Differences Between Financial Accounting And Management Accounting, Breakeven Analysis, And Types Of Budgets

Financial Accounting vs. Management Accounting

1.Accounting is one of the major role that all the entities are requires to play for various purposes. Accounting is broadly classified into two branches Financial accounting and Management accounting. Both these branches of accounting are used in different areas and by different users and both of them are very significant for an organisation (Berman, Knight and Case, 2013). These principal branches of accounting are mainly used for taking prudent decisions. There are many similarities and dissimilarities between them.

Financial accounting is the process of recording all the transactions occurring in the entity and summarising them for the preparation of financial statements. These financial statements are helpful for giving both qualitative and quantitative information about an entity to its users and hence it should give a true and fair view of the entity (Bragg, 2014).

Management accounting is the process of providing relevant financial and non financial information to the managers of an entity so that they can take decisions wisely which will help them to work efficiently and achieve organisational goals. Management accounting is done on the basis of financial accounting as well as cost accounting (Brigham and Ehrhardt, 2017).

There are certain differences in the financial accounting and management accounting which are discussed below-

Financial accounting is usually used for obtaining financial information about an entity and to compare its performance over the years whereas management accounting helps to obtain both financial and non financial information.

Financial accounting is used to prepare financial statements of an entity that are used by both internal as well as external parties and so it is reported publicly. In case of management accounting, the management reports are used only by the internal management and hence these are regarded as confidential information (Brigham and Ehrhardt, 2017).

An entity while doing financial accounting has to follow a prescribed format but there is no such thing in case of management accounting.

Financial accounting is usually done for a fixed period which is usually one year but management accounting can be done as per the requirements of the management quarterly or half yearly.

A company’s financial information is contained in the financial statements that are prepared through financial accounting whereas management accounting provides both monetary as well as non monetary information.

Financial accounting needs to be audited by a statutory auditor as per the governing rules but management accounting is done only for internal use and therefore it is not required to be audited or published. It is mandatory for every company to do financial accounting but it is voluntary to do management accounting.

2.Breakeven analysis is an important step taken to determine that there should be enough revenues to cover the cost incurred. This is used to know the sales goals that a company needs to achieve (Ehrhardt and Brigham, 2011). It is a tool which strengthens a business plan and helps to know that the business plan has a practical approach.

Break-even point is the stage at which the revenues earned by the entity is equal to the total cost that has been incurred in the process of production and distribution. At this point, the entity has no profit or loss but beyond this point with every additional unit of goods sold the profitability increases (Garrison, Noreen and Brewer, 2012).

Breakeven Analysis

This situation can be achieved when it satisfies the following equation-

The total cost incurred includes both fixed cost and variable cost. Fixed costs are those cost which remains fixed irrespective of the volume of production. These also includes the cost incurred to start the production. Such costs cannot be avoided in the short run. For example, the manufacturer has to pay rent every month even if he stops producing any goods (Gitman and Zutter, 2012). Variable cost are those cost which depends on the volume of production directly If the number of units produced increases then such costs also increases and vice versa. For example, the cost of raw material depends on the number of units that need to produced. If the number of units to be produced is more then the raw material will be in huge quantity and therefore the variable cost incurred will be high.

Breakeven point can be calculated both in terms of volume of sales and number of units (Hoyle, Schaefer and Doupnik, 2015). Calculation of break-even point in terms of units means the minimum number of units that a company needs to produce in order to break-even. This can be calculated by using the formula:

A company firstly uses its resources for production and the rest it uses for the growth and development of an entity. Therefore, a proper study is required. This analysis is all about understanding the financial position and the profitability of the entity.

Let us consider an example to understand the break-even analysis more properly-

An entity produces a product X whose selling price per unit is $20 per unit. The fixed cost is $40000 and the variable cost is $10 per unit. We can calculate the break-even point using the given formula-

In the given situation, Fixed cost is $40000 and contribution per unit $(20-10) is $10. Therefore, the breakeven point is 4000 units. The company will have no profit or loss but it will be able to cover all the cost incurred when it sells 4000 units.

Level of units	Total Variable Cost ($)	Fixed Cost ($)	Total Cost ($)	Total Revenue($)
–	–	40,000	40,000	–
500	5,000	40,000	45,000	10,000
1,000	10,000	40,000	50,000	20,000
2,000	20,000	40,000	60,000	40,000
3,000	30,000	40,000	70,000	60,000
3,500	35,000	40,000	75,000	70,000
4,000	40,000	40,000	80,000	80,000
4,500	45,000	40,000	85,000	90,000
5,000	50,000	40,000	90,000	1,00,000

The graphical representation shows that the entity will only be able to cover cost when it sells 4000 units but beyond that point the entity will earn profit. This shows the concept of breakeven analysis more precisely.

