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PM201 Management Accounting : Break Even Chart

Answer:

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

Accounting is the process of recording all its transactions of a specified period to know to ascertain the financial performance of a company. Accounting is not only done to know the financial performance but it also help us to gain information about the non financial performance. Accounting can be classified in two broad categories- Financial accounting and management accounting. There are many things common between the two branches but there are many differences as well (Weygandt, Kimmel and Kieso, n.d.).

Both financial accounting and management accounting forms a part of the total accounting information system and is prepared using principles and concepts (Bragg, 2014). In both the accounting ways economic events are considered and non economic events are ignored. These were some of the similarities but on the other hand there are large numbers of dissimilarities.

Financial accounting means recording all the transactions occurring in a specified period and preparing a financial statement with the help of it. These financial statements should be prepared prudently and should provide a true and fair view about the entity to its users. It enables them to compare past and present performance of an entity. It helps in better understanding about the company (Brigham and Ehrhardt, 2017).

Management accounting is done to inform the managers about the financial and non financial performance of the company so that they can take decisions accordingly. It motivates them to work more efficiently and achieve organisational targets. Cost accounting and financial accounting both are used to do management accounting.

There are many differences between both the accounting systems. Few of them are-

  • Financial accounting is a requirement of law and it is mandatory for all the entities to prepare it but management accounting is optional. Management accounting is done for organisation’s own benefits.
  • The financial statements prepared with the help of financial accounting ha to be reviewed whereas there is no such thing in case of management accounting.
  • Financial accounting depicts the past performance of the company whereas management accounting is the estimations made by the management.
  • The financial statements prepared are used by both external (stakeholders) and internal parties (management). Management reports are used only by the management of the entity.
  • Management accounting is not based on double entry system but financial accounting is done only with the help of double entry system.
  • Financial statements are prepared for a specific period of time i.e, yearly. Management accounting can be done for any period of time (quarterly or half yearly).
  • Importantly, financial accounting has to follow generally accepted accounting principles but it is not relevant in case of management accounting.
  1. Analytically discuss the importance of break-even analysis with the help of a break-even chart

The company incurs huge expenditure in order to covert raw materials into finished goods. So, it has to recover the cost from the customers(Brigham and Ehrhardt, 2017). The company should sell it products over cost in order to earn profit but firstly it is important to recover cost from the customers. It helps to develop a strong business plan to carry on its operation smoothly.

The situation in which the revenues earned by entities are equal to the cost incurred during the process of manufacture. In such a situation the company has no profit or loss. After this every additional unit sold will help in gaining profit. To understand this more clearly we can say that-

TOTAL REVENUE= TOTAL COST OF PRODUCTION.

The cost in the process of manufacturing includes both fixed and variable cost. Fixed costs are those cost which cannot be avoided. This cost remains same irrespective of the volume of production. For example, the manufacturer has to pay rent even if the number of units produced is zero. Variable costs are those cost which are dynamic in nature (Ehrhardt and Brigham, 2011). These costs are based on the number of units that are produced. For example, the raw material requirement for huge volume of production will be more therefore variable cost will be more.


TOTAL COST= TOTAL FIXED COST+TOTAL VARIABLE COST.

There are two ways in which breakeven point can be calculated. Breakeven point can be calculated in terms of number of units and also in terms of sales value. Both has a formula.

Breakeven point (in units) =Fixed cost/ Contribution per unit.

Contribution per unit is the difference between the selling price per unit and the variable cost per unit. Contribution is the amount to cover the fixed cost. As the company can earn profit only when both fixed and variable cost are recovered (Garrison, Noreen and Brewer, 2012).

A proper study is required because this plan helps in the growth and development of an entity. The company first uses it resource in manufacturing and thereafter for the expansion of the entity. The company is able to evaluate its performance with the help of this analysis (Gitman and Zutter, 2012).

An example to understand breakeven analysis more clearly-

A product Zen is produced whose per unit price of sales is $20 The fixed cost is $50000 and the variable cost is $10 per unit. The formula that can be used to calculate the breakeven point is

Breakeven point (in units) =Fixed cost/ Contribution per unit.

The table given below depicts a clear picture of the explanation stated above. It reveals that the breakeven point of this product is 5000 units. The company will have no profit or loss if it sells 5000 units.

Level of units

Total Variable Cost ($)

Fixed Cost ($)

Total Cost ($)

Total Revenue($)

-

-

50,000

50,000

-

500

5,000

50,000

55,000

10,000

1,000

10,000

50,000

60,000

20,000

2,000

20,000

50,000

70,000

40,000

3,000

30,000

50,000

80,000

60,000

3,500

35,000

50,000

85,000

70,000

4,000

40,000

50,000

90,000

80,000

4,500

45,000

50,000

95,000

90,000

5,000

50,000

50,000

1,00,000

1,00,000

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

Budgets are the estimates made by the company for the expenses it has to incur to carry on its operation in the near future (Hoyle, Schaefer and Doupnik, 2015). This is one of the most important business tool as it guides the management and helps to take prudent actions. This is prepared for the use of the management and is not for the use of external parties.

