1. Discuss the importance of management accounting for your selected organisation and differentiate between management accounting and financial accounting.
2. Evaluate different classifications of costs (types, behaviour, function and relevance) with examples.
3. Explain the meaning of variance analysis and discuss the most commonly derived variances, outlining the problems and limitations.
4. Identify different operational budgets and explain the advantages of preparing different operational budgets.
Management accounting is a part of accounting but this particular section deals with the accounting related to the management (Bhattacharyya, 2011). Therefore, management accounting is the systematic process of developing management reports and accounts, which represent the statistical and financial information of an organization in a simple and precise manner (Bhimani, 2012). The main aim of this report is to improve operating efficiency of Jaguar Land Rover Automotive Plc, the manufacturing company of the UK by controlling cost and improving profitability.
Importance of Management Accounting
Within the organization Jaguar Land Rover Automotive Plc, management accounting is an important factor because the particular company is having a complex business as it deals with automotive designing, development, manufacturing and sales of the vehicles. Therefore, systematic management planning is required for the company. Management accounting helps to gather systematic information to assist the managerial investigation, evaluation and verification of the functions of each division in order to take decision and to accomplish the goals of the particular company (Groot and Selto, 2013). Management accounting also helps the managers of the company to accomplish corporate objectives. The other reasons for practicing management accounting within the organization Jaguar Land Rover Automotive Plc are it helps to recognize the financial condition of the company and also reports for directing, controlling, motivating, planning and performance evaluation.
Differentiation between Financial Accounting and Management Accounting
The management accounting and financial accounting both are the part of accounting but serves for different purposes. Management accounting presents the internal data of an organization, whereas, financial accounting is for external purpose that is for the stakeholders of the company. Financial accounting is a precise factor but is adhered to Generally Accepted Accounting Principles (GAAP) and plays important role for potential and current investors. On the other hand, management accounting is based on estimate or guess as exact data remain unavailable to the managers during the time of decision making and this type of accounting also helps managers to make future and current financial decisions (Epstein and Lee, 2015).
On the basis of types, the costs can be mainly classified into direct cost and indirect cost. The cost that is directly related to the production of goods and/ or service is called direct cost. For example, labor cost, material cost, expense and distribution cost as all these costs are associated with production. On the other hand, indirect costs are the costs that are not directly related with the production of goods and/ or services and this cost cannot be easily identified for a particular product, activity, department and project (Drury, 2012). For example, the company Jaguar Land Rover Automotive Plc has manufacturing area, where the cars are manufactured. The electricity that is used to power the entire manufacturing area is considered as indirect cost.
On the basis of the behavior, the costs can be classified in to fixed cost, variable cost and semi-variable cost. The fixed cost does not vary with the numbers of goods produced and is associated with cost accounting. For instance, Jaguar Land Rover Automotive Plc leases a machine for manufacturing cars and it has to pay $3000 per month with the aim to cover the lease cost. This lease payment is considered as fixed cost. Similarly the cost that depends on the quantity of production is termed as variable cost. Therefore, when the production of Jaguar Land Rover Automotive Plc increases, the variable cost also increases and vice-versa. For example, cost incurred for designing cars is a variable cost as this cost increases with the increased production of cars and vice-versa (Horngren, 2011). Lastly, semi-variable costs are the costs that lie between the fixed costs and variable costs. For example, the electricity company charges $300 per month for electricity service and then it charges $0.015 per kilowatt. Thus, the cost of electricity bill is a semi-variable cost.
On the basis of function, cost is of four types – production, administration, selling and distribution, R&D. The cost that is related to production is production cost, like cost of production of cars. The office expenses, warehouse expenses and other costs related to regulation of the business is termed as administration costs (Horngren and Horngren, 2012). The costs like advertising, sampling (test drive) that are related with the selling of the products (cars) are termed as selling and distribution expenses. Jaguar Land Rover Automotive Plc researches to develop new type of cars of various models. The costs incurred for this is termed as R&D costs.
