Importance of Management Accounting
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Introduction of management accounting and its importance in the decision-making process for improving performance of the company
Management accounting is defined as the process by which management reports are prepared to enable the management and the stakeholders see the financial position of the business and use the data as a basis in making decisions. It identifies, measures, analyzes, and communicates information to help the organisation in pursuing its goals. Management accounting usually involves the generation of detailed reports which gives information such as the cash at hand, revenues that have been recently generated through sales, the state of the receivables and payables account at that moment and other important details accounting, finance, and management are all include under management accounting. With the above and business skills and techniques, the management is able to make decisions that are of importance to the organisation.
Management accounting involves the following aspects of accounting: cost accounting, techniques of management control, statistical and quantitative techniques, and tax accounting. Management accounting systems are tools that help in the production of data that the management use in value creation and help them to manage resources at their disposal. Management accounting systems in collaboration with the management accounting reaches to all the department of a business. The departments that are involved are finance, Information Technology (IT), marketing, operations, human resource, and the sales department (Lecture notes, 2019)
Management accounting is a critical department in any organisation as it guides on the decisions to be made and implemented. One importance of management accounting is it helps in analyzing the costs and so make decisions about price for its product and services or to make decisions related to further investments. Before a company takes action, it should explore all the available alternatives to come up with the best strategy of increasing profit. As soon the account management department is done with its cost analysis, the management can use the data to make informed and evidence-based decisions (McLean, 2018).
The analysis helps to identify the most profitable units, and thus they can decide where to invest more time and resources, which can bring in more resources.
It is essential to know the options that suit the need of an organisation as far as the production is concerned. The options are usually two: the organisation to make products themselves or to buy from a producer. At this point, management accounting could help to advise the best option. Management accounting is the one that defines how the budget is going to look like by considering the sales history and the marketing database. Besides, they are involved with controlling by giving ideas on how to reduce operational costs as well as the planning roles.
Prime Furniture has different department from where the various functions of running the business are coordinated and organized. The management accounting department is into sections that each deal with specific tasks. To start with, there is the marketing section that ensures that that the company gets known to the world, and the brand of their furniture is positioned in the customer’s minds. There is the costing section that deals with analyzing what is in the market, the market price and compare what they are offering, the reduced costs to come up with the optimal price of selling their furniture. The section also deals with the analysis to see how much they are supposed to pay for a given amount of raw material and other costs that are incurred before the material reaches the warehouse.
Another important depart is the cost analysis that works together with the planning department. The planning department utilizes data that is generated by the cost analysis department to make informed and sound decisions. The cost department analyses the process that is involved in terms of their cost as well as the cost of the human resources that are involved in the entire production process. The planning department is the one that is involved in going the guideline on the best decision to be implemented to ensure profitability (Bragg, 2019)
(LO2)
Different types of techniques in management accounting
Management accounting techniques are the rules and guidelines under which an organisation keeps its financial records as well as prepare their financial reports. The two main accounting methods for record-keeping are the basis and the accrual basis.
Some of the tools and techniques that are used in management accounting are explained as below:
Financial planning, whose main objective in an organisation to ensure that profit is maximized is another critical technique. The department that is involve with financial planning is like the backbone of the organisation it ensure the growth and sustainability of the business.
The other tool or technique is the financial analysis in which the profit and loss account comes in. These statements are analyzed for specific periods in the life of an organisation. These are the documents that help in identify the magnitude of growth by virtue of comparison of the financial statements and the analysis data. Cost accounting is another technique, in which the costs are presented per product, department, and branch. The data is compared with predetermined data, as the involved personnel reasons out the deviations. Fund flows analysis looks at the movement of funds periodically. It helps to know how the funds are used in a given period compared to previous periods others are the cash flow analysis, the standard costing, marginal cost and budgetary control. (Edmonds, Tsay, & Olds, 2009).
Decision-making accountings involved with the consideration of the various available options before coming up with an optimal decision. In order to achieve this, the different costs that are involved are considered and compared. The information so obtained is used to solve a problem arising from the increasing complexity of the business. (Anon, 2017)
Just like any other business enterprise that is run professionally, Prime Furniture has techniques that are applied in the management accounting to ensure that the business have maximum benefits from its operations. The tools that are applied to Prime Furniture include the financial planning technique. The technique ensures that the prime furniture is able to meet all its operating costs and make some profit in the process. All the processes are planned with the main goal of profitability. For this purpose an income statement using marginal and absorption cost.
