Management Accounting And Financial Planning

Understanding Accounting and Differentiating between Management and Financial Accounting

In order to understand management accounting and financial accounting we first have to understand about accounting. Accounting is a systemised process of recording all the transactions taking place in an entity and this is considered one of the most important function. Accounting is broad term which has two branches management accounting and financial accounting (Warren, Duchac and Reeve, 2014).

These branches of management accounting and financial accounting have many similarities and dissimilarities. They are considered similar because both help to evaluate the performance of entity and to know the financial position also (Warren., 2015). The information from these accounting are used by internal management in common.

There are many differences between both the accounting branches-

1. Definition- Financial accounting is the process of recording and summarising all the transactions that are happening in an entity whereas management accounting is done to prepare reports that are relevant for taking short term decisions.
2. Reports- Financial statement is done for the preparation of financial statement and management accounting is used for the preparation of management reports.
3. Format- In the preparation of financial statement there is a specific format which needs to be followed but in case of management accounting there is no such format.
4. Compulsion- It is compulsory for all companies irrespective of size, nature and legal form to prepare financial statements but it is optional to prepare management accounting.
5. Users- The financial statement are used by both management and stakeholders whereas management reports are useful only to the management.
6. Duration- The financial statement is prepared for a given year and management reports are prepared when the management needs it (Weygandt, Kimmel and Kieso, n.d.).
7. Information – The financial statement gives us all the monetary information but the management reports provide both monetary and non-monetary information
8. Rules- The Company will have to follow certain rules and regulation for the preparation of financial statement but there is no such rules an regulation that has to be followed in the preparation of management reports.
9. Objective- The management reports is used by the management to take prudent decisions whereas the financial statements are prepared for providing financial information to the external parties.
10. Double entry- The financial statement is prepared using double entry accounting system but it is not used in case of management accounting.

Management accounting and Financial accounting both being the branches of accounting has some similarities and much dissimilarity also (Wild, Shaw and Chiappetta, n.d.). These also have merits and drawbacks in it but overall it is an important function to be carried out

The primary aim of every business is to earn profits. A business can survive in the long run only if it is earning profits. A company can earn profits only when it is able to recover all the cost incurred in the production. A company sets target of its sales depending on this and tries to make all efforts to achieve this goal (Cafferky, 2014).

There are basically two types of cost that are incurred during production. They are-

• Fixed Cost – As the name suggests, these are the cost that remain same throughout and does not change with the change in volume in production. These costs cannot be avoided for a short period and has to be incurred till the business is running. For example – Rent, advertisement etc.
• Variable cost – These are the cost which increases with the increase in the volume of production and vice versa. For example- cost of raw material. If the volume of production is huge then the consumption of raw material will be more thereby increasing the cost (Harris, 1978).

Total Cost = Fixed Cost + Variable Cost.

Break even analysis is a study done to know the point at which the sales of the company is exactly equal to the cost. In such a situation, the company has no profit or loss but if the company sells beyond this point it will start earning profits as the cost that is incurred has already been recovered (Kimmel, Weygandt and Kieso, 2011).

There are two ways to calculate the breakeven point-

1. Breakeven point in units- In this way certain number of units is calculated which the sales target of the company is. Say, if the breakeven point is calculated as 5000 units then the company must sell 5000 units in order to recover all the cost incurred. The breakeven point (in units ) can be calculated using this formula-

Breakeven Point (In Units)= Fixed Cost/ Contribution P.U.

1. Breakeven points in sales- This is another way of calculated breakeven point. In this case instead of units the revenues are made the sales target (Shim and Siegel, 2009). The formula used is-

Breakeven Point (In Sales) = Fixed Cost/ Pv Ratio

PV ratio is ratio of contribution to sales. It is expressed in terms of percentage.

To understand this concept of breakeven analysis let us see an example-

Illustration-

 A product is manufactured that is sold in the market for $20 per unit. Following is the information of the cost that is incurred in production-

Fixed cost = $4000.