There are several functional budgets an entity has to prepare to make its business plan more efficient. Few of them are explained below-

  1. Cash budget- The estimated cash inflows and cash outflows for a specific period is called cash budget. This is usually prepared monthly and is useful for smaller companies (Kinney and Raiborn, 2011). This helps to manage the funds of the company so there is no shortage of cash when required. It gives them detailed information whether they should sell goods on credit or not.
  2. Production budget- The production budget is prepared keeping in mind two factors one is inventory and the other is the sales target. Production is made according to the demand of the product so that the company can achieve its sales targets. The company also has to keep certain goods ready for prompt orders; therefore it has to keep information of the inventory he should keep.
  3. Sales budget- The budget prepared to determine the number of units the company is estimating to sell to generate revenues. If the company sells more than it has estimated then the budget prepared was correct and the company was able to achieve its sales target but if the company could not actually generate revenue that it expected then the budget may have some fault. It keeps the company’s focus towards it sales target and keeps the employee motivated to increase their efforts (Iversen and Norpoth, n.d.).
  4. Overhead budget- The company has to bear both direct and indirect expenses in the process of production and distribution. Indirect expenses also known as overhead are those cost which are not directly attributable to the product. It keeps the company informed about the expenses that may arise in the course of production (Mondy, 2015). This budget helps to identify and eliminate the wasteful cost included in the product. Indirect costs are huge and hence are very important to keep proper details of it.
  5. Master Budget- The master budget contains the entire functional budget. It depicts the overall financial movements of an entity. It helps to analyse the key financial ratios of an entity so that the company can analyse its progress and make improvements that are required. It is very important as it helps the management to direct the employees in such a manner which will help them to achieve organisational goals.
  6. Personnel budget- The manpower that will be required by an entity to meet its production target is known as personnel budget. A production process cannot be completed without human efforts. Therefore, it is important to set a budget which will let the company know the correct manpower requirement for the company. If the manpower requirement is less but presence of manpower is more then it may result in increased cost of the product. But if the manpower required is more but the company does not have enough of it, then it may not be able to meet the production requirement.

Budget helps us to maintain a balance between the expense and Income of an entity. It creates a plan in which the money is to be spent. A plan is prepared so that the expenses are made in a prudent way and reduce wasteful expenditures (Schipper, 2012). It helps to reduce cost and maximise profits. If we follow the budget we prepare there will never be shortage of funds at the time of requirement. It makes sure that the funds are available whenever we need it and decreases the chances of increasing debts. This is one of the most important way in which it can keeps its finance on track.

  1. Discuss analytically the importance of variance analysis as a cost controlling and decision making too
  • Any difference between the estimated values and the actual values is known as variations.  It is also defined as the deviation of the expenses from its expected values. The deviation should not be large because it signifies faulty management and corrective measures has to be taken. It is a cost accounting tool to manage expenses and keep a control over them (Davidson, 2009).

There are various variances. Few of them are listed below

  1. Sales variance- The Company expects to sell a give volume of units in a specific time. If the company sells more than it expects then it is considered good but if the sales of the company is very low when compared to the actual sales (Weil, 2014). Then it is unfavourable and the company should find out the reason behind it and take reasonable steps.
  2. Material Variance- A Company has to estimate the requirement of raw material before it starts its production. This estimate will be considered good only when the materials that were brought were sufficient to meet the production targets. If the raw material proves insufficient then the company’s estimate is incorrect.
  3. Labour variance- There may be a gap between the expected manpower required and the actual manpower in an entity. If the actual manpower is huge and more than required then it is considered negative. This increases the indirect cost of the product which leads to the rise in the selling price. Therefore it is very important to estimate the correct amount of manpower required in an entity.
  4. Overhead variance- A company has to keep a track of the indirect expenses. If the actual overhead is more than estimated then the company should look after this and take necessary steps to reduce such costs. The cost incurred indirectly is included in the final product’s cost and therefore it affects the customer. If the estimate is lower than the actual expense then the company will have under recovery and such under covered amount will be charged to profit and loss account.

Variance is mainly used in management accounting. Variance can result in increase in average wage rate, decline in the productivity of finished goods, increase in the idle time, spending more on the wage of labour because of higher production than budget (Balakrishnan, Sivaramakrishnan and Sprinkle, n.d.). It helps in creating a proper plan and setting standards in order to achieve organisational objective. This creates a proactive attitude in the management of the entity. It saves them from taking a wrong decision and work prudently. If the variance analysis is not performed in a correct manner then the actions of the management may get delayed which may affect the working of an organisation. Hence, it is considered very important in all the entities.

References:

Bragg, S. (2014). Corporate cash management. 1st ed. Centennial: Accounting Tools.

Brigham, E. and Ehrhardt, M. (2017). Financial management. 1st ed. Boston, MA, USA: Cengage Learning.

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

Ehrhardt, M. and Brigham, E. (2011). Financial management. 1st ed. Mason: South-Western Cengage Learning.

Garrison, R., Noreen, E. and Brewer, P. (2012). Managerial accounting. 1st ed. New York, N.Y.: McGraw-Hill/Irwin.

Gitman, L. and Zutter, C. (2012). Principles of managerial finance. 1st ed. England: Pearson Education Limited.

Hoyle, J., Schaefer, T. and Doupnik, T. (2015). Advanced accounting. 1st ed. New York, NY: McGraw-Hill Education.

Kinney, M. and Raiborn, C. (2011). Cost accounting. 1st ed. Mason, Ohio: South-Western Cengage Learning.

Mondy, R. (2015). Human resource management. 1st ed. [Place of publication not identified]: Prentice Hall.

Schipper, K. (2012). Financial accounting. 1st ed. [Place of publication not identified]: South-Western.

Weil, R. (2014). Financial accounting. 1st ed. Mason, Ohio: South-Western

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

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

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

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

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

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