The financial analysis is another technique that is applied to Prime Furniture. This technique helps in the preparation of the profit and loss accounts of the enterprise. The statements help the business enterprise whether they are experiencing any growth compared to the previous years. This tool is important as it is the one that is used by the planning department in making a decision about the future of the business.
Trading profit and loss (Income) Statement at Prime Furniture for Q1 and Q2
Using the Absorption and Variable Costing techniques
Calculations
The company’s budget for Quarters 1and 2 are as follows:
Per Quarter: units
Production 80,000 units
Sales 80,000 units
Opening Stock nil
Closing Stock nil
Budgeted Quarterly Statement of Profit or Loss:
| £ | £ | ||
| Sales | 80,000 | ||
| Production Cost of Sales: | |||
| Variable | 52,000 | ||
| Fixed | 16,000 | (68,000) | |
| 12,000 | |||
| Selling & Administration Costs(fixed) | (5,200) | ||
| Profit | 6,800 | ||
Actual production, sales and stock in units for quarters 1 and 2 are:
| Quarter 1 | Quarter 2 | |
| Opening Stock | 0 | 12,000 |
| Production | 78,000 | 66,000 |
| Sales | 66,000 | 74,000 |
| Closing Stock | 12,000 | 4,000 |
Profit and loss statement for the second (Marginal Costing) quarter
| SALES | 74000 | 1 | 74000 | ||
| COST OF GOODS SOLD | |||||
| OPENING STOCK | 12000 | 0,65 | 7800 | ||
| ADD : PRODUCTION | |||||
| VARIABLE COST | 66000 | 0,65 | 42900 | ||
| 42900 | |||||
| LESS:CLOSING STOCK 12000 UNITS | 400 | 0,65 | 2600 | ||
| 52300 | |||||
| 21700 | |||||
| GROSS PROFIT | |||||
| LESS: | |||||
| FIXED COST | 16000 | ||||
| NON MANIFUCTURING COST | 5200 | 21200 | |||
| NET PROFIT | 4700 | ||||
| NOTES: | |||||
| SELLING PRICE=80000/80000=£1 PER UNIT | |||||
Income statement for the two quarters using absorption costing
| Absorption costing | ||||||
| income statement for Q1 | ||||||
| description | amount (£ ) | amount (£ ) | ||||
| sales revenue | 66,000.00 | |||||
| cost of sales | ||||||
| opening inventory | – | |||||
| add production costs | 78,000.00 | |||||
| less closing inventory | 12,000.00 | 66,000.00 | ||||
| gross profit | – | |||||
| under/over absorption | ||||||
| gross profit at actual | ||||||
| less distribution and administrative costs | 5,200.00 | 5,200.00 | ||||
| net profit | (5,200.00) | |||||
| absorption costing | ||||||
| income statement for Q2 | ||||||
| description | amount (£ ) | amount (£ ) | ||||
| sales revenue | 74,000.00 | |||||
| cost of sales | ||||||
| opening inventory | 12,000.00 | |||||
| add production costs | 66,000.00 | |||||
| less closing inventory | 4,000.00 | 74,000.00 | ||||
| gross profit | – | |||||
| under/over absorption | ||||||
| gross profit at actual | ||||||
| less distribution and administrative costs | 5,200.00 | 5,200.00 | ||||
| net profit | (5,200.00) | |||||
The tables show the profit and loss statement using the absorption and the Marginal cost techniques. From the first quarter to the second, there is a reduction of the operating income which is brought about by the increase in expenses as shown in the tables above. Increase in expense will lead to a decrease in the total margins that are realized.
There are different organizational planning tools that organisations can use to ensure performance and stability. The most common planning tools that are used by majority of the businesses are budgeting, standard costing and variance analysis. Budgeting involves planning for the future while standard costing involve predetermining the cost of materials and the finished products. Variance analysis involves analyzing the performance of a business relative to predetermine or previous trading period data. These planning tool have proven to be effective in ensuring sustainability and continuity of a business.
Compare and contrast three planning tools used by PF to ensure stability and performance
The three management planning tools that are used at Prime furniture are the budgeting, cost analysis and the variance analysis. These tools have been used by the business for a long time with excellent results.
Budgeting is one of the major planning tools used at prime Furniture. Budget ensures that resources are allocated appropriately so that the business can achieve its objectives. At Prime Furniture both short term and long term planning are applied. Short term planning is the planning done to cover a span of less than or equal to one year while long term planning is done covering more than one year to a maximum of five years.
