Purpose of Management Accounting

Questions: Indicate the main purposes of management accounting and its relevance to the management of organisations. Evaluate the main cost structures of organisations and methods of their calculation. Determine appropriate methods of calculating break-even, profitability and capital input costs. Answers: Management Accounting 1. Purpose of Management Accounting The purpose of management accounting is to plan for the future needs of the organization through using the financial information and to make the managerial decision through using the knowledge and skill (Drury, 2013). It creates value to the stakeholders of the organization while maintaining an unwavering commitment to ethical values. Through using the techniques (planning, budgeting, forecasting, etc.) of management accounting, management accountant tries to assess the risk of the business and implement strategies on the basis of that assessment (Klemstine and Maher, 2014). In present business world, it has become so critical to manage the business operation. Planning: In the business organization, management accounting is applied to make future plan for the organization through using the available financial information (Seal, 2015). The preliminary purpose of management accounting is to plan the budgets and to implement the strategies for improving the profitability position of the organization (Weetman, 2010). Long run planning is called strategic planning normally time periods of 5 years or 10 years. Such as, if the organization expects to grow the sales by 12% per year for the next 10 years, management accounting helps to forecast the cash flow. Directing and Motivating: The purpose of management accounting is to directing and motivating the staffs and workers. The role of management accountant is to work as liaisons between the employees and top level management to provide answers of question and to help in solving the problem (Wilks and Burke, 2008). Analyzing: Analysis of information is the basic and main purpose of management accounting. Management accountant tries to find out the problematic areas and develop the solutions to overcome the problematic solution (Horngren, 2011). The information of organization is used to find out the solutions for increasing the profit of the organization. Reports: The plans and goals developed by the management accountant are explained in the form of reports. The reports made by them clearly states the conclusion reached by them and the recommendations for solutions of the problem. 2. Importance of Management Accounting In complex business world, systematic management planning is very much important to achieve the success. Decision making process is an important part to conduct the business operation. Systematic way is required to support the management for investigation, evaluation and verification of the function of each division in decision making to achieve the organizational goals (Bhimani, 2012). The role of management accounting is very much important to fulfill the requirement of the management. Management accounting helps to analyze and to develop reports containing appropriate information for the management and supports in achieving the corporate objectives (Lee and Epstein, 2013). Management accounting determines the goal through using the available information and helps to find out the way in which the organization can reach the objectives (Nixon and Burns, 2012). Management accounting is very much essential to recognize the financial situation of the organization. It gives more importan ce on the decision making process for improvement in future and it helps to prepare the plan for the future. Therefore, management accounting is greatly concerned with the rescheduling of the information provided by the financial accountant. Classification of Cost On the basis of type Direct Cost: The costs which are directly related with the production of product such as material cost, labour cost, etc. Indirect Cost: Indirect costs are those costs which are not directly charged with the production such as salary storekeepers, managers, etc. On the basis of function (i) Production Costs The costs which are related with the production of products and services are called as production cost such as direct material cost, quality control cost, store expenses, etc. (ii) Administration Costs The costs which are connected with general management of an organization are called administration cost such as office related expenses (rent, telephone, stationery, etc). (iii) Selling Costs These costs are occurred for achieving sales of the goods and services. Selling costs are also considered as the indirect expenses (selling overhead). The examples of selling costs are salaries of selling staff, commission, discount, etc. (iv) Distribution Cost The expenses which are occurred for distributing the goods from the production house to customers are called distribution cost such as transportation cost, rent of warehouse, and commission to intermediaries, etc. (v) Research and Development Costs The costs related with the development of new product or for improvement are called research and development cost. C. On the basis of behavior (i) Variable Cost Variable costs are those costs which are varied with level of production within a specified period of time such as direct material cost, direct labour costs, etc. (ii) Fixed Cost The cost which becomes unaffected with the changes in the level of production within a specified period of time such as office rent, monthly salary, etc. (iii) Semi-variable Cost There are some costs which fall between the variable and fixed cost. These types of costs are semi-variable costs. These costs are also called as semi-fixed cost. Semi variable costs are neither perfectly variable nor absolutely fixed with the level of production such as telephone charges. D. On the basis of relevance Relevant Costs: The costs related with the process of specific management decision are called relevant cost Irrelevant cost: The costs which are not related with taking of specific management decision are called irrelevant cost. Such as, the salary of investor relation officer cannot be considered as the irrelevant cost if the management takes regarding new product development. 