from the standard costs. Standard costing is a technique of cost control which provides management a benchmark for determining variances i.e. standard costs. The process of analyzing variances whether favorable or unfavorable is variance analysis.

Favorable variance- when the actual cost is less than the standard cost.

Unfavorable variance- when the actual cost is higher than the standard cost.

The intent of variance analysis is to categorize variances as variance which can be controlled and variances which cannot be uncontrolled.

By concentrating on controllable and adverse variances management can exercise control through exception as well as take actions against those employees who are responsible for adverse variances.

Example for controlled variance can be material used in excess of standard quantity will be adverse for which onus can be fixed on the concerned employees. But if this variance is caused due to general strikes, variation in customers, demand variances cannot be controlled and no onus can be fixed for it.

Variances under individual center of cost and revenue are as follows-

Material, labour and overhead cost variances

Material and labour cost variance refers to the gap between material cost which is standard for the product and the actual cost incurred and actual quantity of material used or the standard direct wages specified and the actual wages paid respectively.

Direct Material cost

Variances can be used to measure the price differences like the material price variance and labour rate difference. In the similar way we can determine variances in material usage and labour efficiency commonly known as material usage variance and labour efficiency time variance respectively. Labour efficiency variance Is further classified into-

Idle time variance

Labour mix variance

Labour yield vareince

Overheads cost variances are the deviations in variable and fixed overheads. Variances which are used in determining price differences are fixed and variable price variances, on the other hand variances determining efficiency of the overheads are fixed and variable efficiency variance.

Sales variances

Sales variance is termed as the spread between budgeted sales and actual sales and its impact on profits. Sales variance can be calculated by two methods:

The turnover/value method

The margin/profit method

Limitations of variance analysis-

Firstly, variance analysis do not furnish us the causes of deviations which are calculated using variance analysis.

Since all attention is paid to unfavorable variances, it does not mean favorable variances need no investigations. A constant favorable variance can be the result of sub standard products, or maybe genuine improvement in performance.

For example, Pizza hut has specified a uniform quantity of cheese that should be in a pan cheese pizza. Variance would be favorable if less cheese was used than the specified standard. The result could a below standard pan cheese pizza and probably an unsatisfied customer.

Variance analysis points out at works upon the negatives and ignore the positive results due to which employees feel disappointed due to look of appreciation.

Variance reports are generally prepared monthly and are presented even weeks after the closure of the month which limits the utility of the data to be used for decision making. Therefore, Variance reports are needed to be reported timely and frequently so that the data might not become stale and useless, for that the frequency of reporting has to be daily and data may be approximate if not precise.

The term “budget” can be elucidated as a financial or quantitative statement prepared prior to a defined period of time, pursued for that period of time to attain the given objectives.

The types of budgets can be explained with respect to functional areas of management, which are as follows –

Sales/marketing budgets –

Sales budget- It is an estimate of total sales that is expressed in terms of quantity or amount. It is an interconnection between sales volume and sales price.

Indirect Material cost

Selling and distribution budget –is prepared on the basis of flexible budget for each class of distribution and selling costs, keeping the basis as sales volume which has to be reached.

Advertising cost budget – is constructed in the shape of a fixed amount for the budgeted period. This cost is incurred to increase the sales.

Production budgets – It is an estimate of production volume for the budget period which can be framed in two ways i.e in terms of volume and in terms of amount such as cost of direct materials, cost of direct labour and the overheads cost.

Personnel budgets – it refers to the labour force that would be required be it skilled or unskilled, to conform with the budget of revenue and production. The budget also pays heed to training plans for new workers.

Finance budgets – is the cash budget which provides an estimate amount of receipts of cash and cash payments to be made during the budgeted period. It helps in predicting excess or shortage in cash at any point of time. It can be prepared by these methods

Receipts and payment method- useful for estimates to be used for short term analysis

Balance sheet method- useful for estimates to be used for long term analysis

Adjusted profit and loss method- is prepared to highlight the cash balance that is estimated at the end of the period

Overheads cost budget – it indicates various forms of overheads to be spent during the budgeted period for which the overheads have to be classified into fixed, variable and semi-variable.

Capital expenditure budget – It is the estimated investment in capital assets. This budgeted has to be coordinated with other functional budgets.

Master budget – is prepared by incorporating all the budgets that are functional which takes the shape of income and loss account and the budgeted statement of affairs.

Advantages of preparing operational budgets

• It is an aid for managers which would assist in performance appraisal.
• It is a medium for facilitating coordination. It develops team spirit and helps in finding solutions to common problems
• Budgeting reveals the areas of adverse variations, keeping aside those areas with no variations.
• It acts as a mode to communicate. The plans framed down by senior management are assigned to the subordinate levels of management via budgets. Each and every employee is aware of his duties in reference to those of others.
• Budgeting acts as a media to declare the polices of the management to the employees.
• It is a strong tool used for the purpose of cost control.

Conclusion and Recommendation

So finally we can conclude that management accounting can help Vihaan Engineering Inc as a necessity for all the business undertakings which have intent of expansion and thrives to increase its competitiveness in the global world. It fulfills the shortcomings of financial and cost accounting, and serves the management with quantitative as well as qualitative data which can be used to make strategic and operational decisions. Elements of costs are classified on the basis of types, behavior, relevance etc. which assists in preparing budgets and hence acts as an aid for all the cost centers, by providing them the direction in which they have to work upon. Further budgeting data provides business inputs for variance analysis. The result provided by variance analysis aids the management to concentrate on key result areas as well as facilitate management by exception, hence reducing wastage of resources.

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