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ACCT322 Management Accounting | Operational Budget and Utility

1.Analytically discuss how management accounting varies from financial accounting.

2.Analytically discuss the importance of break-even analysis with the help of a break-even chart.

3.Evaluate the importance of any six operational budgets for a limited company.

4.Discuss analytically the importance of variance analysis as a cost controlling and decision making tool.

Answer:

Financial Accounting vs. Management Accounting

Financial accounting is of utmost important to the stakeholders and other parties who have an interest in the functioning of the company. Such parties include investors, employees, government, agencies, etc. Financial accounting helps in providing clear-cut information to the parties at large. The stakeholders refer to financial accounting because it aids in decision making process. It is done in accordance to the regulations framed by the disciplinary bodies and therefore, the preparation is not based on the whims of the managers. A standard format needs to be followed and a specific needs to be followed (annually). Therefore, it helps in shedding light on the working of the company and enables preparation of the financial statements. The standards are laid down by IFRS or GAAP. It is important to prepare financial accounting report as the related parties can know about the operation of the company (Albrecht et. al, 2011). Further, financial accounting resides on assumptions like going concern, consistency, historical cost, etc. It is different from management accounting in various ways like the basis of preparation, usefulness and the purpose.

On the other management, accounting plays a vital role in decision-making process. It enables the managers to take decisions that relate to the day to day activities. It is not associated with the performance of the past but makes a prediction into the future. It plays a major role in the preparation of the budget and other ancillary reports. It has no ambit and can be applicable to a particular environment or the organization at large. There is no predefined format and can be done as per the need of the manager. The main aim of management accounting is to help the managers in taking various internal decisions and aids the preparation of a budget that ultimately supports the financial statements. In short, it helps the organization to steer in the correct direction (Needles & Powers, 2011). Therefore, the activities of the management accounting are linked to the performance of the management and help in achievement of the result.

Going by the discussion, it can be said that financial accounting has a major reliance on management accounting as the entire functioning depends on it. The preparation of budgets and other planning is framed with the help of management accounting. This helps the concept of financial accounting. Hence, the area of management accounting is vast in the scenario as compared to financial accounting.

Importance of break-even analysis

Break-even analysis is one of the potent tools used in various industries so that the performance can be evaluated considering the costs. This is due to the fact that the analysis of the supply side plays a predominant role. When it comes to the implementation of the cost function, the break-even analysis plays a vital role. Three main factors are considered here that is the sales volume, cost, and profit. It helps in classification of the dynamic link that is present between total cost, as well as sales volume of the company. It is even tagged as cost volume profit analysis and enables to ascertain the operating condition that is present when the company break even (Charles, 2012). It is a point when the sales climb a point where sales equal to the expenses incurred in the attainment of the sales level. The breakeven point can be defined as that sales level where the total revenues are equivalent to the total cost and the net income becomes zero. This is even tagged as a point where there is no profit or no loss.

Break even chart are used by various companies to trace the break-even point and therefore, helps in the break-even analysis. Under the break-even chart, the costs such as fixed, variable and total cost are shown in a separate manner. Hence, the chart helps to project the profit level or loss at various different levels of operations (Robinson & last, 2009). In a simple description, the break-even chart is a graphical presentation of the costs at the different level of activity.

In the diagram, the line OA projects the fluctuations in the level of income at various point o production activity. OB denotes the total fixed costs that are present in the business. When the output enhances, variable costs is bound to happen that indicates the total costs also increases. At output level, cost ranks higher than income. At the point of intersection, P, costs are equivalent to income and therefore, the situation is neither profit nor loss. The overall analysis projects the breakeven point and eve classified the costs in a distinct manner that is the variable, fixed and the total cost (Don & Maryanne, 2006). If we shed light on the overall graph, a clear-cut conclusion can be drawn that the break – even chart helps in performing the break – even analysis in an effective manner. It is due to the fact as the overall costs are projected, the profit and loss are segregated and the income is differentiated with the costs. The break-even point in the chart denoted the point where the total revenue crosses the total expenses. In the above chart, the income line is above the cost and hence, a profit is achieved by the business (Hanninen, 2013).

When it comes to the break-even point it is important to trace at which point the revenue surpasses cost. A hypothetical example of a restaurant that deals in pizza is provided. Initially we need to differentiate between fixed and variable cost:

 Fixed Costs

Variable Costs

Labor

$1,200

 Flour

$0.40

 Rent

$2,000

 Yeast

$0.05

 Insurance

$800

 Water

$0.02

 Advertising

$700

 Butter

$4.00

Fees

$500

 Pepper

$1.00

 Total

$5,250

 Total

$5.47

As per the total variable expense per pizza we get a clarity that the company must price the pizza at $5.47 ($0.40 + $0.05 + $0.02 + $4.00 + $1.00) or more so that the costs can be covered. However, if the pizza charges $10 for the finished goods then $4.53 is received on per pizza to add to the fixed costs and hence, the restaurants will earn profit.