On the basis of relevance, the costs are of three types – avoidable costs, opportunity costs and incremental cost. The costs that be avoided with the refusal of the implementation of the particular decision are called avoidable costs. For example, the company might decide to open another plant for manufacturing, if this decision is not implemented in real then all the costs associated with buying plot, construction of plant can be avoided. Opportunity cost is the expense that one can incur for one purpose only or for the next best alternative and that cannot be invested in other project. Incremental cost is the expense where various alternatives are considered.
Variance analysis is defined as a quantitative investigation of difference between the planned behavior and the actual behavior (Eldenburg, 2011). This particular analysis is used to control and maintain the business. It can easily be explained by an example – the budget for sales of cars is $20000 and lastly it seems that the actual sales of cars took place is $18000. Therefore, the variance is $2000. The variance analysis is primarily effective at the time of review of the variance amount as per a trend line such that the changes in the level of variance from one moth to another are readily apparent. Variance analysis also includes the investigation of the differences of these, whose outcome is the difference from expectation.
There are various types of variance analysis, but the most commonly derived variances that are generally used in all businesses including in the manufacturing companies like Jaguar Land Rover Automotive Plc, are – material variances, variable overhead variances, and labor variances and fixed overhead variances (Jaguarlandrover.com, 2016). Material cost variance is defined as the differentiation that takes place between the cost of direct materials that is considered as the standard and are specified for the achieved output and the real cost of the materials that are considered as direct. The material cost variance (MCV) is determined from the differences between quantities of material allowed and the quantities consumed for the production (Drury, 2012). It is the differentiation between predetermined and the actually paid prices.
Mathematically, the material cost variance is represented as:
MCV = (SQ x SP) – (AQ x AP)
Where, AQ represents Actual Quantity, AP represents Actual Price, SQ represents Standard Quantity for the actual output and lastly, SP signifies Standard Price.
Materials Price Variance (MPV) represents the difference between the price at which the raw materials are purchased and the raw materials’ average price. It is mathematically represented as:
MPV = (Standard Price – Actual Price) x Actual Quantity
It is considered as unfavorable at the time when definite price paid for raw materials exceeds predestined standard price. This is used for calculation during the purchasing of materials rather than during the use of the materials. MPV helps in corrective action and performance management (Horngren et al., 2012).
The material quantity variance (MQV) is the definite quantities of materials which are utilized in production of goods and vary from standard magnitude. It is mathematically represented as:
MQV = (SQ for actual output – AQ) x Standard Price
It is considered to be favorable when the use of definite magnitude of direct raw materials is lower than standard magnitude.
The material mix variance (MMV) occurs at the time during which raw materials are not used in producing products used in the standard formula of accounting (Young, 2012). It is mathematically represented as:
MMV = (Revised Standard Quantity – AQ) x Standard Price
Labor cost variance (LCV) identifies the differentiation that takes place between the standard direct wages and the real direct wages paid specially for the output received. Mathematically, it is represents as:
LCV = (SH x SR) – (AH x AR)
Labor rate variance (LRV) is the differentiation of the actual fee that is paid to labor and the specified standard price of labor. It is mathematically represented as:
LRV = (Standard Wage Rate – Actual Rate) x Actual Time
This is considered as unfavorable at the time during which actual rate of wage paid go above the prearranged standard fee of wage.
Labor efficiency variance (LEV) is defined as the time taken relative to the specified standard time for work performance (Horngren et al., 2012). It is mathematically represented as:
LEV = (SH for actual output – AH) x Standard Rate.
It is considered to be favorable at the time during which real hours are relatively lower than allowed average hours.
Thirdly, Variable Overhead Variances is the differentiation that takes place between the real variable overhead that incurred and that variable overhead that is considered as the standard. It is mathematically represented as:
Variable OH Cost Variance = Standard Variable OH on actual production – Actual variable OH
Lastly, the differentiation that takes place between the absorbed or recovered average overhead for definite productivity and fixed overhead that is actual is termed as Fixed Overhead Cost Variance. It is mathematically represented as:
Fixed OH Cost Variance = (Recovered or absorbed Fixed OH) – (Actual Fixed OH)
Problems and Limitations of using Variance Analysis
The main problems of using variance analysis by the company are:
Firstly, the variance analysis is a time consuming factor as this analysis needs a one month time. However, the management requires the information much faster for decision making, thus this type of analysis is generally avoided by the managers (Epstein and Lee, 2011).