Variable cost = $ 10 per unit.

The Concept of Breakeven Analysis and Its Importance

The following graphical representation and table will help us undertand the solution.

Level of units	Total Variable Cost ($)	Fixed Cost ($)	Total Cost ($)	Total Revenue($)
–	–	4,000	4,000	–
50	500	4,000	4,500	1,000
100	1,000	4,000	5,000	2,000
200	2,000	4,000	6,000	4,000
300	3,000	4,000	7,000	6,000
350	3,500	4,000	7,500	7,000
400	4,000	4,000	8,000	8,000
450	4,500	4,000	8,500	9,000
500	5,000	4,000	9,000	10,000

Breakeven analysis helps us to analyse and evaluate our performance and motivates us to achieve the target to increase the profitability. This helps us to study and evaluate the financial position of the company.

A company prepares budgets in order to work efficiently with a proper plan. Budgets are the estimates that are made by the company of its expenses and revenues (Balakrishnan, Sivaramakrishnan and Sprinkle, n.d.). This is a very helpful tool as it provides a proper plan for the activities and also helps in setting targets for the company in future. This motivates employees to work efficiently in order to achieve the organisational goals

There are many advantage of preparing budget. Some of the common advantage that all the companies have are-

• It helps to provide control of the expenses that are incurred.
• It helps us to be prepared before any unexpected happening.
• It helps us to know if we are in a position to raise or give loan.
• Helps us to save for some unexpected situation that may arise anytime.
• It keeps us focussed towards the money goals that we have thought of.
• It helps us to make small saving like eliminating late fees or any kind of penalties that may have arose if the budget was not made.

There are several budgets that are prepared in a company and each budget has its own significance. These are the six companies and their importance given below-

1. Financial Budget- A Company has to make estimation of the resources that it would require to run the operations smoothly (Barr and McClellan, 2011). A company needs to have sufficient funds and capital to carry on its business without obstacles. There should be a ready cash available for the cash crunch situation, Lack of liquidity may lead to opportunity losses. Therefore, the company should be efficient enough in managing its resources.
2. Production budget- In the preparation of production budget there are two factors that has to be considered. Firstly, the right quantity of inventory that a company should keep so that there is no excess storage cost or loses of opportunity of missing the orders. Secondly, Sales target which is the most important. We know that a company cannot earn profits without selling the products and therefore it is very necessary to make a target (Davidson, 2009).
3. Overhead Budget- A Company has to maintain records of the indirect expenses it has incurred so that the expenses are recovered from the customers. It helps the company to know the unnecessary expenses it has made and eliminates such cost. If there is an under recovery then it is a loss for the company but in case of over recovery the company gains profit. Overhead has a major part of it in the total cost and therefore it is necessary (Shim, Siegel and Shim, 2012).
4. Sales Budget- A company can earn profit only when it sells a considerable amount of goods. There should be no gap between the estimated sales and actual sales in order to earn profits. This budget helps in evaluation of performance and encourages employees to take corrective steps for better results in future. If the estimated sales is not equal to the sales that are actually made then there may be some fault in the budget that is prepared.
5. Personnel Budget – The most important things apart from the raw material is manpower. It is not possible to run a business without manpower and it is also equally important to know the correct manpower requirement. If the manpower requirement is less but there is a large number of labours employees then it is said that there is a huge involvement of unnecessary cost which needs to be eliminated. But if the manpower requirement is huge but the actual number of person that are working are considerably less then there will be many situation when the company will not be able to sell it goods because of low supply.
6. Master budget- This budget is the summary of all the budgets that are prepared in a company and hence its name is master budget. This budget helps in the evaluation and self assessment so that the company can perform more excellently in future. This budget provides confidence to the employees in taking decisions.

