Management Accounting is formed of two words where the term “Management” denotes the process of planning and organizing the efforts of personnel to achieve desired results and “Accounting” denotes the process of recording, classifying and analyzing the day to day transactions. (Agrawal, 2009) Therefore, Management Accounting can be said as the process of accounting of business transactions in such a way that it results in fulfilling the overall business objectives. (Maurice L. Hirsch, 2006)
The term Financial Accounting however is related to the financial aspects of the business only. It refers to formation of reports and statements which are the production of day to day business transactions. (Banerjee, 2008)
Financial Accounting is concerned with the proper recording and systematic maintenance of business transactions so that the financial position can be ascertained at the end of a period whereas Management Accounting provides useful information to the management to enable them to take necessary actions for efficient business management. (CMBKK, n.d.)
The Generally Accepted Accounting Principles (GAAP) form the basis of financial accounting and it needs to be strictly followed by a financial accountant. The Management Accounting is not too strict about adherence to such principles and conventions. (CMBKK, n.d.)
Financial Accounting results in preparation of financial statements projecting the status of affairs and profit & loss generally for a period of 12 months. However, management accounting can be done for any period of time. Generally it is done at regular intervals to assess the business performance. Therefore, a higher level of accounting is needed in this method. (CMBKK, n.d.)
Financial Accounting is more peculiar about precision as it focuses on actual figures and numbers rather than their meaning and thus provides no room for approximation. In management accounting the objective is to analyze whether the business is working in the desired direction and therefore the actual and correct figures are not a peculiar requirement.. (CMBKK, n.d.)
The Balance Sheet and Profit and Loss Statement are the final production of financial accounting which is generally published for the use of public and stakeholders. The statute requires mandatory audit of the final accounts of a business by a professional qualified to do the same. But there is no such requirement of management accounting reports because they are meant only for the management and internal use of the business. (CMBKK, n.d.)
Break Even Analysis is a management technique to assess the profitability of a business to find out whether the production and operation of an organization are lucrative. The financial experts generally use the Cost-Volume-Profit analysis or break even analysis to measure and forecast the profits of a business. Break-Even means that level of production by the organization which gives a no profit no loss situation. (Cafferky & Wentworth, 2010) This enables the managers to identify the minimum level of activity below which there can be losses. Thus, it helps in reducing the losses and set a suitable profit margin which reflects the actual operations.
Break Even Point reflects the volume of operations of a business where total marginal sales equals total marginal costs. In other words, it shows whether the business is able to cover its total production costs at a given level of activity. (Commission, n.d.)
The break even analysis is based on the two important cost factors which are described as under:-
The marginal costs or the costs which changes with a change in the level of production is referred to as Variable Costs for eg; the cost of raw material, direct labor, variable overhead etc. (pinson, 2008)
The cost which remain constant whatever the level of activity is referred as the fixed cost. These costs normally include the administration and maintenance related expenses for eg; salaries of office staff, rent and rates, depreciation, advertisement and other marketing expenditure, insurance etc. (pinson, 2008)
The graphical representation of the BEP level of activity depicting the relationship between the costs of production bifurcated into fixed and variable, the volume of sales and profitability is known as the BEP Chart. The point of break-even is reached where the line representing total costs crosses the line of total revenue. (Dutta, 2005) An analysis of a BEP chart can be well understood as under:-
With the help of this analysis the managers can make a useful insight of the profit margin at different possible volume of sales as shown in the chart above. The chart further elaborates that at sales volume of 40 units the company has reached its break-even point. Therefore the company should operate above this level to earn profits. (Sharan, 2009)
This analysis can be used to find out the total volume of sales which should be made in order to earn a desired profit. Normally companies follow the method of operation by earning a fixed percentage of profit and it is important to know what amount of sales is required to earn the desired percentage. BEP provides a helping hand for this. (Sharan, 2009)
Whenever there is proposal for change or replacement of machinery the management needs to analyze the impact on fixed and variable costs and the overall profit margin. BEP chart provides a useful measurement framework for this as depicted above. (Sharan, 2009)
Budget can be defined as a prior plan or a forecast for a particular period of time taking into consideration the various factors relating to the period of budget. Thus, it is advance preparation of the statement of operations to take useful decisions about the future. (Venkatesh, n.d.)