Secondly, the reasons for variances cannot be identified from accounting records (Drury, 2013). Thus, the managers have to search for information in bills of materials, overtime records. This extra work is cost-effective.
Lastly, as variance analysis is a comparison of arbitrary and actual results, the resulting variance might not defer any useful information.
Different Types of Operational Budgets
Operating budget is defined as a statement that represents the financial plan of an organization during period of budget and reflects the operating activities of the business that is expenses and revenues. The types of operational budgets are revenue, expense and profit budgets.
Expense budget represents the expected expenses at the time of budget period (Seal et al., 2012). In this type of budget, three types of expenses are evaluated; these are fixed, discretionary and variable expenses.
Revenue budget determines the revenue required by the firm and it also projects the amount of future sales.
Profit budget is the combination of both revenue and expense budgets into a single statement that indicates the net and gross profits.
Advantages of Preparing Different Operational Budgets
The primary advantages of preparing various kinds of operational budgets are – firstly, the different types of budgets help the managers to keep a track of record of total expenses, total revenue and the profit earned by the company. Secondly, the different types of operational budgets help to establish financial accountability and reduce the probability of losing the aim of the organization (John Y. Lee., 2012). These budgets help the managers to take decision as all the data are readily available. Thirdly, confusion reduces and the accounting becomes more transparent and simple. Lastly, the future expenses of the organization can also be projected easily and thus helps in decision making.
Conclusion
Therefore, it can be concluded that, in every organization including Jaguar Land Rover Automotive Plc, management accounting is applied in order to collect systematic information of the organization. This assists the managerial investigation, evaluation and verification of the functions of each division in order to take decision and to accomplish the goals of the particular company. Depending on the industry to which a particular company belongs to, the various types of costs and variance analysis are applied in order to make the operation of the company easier.
Thus, it can be recommended that the company should employ management accountant in order to make the operations of the company easier. It is not necessary to implement all the types of variances in an organization. For instance, it can be recommended that the organization Jaguar Land Rover Automotive Plc, should implement the purchase price variance as the particular company belongs to the manufacturing industry and this specified company is in a highly competitive market. Similarly, it is not necessary to implement all types of costs within the organization; rather based on the operations of the organization the costs should be calculated.
References
Bhattacharyya, D. (2011). Management accounting. Noida, India: Pearson.
Bhimani, A. (2012). Management and cost accounting. Harlow, England: Financial Times/Prentice Hall.
Drury, C. (2012). Management and cost accounting. Andover: Cengage Learning.
Drury, C. (2013). Management accounting for business. Andover: Cengage Learning.
Eldenburg, L. (2011). Management accounting. Milton, Qld.: John Wiley & Sons.
Epstein, M. and Lee, J. (2011). Advances in management accounting. Bingley, UK: Emerald.
Epstein, M. and Lee, J. (2015). Advances in management accounting. Bingley, U.K.: Emerald.
Groot, T. and Selto, F. (2013). Advanced management accounting. Harlow, England: Pearson.
Horngren, C. (2011). Introduction to management accounting. Upper Saddle River, N.J.: Prentice Hall.
Horngren, C. and Horngren, C. (2012). Management accounting. Toronto: Pearson Canada.
Horngren, C., Datar, S. and Rajan, M. (2012). Cost accounting. Upper Saddle River, N.J.: Pearson/Prentice Hall.
Horngren, C., Harrison, W. and Oliver, M. (2012). Accounting. Upper Saddle River, N.J.: Pearson Prentice Hall.
Jaguarlandrover.com. (2016). English | Jaguar Land Rover Corporate Website. [online] Available at: https://www.jaguarlandrover.com [Accessed 30 Mar. 2016].
John Y. Lee., (2012). Advances in Management Accounting. Emerald Group Pub.
Seal, W., Garrison, R. and Noreen, E. (2012). Management accounting. London: McGraw-Hill Higher Education.
Young, S. (2012). Readings in management accounting. Boston: Prentice Hall.
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