Budgeting is critical as it allows Prime furniture allocate resources to the different project over time to ensure effective use of the resources. With a budget, the business can monitor the progress to see if there is any deviation and thus adjust appropriately.
Cost analysis involve analyzing the cost of resources as to budget appropriately. Costing may involve raw material costing cost, the cost of human labor or the selling price of each of the furniture. Cost analysis of material helps determine the number of pieces of each type of furniture that should be manufactured as well as determine the selling cost of each piece so as to ensure profitability.
Variance analysis involves the comparison of data from the past trading period and the previous data so as to predict the future of the business. In variance analysis, the business looks at the previous data and compares the current data, makes the necessary adjust to come up with a trend that can be used to extrapolate about the future operations of the business. With variance analysis, Prime Furniture is able to make an informed prediction of the sustainability and the performance of the business in the future.
The three planning tools that are used at Prime \furniture are interdependent as they work together. Standard costing is the fundamental as it analyses the cost of the raw materials and the selling prices of each piece. With the cost of raw materials known or predicted then it becomes possible to come with a budget that will work for the business. Variance uses the budget to compare past data to predict the future of the business.
Advantages and disadvantages of the planning tools used by PF
Planning tools that are applied at Prime Furniture are very vital in the growth of the business.one of the advantages of standard costing ensures that the company only procures material that they need and at a predetermined cost. With the information, the can correctly predict the selling price of each piece of furniture made. With the information the business is able to do cost control and possible reduction of the production costs. With standard costing the business is able to keep track of their inventory at a relatively low cost. Budgeting and variance analysis helps the business to predict with accuracy the future of the business to adjust for sustainability
The main disadvantage of planning tools application is the time that is used preparing the data. The process is very tedious. The planning tools applied at Prime furniture are rigid and thus resistant to changes. In addition, the case of variance analysis, the past data used for comparison is bound is to subject to bias as well as political influence.
How Prime Furniture minimize the risk by using management accounting systems.
Management accounting is used by Prime Furniture for risk reduction. The management accounting department different strategies that are applied to study the business environment in the past and the present so that it can be able to project the future. For example, the planning department has been in collaboration with the material sourcing department who has, in the past, informed of the impending increase in the price of raw materials. The planning department reacts in advance and ensures that the business sources most of the material that they need in the future to avert the future shortage or price increase. By so doing, continuous production is ensured. The sales department is able to see the current trends in the market of the market; they have advised the planning department to act according to reduce the possibility of dead stock.
How the Management accounting is dealing with these issues?
Collaboration between the different departments that are involved in the management accounting ensures that any impending risk is addressed before it brings losses to the business. The management account department at the prime furniture has actually been hailed as the most efficient and effective department of the business enterprise.
Risk management systems used by Prime Furniture
Uncertainties and risks exist in all businesses for a business to ensure sustainability, they should have a way of addressing the uncertainties and the associated risk. At the Prime Furniture, there is the application of management account in risk management. The business utilizes probability in decision tree. This involves the performing of the discounted flow analysis by the use of the probability tree. In this approach, the business incorporates elements of uncertainties in cost-volume-profit analysis.in the decision tree, the risks are incorporated so as to come up with the best alternative decision. The method has been applied by the Prime Furniture now and to good effect.
IKEA comparison
In comparison, IKEA is a Furniture making Company based in UK that also has its ways of risk management. For this one, risk control is by analyzing the acceptable level of risk within which no action need to be taken. The company practice risk avoidance in which they will forego an activity or even if they perceive the risk to be too much. The company applies SWOT analysis as way of reducing uncertainties and risks that may be involve in doing their business.
As seen in the two companies, decision process is very key in uncertainties and risk identification and management in a business. The accuracy of the method used and the action that is taken is what will determine whether the business will survive during the risk period.
Analyses and evaluate how management accounting planning tools would help PF to maintain sustainable success
Management accounting is vital in ensuring that a business has sustainable success. In fact, most businesses tend to have a different department that is tasked with analyzing sustainability so that they can advise the planning department on their find (Bebbington & Larrinaga, 2014). At Prime Furniture, the sustainability issue is addressed by the planning department, which studies that business environment in the past and present to predict the future. Prime furniture has emergency funds that are kept aside to deal with any unpredictable environmental-related eventuality. The business has identified the most likely environmental-related issues, calculated the possible risks involved, and kept the funds aside for dealing with that unexplained-unplanned-unexpected emergency that may arise. The business has also done benchmarking against environmental best practices.