Hence, the management can utilize the break-even chart to analyze the situation. Break-even chart is of great importance when it comes to break-even analysis as a pictorial representation is done and thereby the management is able to ensure a smooth conduct of the business.

Operational Budget and Utility

An operational budget is one that helps the management in terms of planning, as well as management of the activities that is concerned with the day to day operations. Moreover, the main aim is to eliminate and deficiency that comes in the way. One of the unique features lies in the fact that this budget can be forecasted with the income. The major goal lies in the prediction of the revenues (Hilton et. al, 2008). Hence, it can be commented that the operational budget aids the organization and helps in the decision-making process. The six important operational budget are described below:

Sales budget

It is considered as the major budget because various other budgets are linked to it. It helps in establishing a strong budget for the business. This budget consists of the units in total that need to be sold and the selling price.

Forecasted unit sales

5,000

7,000

5,000

6,000

x Price per unit

$12

$12

$10

$10

Total gross sales

$60,000

$84,000

$50,000

$60,000

Sales

$1,100

$1,200

$1,540

$1,760

Net sales

58900

82800

48460

58240

Production budget

This budget helps in knowing the overall number of units required to be manufactured. This budget enables the company to stress on the concept of cost and helps in estimating the number of units required to be sold. The inventory sale rests on inventory, as well as the sales target (Horngren, 2011). Therefore, it supports in providing detail to match the inventory and forecast the cost needed to match the product sales.

Production budget

 

2015 ($)

Sales prediction

5000

Add: planning

1000

Overall production

6000

 Less: Inventory (opening)

1500

Units required for manufacturing

4500

Material Budget

The material acts as a direct budget and enables in knowing the raw materials required for the purchase. If the units requirements are predicted then it can be multiplied by the cost per unit to know the budget amount. After the material budget, the labor budget is done and material budget aids in the preparation of the material budget with ease (Lanen et. al, 2008).

Direct Material Budget

Year

 
 

1

2

Production in Units (Budgeted )

1,400

920

× per unit Dm required (lb.)

5

5

 Production (lb.) DM needed

7,000

4,600

Add: Budgeted DM (lb.)

550

650

Less: Dm at the start (lb.)

-750

-525

 DM Purchases (lb.) Budgeted

6,800

4,725

cost

$2.10

$2.35

 DM Purchases in (Budgeted) $

14280

11103.75

Direct Labour Budget

Direct labor budget projects the direct labor cost in total and direct labor hours required for the process of production. The management gets adequate help from the budget in planning the need of the labor force (Elmerraji, 2015). It is an essential part of the master budget. It is done after the production budget as the budgeted production figure acts as an initiation part in the direct labor budget.

 

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Units production

6000

4000

5000

6000

Labor hours

0.4

0.4

0.4

0.4

Total direct labor hours

2400

1600

2000

2400

Direct labour cost

10

10

10

10

Labor cost

24000

16000

20000

24000

Manufacturing overhead budget

This budget comprises of all the manufacturing costs apart from the direct material cost and direct labor. The data given in the manufacturing overhead appears in the cost of goods sold in the master budget (Maher, 2005).

 

Quarter 1

Quarter 2

Quarter 3

Salaries administration

$122,000

$123,000

$140,000

Taxes payroll

8,000

8,000

9,000

Rent

23,000

25,000

24,000

utilities

4,000

7,000

8000

Selling expenses budget

This budget comprises of the budget of departments related to manufacturing like the sales, marketing, engineering and other departments. It is done in a monthly or a quarterly format. The managers get a strong help through this budget as they can ascertain the expenditure level (Hanninen, 2013). 

 

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Advertisement

$5,000

$5,000

$10,000

$11,000

Insurance

2,000

2,000

2000

2000

Taxes

1300

1400

1500

1100

4. Variance Analysis and importance

Variance analysis is a method of analyzing and measuring the differences betwixt two figures. It assists the managers in managing betwixt the actual and budgeted costs of a specific project. In this way, project managers can evaluate the quantitative information regarding the revenue, costs, and inventory level associated with a project, thereby assisting them in managing and redefining business objectives. Accounting managers can also measure a project’s materiality threshold with the help of variance analysis. In addition, it can identify factors like a holiday and seasonal sales, thereby assisting managers to plan and forecast for the future. Hence, it serves both as a decision-making and cost-controlling tool.

Material variance is the difference betwixt actual and expected cost of the direct materials. It is very significant in ascertaining the capability of a specific business to incur material costs that are close to the levels at which it had determined to incur them. Furthermore, auditors to seek explanations of all variances that have depicted a change in comparison to the preceding year also use it. This means that any transaction material if its absence or presence can alter the decisions of a user can be identified through material variance.