Sales Budget could be said the initiation point for preparation of other operational budgets. It shows the estimated sales for the future period in volume as well as amount. The management should take into account three major factors while preparing a sales budget-
The normal duration of sales budget is for the whole financial period. However, in order to co-ordinate with various production programs and the policy for stocking the sales budget can be prepared for shorter durations as well. (Bhattarcharyya, 2011)
The purchase budget provides elaborative information about the purchasing needs of the organization. This budget mainly depends on the budget for raw material and the service budget for the period. (Bhattarcharyya, 2011)
The major factors to be kept in mind for preparation of an efficient purchase budget are-
This budget is one of the important budgets after sales budget. This depicts the number of actual units to be purchased during the period of budget. It provides a detailed program of production which the organization needs to follow. Further, it specifies that at what level the organization needs to work in order to match the budgeted sales. (Bhattarcharyya, 2011)
Material budget covers the requirement of purchase of raw material for the budgeted level of production. It further shows the requirement of spare parts and consumable stores which are normally required for the repairs and maintenance of fixed assets needed for the manufacturing process for example, plant, machinery and other equipments. (Bhattarcharyya, 2011)
Labor Budget on the other hand provides an insight for the need of direct as well as indirect labor. (Bhattarcharyya, 2011)
A typical labor budget discloses the following information-
Overhead budget is bifurcated into Production Overhead Budget, Administration Overhead Budget and Selling and Distribution Overhead Budget. Production overhead budget shows the requirement of indirect materials, indirect labor and other indirect costs. Generally, the expenses under this budget are classified into fixed, variable and semi-variable expenses. Similarly, the administration budget depicts the requirement of office and R&D expenditure and the selling and distribution budget depicts the advertisement and expenditure related to the sales executives. (Bhattarcharyya, 2011)
Cash budget shows the anticipated cash receipts and cash payment for the budget period. The planning and forecasting of cash is always a useful thing to be done for the analytical work of management. This budget depicts the availability of cash for taking trade advantages, requirement for short term funds, excess cash requirements and additional funds etc. (Bhattarcharyya, 2011)
The below graph shows a budgeted cost structure of a concern under various levels of production-
Variance can be defined as the difference between the standard cost fixed by the management and the actual costs incurred during the period. This analysis needs proper support and insight of the top management because the division of total variances should be made in such a way that the identification of the personnel responsible for various tasks is possible. This would help the management in determining whether the deviation in performance is due to the mistake of which personnel and what corrective actions are required. (Berger, 2011)
Favorable Variance means a positive result when we deduct actual cost from standard cost. This implies that he actual costs incurred is less than what is set to be incurred and shows the operating efficiency of the organization. Unfavorable Variance on the other hand gives a negative result when the actual costs are deducted from standard cost. This depicts a situation of under-budgeting the production level and gives the picture of inefficiency of performance. (Gupta, 2012)
A variance is the responsibility of a particular person who is responsible for discharging efficient functions and his degree of efficiency can be reflected in the size of variance. This kind of variance is known as Controllable Variance. For e.g.; the foreman is responsible for maintaining the balance for usage of material and its excess usage is his responsibility. However, if there is a defective material, the inspection department comes in the light and is responsible for the deviation as the non-detection of defects is purely the inefficiency of the inspectors who receive the material.
If the variance occurs due to the factors which are beyond the control of management, it is known as Uncontrollable Variance. The examples of such variance could be a change in the overall market prices of material required for the production, decrease or increase in the labor rates, insurance rates or the rates of power etc. these factors operate at macro level and can never be controlled by the management. Their responsibility cannot be assigned to any particular department or individual.
The controllable and uncontrollable variances are very important for management. More emphasis should be given to the controllable variances and efforts should be made to minimize the variance to the least possible. The uncontrollable variances are always beyond the control. The very well-known principle of management i.e. “Management by Exception” applies here which says that the matters which are working in correct direction should not be given attention and the deviations visible from the expected performance should be investigated. (Gupta, 2012)
The below graph represents the variance analysis of the labor division which will help in understanding the topic better-
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