3.The estimates made by the company of its expenses for a specified period of time are called a budget. This helps the decision making easier. It is one of the most important tools as it helps to create a plan for the future activities that the company is going to perform (Kinney and Raiborn, 2011).

There are several types of budgets with their own importance. Few of them are explained below-

Financial budget- Financial budget is considered one of the most important budget. The management gets an idea of the resources that it would require in the future to carry on its future operations (Koster, 1997). As we know, lack of liquidity can stop the operations of the entity which may lead to heavy losses. Therefore, it keeps the entity prepared for any kind of sudden changes or cash crunch situations. It is necessary to know that what expenses are important to the entity and make a planned budget according to the requirements.

Types of Budgets

Production budget- A production budget is used to keep a track of the cost incurred in production of goods (Mondy, 2015). The production budget is mainly based on two factors one is inventory and the other one is sales target. A production budget is prepared keeping in mind the cost involved in producing the inventory that an entity wants to keep available to meet sudden requirements. Secondly, the production budget estimates the cost that will be incurred to fulfil the demand of its product.

Overhead budget- The cost that are not directly attributable to the product or are indirectly related to the product are called overhead cost. For example,  greight, travel, supplies, etc. This budget helps the company to control cost wherever possible. It helps the company to keep a plan of the overhead that will arise to meet the production targets (Pratt, Anthony and Clement, 2003). It helps to increase the efficiency of an entity as it helps in eliminating the unnecessary costs. This budget is considered very important as it involves a large part of the total expenditure incurred by the company.

Sales budgeT- Sales budget is a master plan to generate revenue. It helps the entity to determine the number of units that will be produced and the expenses relating to such production which will help to generate revenue (Ramsey and Ramsey, 2003). The company can Evaluate its performance for the specified period by comparing the estimated sales to the actual sales. If the actual sales is less than expected sales then the budget is considered faulty. The budget also acts as a target which the company aims to achieve in order to earn maximum profits and generate the expected revenues.

Personnel budget- This budget helps to determine the manpower that will be required in the entity for the budgeted period. This is a very important budget as we know there is no entity which can carry out its operations without manpower. Manpower does not only include labour but also persons involved in administration or distribution departments (Schipper, 2012). It helps in shifting employees from one department to other so that they can give best results. There are departments which analyse the abilities of various employees and allocate them job according to their abilities this budget also includes the recruitment practice of a company.

Master budget- The summary of all the functional budgets which gives an overall image of an entity is called master budget. It helps in making decisions wisely so that the company is able to achieve the expected targets. It helps the company to analyse its own performance by carrying out ratio analysis which gives a scope of improvement in the future.  This is a very important as it helps the company to direct the activities of the employees of the entity (Stickney and Weil, 2003).

4.Variance analysis is the difference between the estimated values and the actual values. If the difference between them is large then the reason for it is checked.  It is one of the mostly used tools of cost accounting as it helps to analyse the expenses and ways to control these expenses.

Material variances- This variance is used to determine the gap between the actual consumption of raw material and the expected consumption of raw material. It helps to maximise the output and minimise the wastage of raw material and hence it results in saving of cost (Weil, 2014). As we know that material is the major input required to produce a finished good we need to use it efficiently so that there are minimum wastage as raw material involves huge cost. This study not only helps to minimise cost but also leads to improvement of the quality of the product. Hence, it is useful for the enterprise as well as the end consumers.

Sales variance- Sales variances are the variance between the actual sales of a specified period and the estimated sales. If the actual sales are more than the expected sales then it is considered favourable and is considered good for the company. But achieving the sales target should not be the only motive of the company. It should also analyse its performance by calculating the profitability and efficiency ratios of the company.

Variable overhead-   Variable expenses are the indirect expense which increases with the increase in production. If the actual overhead incurred is more than the expected overhead then it is known as negative variance and in such a situation the management should find out the reason for it and take corrective steps. Positive variance is beneficial for the large scale operation.

Labour variance- The difference between the actual manpower used in the budgeted period and the expected manpower is labour variance. Negative variance is unfavourable as the company has spent more manpower than it was planned by the entity. This increases the cost burden but decreases the efficiency, Positive variance that the company is using its resources in an optimum way and efficiently.

Variance analysis is a managerial accounting which helps to determine the deviation between the performance of an entity. This is a a very important tool that should be used by all entities to evaluate their performance and take all the possible corrective measures in order to get positive outcomes. It helps the entity in taking decisions confidently and creating a proper plan to use its resources more effectively and efficiently. It benefits the company in two ways. Firstly, it helps to reduce the cost. Secondly, it maximises profit. It makes the entity more focussed towards it goals and keep them motivated to achieve it by providing them proper plan.

References:

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