Main Purposes And Importance Of Management Accounting In Organizations

Accounting and Its Relevance

Financial Accounting and Management Accounting

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

In this report, discussion will be mainly based on management costing concept, its impact on the management in taking strategic decision and how it differs from the financial costing. While understanding the concept of management accounting an in-depth knowledge of various types of cost is required to be required. After that, all the costs are identified and categorized. Then budget for the upcoming year is to be prepared based on the cost and production level analysis (Kaplan and Atkinson 2015). Then after the actual performance during the whole year, variance analysis is made between budgeted cost and actual cost where the reasons for variances are identified and reported to the management.

Financial accounting is based on various accounting standards, which an organization must comply in order to present a transparent financial statement with the users. Whereas management accounting is concerned with the operation report that helps the management to understand the present financial position of the company and make strategic plans for future (Horngren et al. 2013). For example, the cost of not meeting demands or opportunity cost is not reflected in financial accounting but it is reflected in management accounting so that management can understand what would have been there actual profit if they had been able to meet their demands fully.

Whenever any new software is to be implemented, management must consider all the factors of it which will affect the financial accounting as well as management accounting. Financial accounting tends to report on the entire business of the organization where management accounting provides a detailed analysis of product line, cost allocation between various products (Deegan 2012).  Financial accounting mainly focuses on the profitability of the organization whereas management accounting indentifies the causes of problem related to the operation and help in finding ways to fix them. In financial accountings records are required to be preserved to prove that financial statements are prepared in consistency with accounting policies whereas management accounts deals with future forecast and decision making aspects of the organization (Edwards 2013). It includes budget and variance analysis.

In case of financial accounting, financial statement is required to be prepared at the end of accounting period that may be quarterly, half yearly or yearly whereas in management accounting reporting is made to the board of directors frequently so that they can make strategic planning with the latest report.

Classification of Cost

Cost and revenue are the two important aspects based on which the completely financial statement is prepared. Either every item in the financial statement is a cost incurred by the company or revenue generate from sale of goods and service (DRURY 2013). Therefore, classification of cost is very important so that financial statement reflects the true picture of the organizational performance. 

• Committed fix cost: Committed fix cost are those type of fix cost, which has been committed to be incurred in future. For example, monthly salary paid to employees, office rent and warehouse rent. These costs are relevant for long term planning and not for short term planning (Ramanathan 2014). These costs do not vary with the production level and is reduced per unit when production level increases.
• Sunk Cost: These are cost which have already been incurred and nothing can be done. For example, non-refundable down payment, which has already been, paid to purchase machinery which will be forfeited if the machinery is not purchased. These costs are irrelevant for decision-making purpose.
• Slab fixed cost: This type of cost is fixed up to a certain level after that it increases and remain fixed again up to a certain level (Balakrishnan, Labro and Soderstrom 2014). For examples, number of nurses required is 4 for 100 patients or part thereof. So whenever the number of patients increases above 100, number of nurses required is 8.
• Discretionary fix cost: This type of fix cost is relevant to any decision making. For example, if any new proposal is to be accepted by the management for the ideal capacity it have then it may have to incur certain fix cost, which is specific to the new proposal.
• Opportunity cost: It is the contribution lost for not producing one product because of producing any other product in its place. This cost is to be taken into account while taking any new proposal i.e. it is relevant for decision-making purpose. It is also known as shadow cost (Fullerton, Kennedy and Widener, 2013). Whenever decision is to be taken for any other alternative then net evaluation of the product is to be computed based on shadow price based on that decision is to be taken.
• Variable cost: Variable costs are those changes with the production level. It is relevant for short term as well as long term since they are measured per unit. It is fixed per unit of goods sold whereas fixed cost per unit changes with increase in production level. For examples raw material per unit, labour cost per unit and other cost which are measured per unit.
• Marginal Cost: It is the cost of producing one additional unit of a product. Marginal costing is used to compute profit volume ratio, breakeven point (Ward 2012). It is relevant for short-term decision making by the management. Management must do breakeven analysis whenever any new investment is to be made.

Budget is required to be prepared before starting any business and every year so that management can have an idea of the cost and revenue structure of upcoming year. Budget is prepared and presented to the management as an estimation of various cost and the profitability of the company given a particular production level.

Zero Based Budgeting (ZBB) is the starting point of preparing budget. First the cost centres are to be identified then flexible budget is to be prepared, then identify the principal budget factor. After that functional budget is to be prepared and at last variances are to be computed. In this process, traditional budget is to be prepared and then differences are adjusted with functional budget as budget allowances (Otley and Emmanuel 2013). Now after six or seven years the budget will not reflect the exact position of the business. Hence, to get back the original budget performance the budgeting process will again start from zero i.e. identification of cost centre, flexi budget and so on and for this purpose budget allowance are not considered. This whole process is known as ZBB. However, this process is costly and time consuming.

Operational budget is a plan for the expenditure to be incurred in future. For example, operational budget typically includes anticipated labour and material cost. Operational budget are of various types:

Flexi Budget: In this type of budget production cost is anticipated for various production level based and profitability is determined based on that, it is decided to commence production at a particular level (Strumickas and Valanciene 2015). The structure of flexi budget consists of fixed cost that are fixed at every production level, semi variable cost which means some portion of the cost is fixed while some portion is variable and variable cost which varies with the level of production like material and labour cost.