The business has, besides, designed systems and processes that are meant for recording, analyzing, and reporting on environmental performance.
The business is also in collaboration with the citizen of London. This is known as corporate social responsibility, where the organisation provide a public support. They organize charity, a donation to an educational institution, help in leading environmental sustainability by organizing tree planting days, and teaching the public on the importance of tree planting. The corporate social responsibility does not only ensure the harmonious existence of the population and the business, but it also ensures that the community accepts the business as their own. This ensures the sustainability of the company as they will support it by being loyal customers.
Provide examples of how management accounting systems are applied effectively and used in dealing with financial problems and preventing them.
Different account systems are applied at the Prime Furniture to ensure that they are able to analyses the present operation and in predicting the future based on the objectives they want to fulfill. This is done by the preparation of reports which help in promoting understanding between the different departments of an organization.
One of the accounting systems that is applied to Prime Furniture is the sales system. This system deals with invoices and income. The department has different personnel, each dealing with a specific task. One deals with recording invoices and monitoring their maturity. They also send the necessary documentation to remind the customers that the payments are due. The other section of the system deals with the analysis of the income to the business. The system keeps records of transactions between the company and their customer or any other involved person and generates the income position of the company. These data are incorporated in the compilation of the financial documents such as the profit and loss account.
SWOT is an acronym meaning Strengths, weaknesses, Opportunities and Threats. SWOT is an analysis tool that allows one to analyses business opportunity based on those key factor to know its viability or the chances of survival. These are the internal factors of a business.
PESTLE is also an acronyms that stands for Political, Economic, Social, Technological, Logical and Environmental (Anon, 2019).
SWOT and PESTLE are very important tools that helps Prime Furniture to prepare and plan before activating particular idea. The two combined are the key to success of a business. SWOT seeks to analyze the internal factors while the PESTLE addresses the external macro-environmental factors.
For example with the Prime Furniture making chairs, they will have to do the SWOT analysis to see the marketing chances of the chair. This will be done be analyzing the strength. A question like, “What is so different about this chair that will make the customers buy it?” that addresses strength. Do the same for weakness by asking a question like, “What are the weak point that will the customer go for competing product?” this may elicit a need for strengthening the weakness. The same is done for the other factors and the necessary adjustments are made. Doing this will ensure that the product is ready for the market. The next step is the analysis of the market and that is where PESTLE analysis comes in. the analysis is mainly done by getting the facts which are usually available in the news or in the media. After this analysis and Prime furniture are satisfied that everything is okay, they will release the chair into the market and it is supposed to be a success.
Using the Absorption and Variable Costing techniques
Calculations
The company’s budget for Quarters 1and 2 are as follows:
Per Quarter: units
Production 80,000 units
Sales 80,000 units
Opening Stock nil
Closing Stock nil
Budgeted Quarterly Statement of Profit or Loss:
| £ | £ | ||
| Sales | 80,000 | ||
| Production Cost of Sales: | |||