Material

Quantity Used

Standard Usage Per Bag

Actual Price

Standard Price

  

Stone

150 tons

12 KG

$76/ton

$72/ton

  

Gypsum

100 tons

15 KG

$20/ton

$22/ton

  

Sand

200 tons

25 KG

$10/ton

$10/ton

  

Material Usage Variance will be calculated as follows:

      

calculation of Standard Quantity

      

Stone

20,000 units

x

12 / 1000

=

240

 

Gypsum

20,000 units

x

15 / 1000

=

300

 

Sand

20,000 units

x

25 / 1000

=

500

 

Step 2: Calculate the Variance

      

Material Usage Variance = [Actual Quantity - Standard Quantity (Step 2)] x Standard Price

 
       

Stone

(150 - 240)

x

$72

=

-6480

Favorable

Gypsum

(100-300)

x

$22

=

-4400

Favorable

Sand

(200-500)

x

$10

=

-3000

Favorable

  • A labor variance arises when the actual costs related to a labor activity varies from the anticipated amount. It is especially suspect when the standard or budget upon which it is based has no similarity to actual expenses being incurred. Therefore, a manager might use political pressures in order to enhance labor standards artificially through this variance, so that improvement of standards become easier, thereby resulting in perpetually favorable variances that can develop the manager’s performance artificially.

Standard labor rate

17

 labor rate Direct

16

 labor hours direct

500

Answer

 
  

Standard Rate

$ 17.00

− Actual Rate

16

Difference Per Hour

0.7

× Actual Hours

130

Direct Labor Rate Variance

91

  • Sales variance is the difference betwixt actual sales and expected sales. It is very important to measure the performance of a sales function and can assist in evaluating the business outcomes so that the market scenarios are better understood to the managers (Berger, 2011). Furthermore, companies regularly evaluate sales variances to illustrate revenue performance over a quarter, month, or year accounting cycle. The resulting figure assists firms in isolating the problems and accelerates their future sales and marketing attempts towards enhanced sales growth. Hence, fluctuations in actual versus anticipated sales can require an analytical operation to depict the underlying causes.

Hypothetical example of a company manufacturing fertilizer:

Material

Quantity

Actual Price

Standard Price

  
      

NHK-II

250 tons

$350/ton

$450/ton

  

ORG-I

350 tons

$630/ton

$600/ton

  
  
 

Actual price (x)

Standard price (y)

x-y =z

units sold (a)

z*a

NHK-II

350

450

-100

250

-25000

ORG-I

630

600

30

350

10500

  • Variable overhead variance is the difference betwixt the actual variable overheads incurred and the absorbed variable overheads. These variances are very helpful in depicting the differences betwixt the variable overhead costs and the efficiency of labor as a whole (Berger, 2011). Hence, the reasons for an unfavorable variance may call for an investigation and proper corrective actions can be implemented in order to improve the scenario, thereby controlling the actual rate.

units

500

Standard labor rate

0.3

standard direct labor hours

150

Standard Direct Labor Hours Allowed

150

actual

130

Difference

-20

Standard Direct Labor Rate

$14

Direct Labor Efficiency Variance

-280

The efficiency variable is negative hence, can be said to be unfavourable in nature.

References

Albrecht, W., Stice, E. & Stice, J 2011, Financial accounting, Mason, OH: Thomson/South-Western.

Berger, A 2011, Standard Costing, Variance Analysis and Decision-Making, Munich, GRIN 

Charles, T.S 2012, Cost Accounting: A Managerial Emphasis, Pearson Education

Don R. H & Maryanne M. M 2006, Cost Management Accounting & Control, Ohio: Thomas South-Western

Drury, C 2011, Cost and management accounting, Andover, Hampshire, UK: South-Western Cengage Learning.

Elmerraji, J 2015, How Budgeting work for companies, viewed 22 March 2017, https://www.investopedia.com/articles/07/budgetingforcompanies.asp

Hanninen, V 2013, Budgeting at a crossroads – the viability of traditional budgeting – a case study Master’s thesis, Aalto University School of Business

Hilton, R. W., Michael W. M & Frank H. S 2008, Cost Management Strategies for Business Decision, Mcgraw-Hill Irwin: New York.

Horngren, C 2011, Cost accounting, Frenchs Forest, N.S.W.: Pearson Australia.

Lanen, W. N., Anderson, S & Maher, M. W 2008, Fundamentals of cost accounting, NY: Hang Loose press.

Maher, L 2005, Fundamentals of Cost Accounting, McGraw-Hill

Needles, B. E.& Powers, Marian 2013, Principles of Financial Accounting. Financial

Needles, S. C 2011, Managerial Accounting, Nason , USA: South Western Cengage Learning .

Robinson, M., & Last, D 2009, Budgetary Control Model: The Process of Translation. Accounting, Organization and Society, NY Press


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