Cash budget: In this type of budget the cash inflow and outflow during the entire year is shown on a monthly basis. It starts with opening cash balance during the month that is the closing balance of the previous month. After that all cash inflows like cash sales, recovered from debtors and other cash receipts are added with the opening balance (Parker 2012). Then all the cash outflows like cash purchase, payment to creditors and other cash expenses are to be deducted to arrive at the closing cash balance for the month, which is then carried forward to the next month.

Budget

Production Budget: It determines the number of units required to be produced to meet the demand, which takes into account the principal budget factor or bottleneck factor.Raw material purchase budget: It determines the units of raw material required to be purchased for producing at a particular level of capacity. It also determines the amount of amount required for the purchase of raw material.

Labour budget: It determines the amount if labour cost, number of labour required and takes into account the labour down time and labour idleness

Master budget: This type of budget is takes into account and covers all the aspects in an organization that is why it is called master budget. All those costs which are relevant for any decision making is known as relevant cost like variable cost, opportunity cost and discretionary fix cost and are considered while preparing master budget (CPA and Shi 2016). It takes into account all the budgets discussed above.

Standard Cost means should be cost for actual units produced. It is never possible that estimated cost and production unit is the same as actual cost and production units that is why the concept of standard costing came, which involves determination of revenue and cost on the basis of benchmarking. Based on these variances is calculated comparing actual cost with standard cost. Variance is calculated for sales, volume and all types of cost. Variances are further sub divided into rate variances, usage variance and ideal capacity variance. Rate variance is the difference in actual and standard cost due to change in estimated rates (Öker and Adıgüzel 2016). Usage variance is the difference between actual and standard cost due to change in estimated consumption of units. Ideal cost variance is used while calculating variances for labour, variable and fixed overhead. It is the cost for which payment has to be made but no production of goods will occur due to labour down time.

In case of sales, sales price variance means the difference between standard sales and actual sales due to change in the estimated sales price. Sales volume variance means the difference between actual sales and standard sales due to change in estimated sales volume whereas profit values variance means the change in profit due to change in estimated volume. Variances are further categorized into material mix and yield variance, labour gang variance, capacity and sub capacity variance, margin variance, operational and planning variances that are required for detailed analysis of variances (Wild and Shaw 2013). All the variances are adjusted with the budgeted profit to get the actual profit.

Zero-Based Budgeting (ZBB)

Variances are of two types’ favourable variance and unfavourable variance. Favourable are those, which are good for the organization whereas unfavourable variances are those, which are not good for the organization. Favourable variances occur when actual cost is less than the standard cost, actual revenue is more than the standard revenue or actual production units are more than estimated production units. Unfavourable variances occurs when actual cost is more than standard cost, actual revenue is less than standard revenue or actual production units are less than estimated production units (Bedford and Sandelin 2015). Revenue and all type of cost can have either favourable or unfavourable variance except for ideal cost variance, which is always unfavourable.

This analysis of variances is to be reported to the management on regular interval so that they can take decision based on information and take steps to minimize unfavourable variance

Conclusion

From the above discussion, it can be concluded that management accounting is for internal purpose whereas financial accounting is for external purpose. Cost are mainly of four types fixed cost, variable cost, semi variable cost and slab fixed cost which can be further classified into relevant and non relevant. Budget is a very essential part of management accounting that is why it is required to be prepared every year. Based on budget and actual cost incurred during the year variance analysis is made which may be either favourable or non-favourable and reported to management for decision making purpose

References

Balakrishnan, R., Labro, E. and Soderstrom, N.S., 2014. Cost structure and sticky costs. Journal of Management Accounting Research, 26(2), pp.91-116.

Bedford, D.S. and Sandelin, M., 2015. Investigating management control configurations using qualitative comparative analysis: an overview and guidelines for application. Journal of Management Control, 26(1), pp.5-26.

CPA, A.B. and Shi, Y., 2016. LEANING AWAY FROM STANDARD COSTING. Strategic Finance, 97(12), p.38.

Deegan, C., 2012. Australian financial accounting. McGraw-Hill Education Australia.

DRURY, C.M., 2013. Management and cost accounting. Springer.

Edwards, J.R., 2013. A History of Financial Accounting (RLE Accounting) (Vol. 29). Routledge.

Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2013. Management accounting and control practices in a lean manufacturing environment.Accounting, Organizations and Society, 38(1), pp.50-71.

Horngren, C.T., Sundem, G.L., Schatzberg, J.O. and Burgstahler, D., 2013.Introduction to management accounting. Pearson Higher Ed.

Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.

Öker, F. and Adıgüzel, H., 2016. Timeâ€Âdriven activityâ€Âbased costing: An implementation in a manufacturing company. Journal of Corporate Accounting & Finance, 27(3), pp.39-56.

Otley, D. and Emmanuel, K.M.C., 2013. Readings in accounting for management control. Springer.

Parker, L.D., 2012. Qualitative management accounting research: Assessing deliverables and relevance. Critical Perspectives on Accounting, 23(1), pp.54-70.

Ramanathan, S., 2014. Accounting for Management: A Basic Text in Financial and Management Accounting. Oxford University Press.

Strumickas, M. and Valanciene, L., 2015. Research of management accounting changes in Lithuanian business organizations. Engineering Economics, 63(4).

Ward, K., 2012. Strategic management accounting. Routledge.

Wild, J. and Shaw, K., 2013. Managerial accounting. McGraw-Hill Higher Education.