Variance refers to the gap between the actual and the estimated data. It is one of the most important and widely used tools that helps the company to reduce cost. It is considered unfavourable if there is a huge variance and so the reason for the variance is found out and corrective measures are taken (Glantz, Slinker and Neilands, n.d.).

There are many kind of variances that are found in a company. Some of them are explained below-

• Material Variance- A company estimates the requirement of raw material at the beginning. However if the actual consumption is not equal to the estimated consumption then it is said that there is a variance (Iversen and Norpoth, n.d.). This is considered one of the most important tool because a company incurs huge amount of money on raw material and so it is necessary to eliminate wastage and reduce cost. A proper study of variance is very important both for the company and the users because it has its ultimate effect on the cost and quality of product.
• Labour Variance- Manpower is the most important requirement of the company. But there must be an adequate quantity of manpower in the company. The company must employ the manpower after a proper study because if there is a surplus number of employees then there will be an increase in the cost of product which is neither considered good for the company nor consumers. But it is also important to keep in mind that the company should not employ less because it may affect the quality of the product produced because of shortage of labour(Scheffe?, 2010).
• Sales Variance- A company sets a sales target and make all necessary efforts to achieve that target. In any case if the company is unable to achieve the sales target then it is said that there is a variance in the sales.In this case if the actual amount is greater than the budgeted amount them it is good for the entity. This shows that entity has achieved sales which are over and above the targeted revenue. Just achieving more sales is not enough, the entity should check for the profitability also.
• Variable overhead- These expenses depend on the volume of production. There will be variance only when there is variance in the production volume (Searle, Casella and McCulloch, 2006).In case the budgeted and actual level of production is same and still there are variances then the management should look in to the reasons cause negative variances. Positive variances imply benefits of large scale production which also implies operating efficiency.

Variance analysis is a managerial accounting which helps to determine the deviation between the performance of an entity. It helps the entity in taking decisions confidently and creating a proper plan to use its resources more effectively and efficiently.

References:

Warren, C., Duchac, J. and Reeve, J. (2014). Financial and managerial accounting. 1st ed. Mason, Ohio: South-Western Cengage Learning.

Warren., (2015). Financial & Managerial Accounting. 1st ed. Cengage Learning.

Weygandt, J., Kimmel, P. and Kieso, D. (n.d.). Financial & managerial accounting. 1st ed.

Wild, J., Shaw, K. and Chiappetta, B. (n.d.). Financial and managerial accounting. 1st ed.

Cafferky, M. (2014). Breakeven analysis. 1st ed. New York: Business Expert Press.

Harris, C. (1978). The break-even handbook. 1st ed. Englewood Cliffs, N.J.: Prentice-Hall.

Kimmel, P., Weygandt, J. and Kieso, D. (2011). Accounting. 1st ed. Hoboken, N.J.: Wiley.

Shim, J. and Siegel, J. (2009). Modern cost management & analysis. 1st ed. Hauppauge: Barron’s.

Balakrishnan, R., Sivaramakrishnan, K. and Sprinkle, G. (n.d.). Managerial accounting. 1st ed.

Barr, M. and McClellan, G. (2011). Budgets and financial management in higher education. 1st ed. San Francisco: Jossey-Bass.

Davidson, I. (2009). Budgetary control in modern organisation. 1st ed. Saarbru?cken: VDM Verlag Dr. Muller.

Shim, J., Siegel, J. and Shim, A. (2012). Budgeting basics and beyond. 1st ed. Hoboken, N.J.: Wiley.

Glantz, S., Slinker, B. and Neilands, T. (n.d.). Primer of applied regression & analysis of variance. 1st ed.

Iversen, G. and Norpoth, H. (n.d.). Analysis of variance. 2nd ed. 1st ed.

Scheffe?, H. (2010). The analysis of variance. 1st ed. New York: Wiley-Interscience Publication.

Searle, S., Casella, G. and McCulloch, C. (2006). Variance components. 1st ed. Hoboken, NJ: Wiley.