| Variable | 52,000 | ||
| Fixed | 16,000 | (68,000) | |
| 12,000 | |||
| Selling & Administration Costs(fixed) | (5,200) | ||
| Profit | 6,800 | ||
Actual production, sales and stock in units for quarters 1 and 2 are:
| Quarter 1 | Quarter 2 | |
| Opening Stock | 0 | 12,000 |
| Production | 78,000 | 66,000 |
| Sales | 66,000 | 74,000 |
| Closing Stock | 12,000 | 4,000 |
| PRIME MANIFACTURING LIMITED | ||||||||||||
| PFOFIT & LOSS STATEMENT | ||||||||||||
| FOR THE FIRST QUARTER | ||||||||||||
| SALES | 66000 | 1 | 66000 | |||||||||
| COST OF GOODS SOLD | ||||||||||||
| OPENING STOCK | 0 | 0 | 0 | |||||||||
| ADD : PRODUCTION | ||||||||||||
| VARIABLE COST | 78000 | 0,65 | 50700 | |||||||||
| FIXED COST | 78000 | 0,2 | 15600 | 66300 | ||||||||
| 66300 | ||||||||||||
| LESS: CLOSING STOCK | 12000 | 0,85 | 10200 | |||||||||
| 56100 | ||||||||||||
| 9900 | ||||||||||||
| LESS:UNDER ABSORPTION OF FIXED COST | 2000 | 0,2 | 400 | |||||||||
| GROSS PROFIT | 9500 | |||||||||||
| LESS: NON-MANUFACTORING COST | 5200 | |||||||||||
| NET PROFIT | 4300 | |||||||||||
| NOTES: | ||||||||||||
| OVERHEAD ABSORPTION RATE (OAR) | 16000/80000 | |||||||||||
| £0.2 per units | ||||||||||||
|
|
||||||||||||
| Profit and loss statement for the first (Marginal Costing) quarter | ||||||||||||
|
|
||||||||||||
| SALES | 66000 | 1 | 66000 | |||||||||
| COST OF GOODS SOLD | ||||||||||||
| OPENING STOCK | 0 | 0 | 0 | |||||||||
| ADD : PRODUCTION | ||||||||||||
| VARIABLE COST | 78000 | 0,65 | 50700 | |||||||||
| 50700 | ||||||||||||
| LESS:CLOSING STOCK 12000 UNITS | 12000 | 0,65 | 7800 | |||||||||
| 42900 | ||||||||||||
| 23100 | ||||||||||||
| GROSS PROFIT | ||||||||||||
| LESS: | ||||||||||||
| FIXED COST | 16000 | |||||||||||
| NON MANIFUCTURING COST | 5200 | 21200 | ||||||||||
| NET PROFIT | 1900 | |||||||||||
| NOTES: | ||||||||||||
| SELLING PRICE=80000/80000=£1 PER UNIT | ||||||||||||
| Profit and loss statement for the second quarter |
| SALES | 74000 | 1 | 74000 | ||
| COST OF GOODS SOLD | |||||
| OPENING STOCK | 12000 | 0,85 | 10200 | ||
| ADD : PRODUCTION | |||||
| VARIABLE COST | 66000 | 0,65 | 42900 | ||
| FIXED COST | 66000 | 0,2 | 13200 | 56100 | |
| 66300 | |||||
| LESS: CLOSING STOCK | 4000 | 0,85 | 3400 | ||
| 62900 | |||||
| 11100 | |||||
| LESS:UNDER ABSORPTION OF FIXED COST | 14000 | 0,2 | 2800 | ||
| GROSS PROFIT | 8300 | ||||
| LESS: NON-MANUFACTORING COST | 5200 | ||||
| NET PROFIT | 3100 | ||||
| NOTES: | |||||
| OVERHEAD ABSORPTION RATE (OAR) | 16000/80000 | ||||
| £0.2 per units | |||||
| SELLING PRICE =80000/80000=£1 PER UNITS | |||||
Profit and loss statement for the second (Marginal Costing) quarter
| SALES | 74000 | 1 | 74000 | ||
| COST OF GOODS SOLD | |||||
| OPENING STOCK | 12000 | 0,65 | 7800 | ||
| ADD : PRODUCTION | |||||
| VARIABLE COST | 66000 | 0,65 | 42900 | ||
| 42900 | |||||
| LESS:CLOSING STOCK 12000 UNITS | 400 | 0,65 | 2600 | ||
| 52300 | |||||
| 21700 | |||||
| GROSS PROFIT | |||||
| LESS: | |||||
| FIXED COST | 16000 | ||||
| NON MANIFUCTURING COST | 5200 | 21200 | |||
| NET PROFIT | 4700 | ||||
| NOTES: | |||||
| SELLING PRICE=80000/80000=£1 PER UNIT | |||||
| RECONCILATION OF ABSORPTION AND MARGINAL COSTING | |||||
| QUARTER 1 | QUARTER 2 | ||||
| PROFIT AS PER ABSORPTION COSTING | 4300 | 3100 | |||
| ADJUSTMENT OF STOCK FIXED COST | |||||
| OPENING STOCK | 0 | 12000 | |||
| CLOSING STOCK | 12000UNITS | 4000 | |||
| DIFFERENCE OT STOCK | -12000 | 8000 | |||
| (0-12000) | |||||
| RATE OF FIXED COST | £0,20 | -£2 400,00 | £0,20 | 1600 | |
| PROFIT AS PER MARGINAL COSTING | 1900 | 4700 | |||
The tables show the profit and loss statement using the absorption and the Marginal cost techniques. From the first quarter to the second, there is a reduction of the operating income which is brought about by the increase in expenses as shown in the tables above. Increase in expense will lead to a decrease in the total margins that are realized.
References:
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