3. Importance of Cost-Volume Profit Analysis in decision making. CVP analysis helps to manager to finds out the solution of specific pragmatic questions required for the business analysis. These questions are as follows: What will the breakeven point for the organization? Which product is the most profitable for the organization? What situation will be arisen if the sales volume decreases? Is the product will be produced by organization or will be made special order? If the fixed cost of the company increases, what volume of sales is required to cover the increased cost? CVP analysis helps to analyze the relationship between the fixed cost and variable cost, volume, and the profits (Malmi and Granlund, 2009). There are three types of tools of CVP analysis which are described below: Contribution Margin Analysis: According to the contribution margin analysis, the company can compare the profitability of different products offered by them. Breakeven Analysis: Break analysis can help to determine the sale volume required to cover the all costs (Epstein and Lee, 2011). The company can also determine new breakeven point which is required to meet if the company decided to increase the fixed costs. Operating Leverage: It can help to determine the degree to which the organization uses the fixed costs, which magnifies the profits of the organization as sales increase, but also magnifies the losses as the decreasing in sales (Scapens and Bromwich, 2010). The organization can select between a high level of fixed assets and lower level of fixed assets. If the organization replaces the labour with some equipment, the fixed cost can decrease and the variable cost can increase. Benefits of Preparing Budget Budgeting is the process for planning for future expenses and revenue. All the items of expenses and revenues are forecasted in budgeting process. Budget is prepared for future period. When the actual time comes, the budgeted figure of all costs and incomes are compared with the actual budgeted figure. The difference between the budgeted and actual figure is called Variance. The benefits of preparing budget are as follows: Planning orientation Budget is prepared from the short-term view or daily-to-daily business operation. But it also tries to emphasize on the long-term thinking. So, the main objective of the budget is to plan for future. The objective of the budgeting still work though the management of the organization fails to achieve the goal according to the outline of the budget because it focuses at least on the competitive and financial position of the organization and on the improvement (Seal, Garrison and Noreen, 2009). Assumption Review The process of budgeting helps to identify the objective of business and also to assume the key things regarding the business environment. It these issues are re-evaluated time-to-time, the assumptions will also alter. Performance Evaluation The performance of the worker can evaluated through budget. The company set the goals for a budgeting period and can also promise to pay the bonuses and incentives according to their performance. After comparing the budget and actual report, it can be appraised the performance regarding the progressing to meet their goals. Cash Allocation If there is limited cash available for the investment in fixed and working capital, the procedure of budgeting is very much important to determine the most worthy assets which are required to invest in business operation. Bottleneck Analysis Budgeting process also creates focus on the bottleneck whether to increase the capacity or to shift work. Types of Budget Operating Budget Operating budget is done to forecast the operating expenses related with the business operation. Operating expenses of business organization is generally not changed over the period. If there is any changes happened in operation due to reduction in sales or any other obstacles. The different techniques of budget which can be followed by the company are as follow: a) Sales Budget The beginning part for the preparation of all other budgets is the sales budget. Sale predictions are done which are based on an analysis of past sales and an estimate of future economic prospects. Sales from past years are usually broken down by product line, regions, and sales-people, management tries to accurately forecast future market conditions and demand (Kieso, Weygandt and Warfield, 2012). After the forecast is complete, management tries to develop strategies and policies to obtain its desired market share. Also, planned sales may be overstated, and so it necessary to revise the sales budget frequently, probably after every month because of changing conditions in the economy. b) Production Budget After the preparation of sales budget, the production budget can be estimated. In preparing of production budget, an important consideration to be kept in mind is the firms inventory policy (Busco, Quattrone and Riccaboni, 2007). The sales budget forms the foundation of for the production budget with adjustments for beginning inventory and the inventory expected at the end of the budget period. This budget depends on three factors: Sales forecast in unit as indicated in the sales budget. Finished goods inventory level that management wants at the end of the period. Anticipated inventory at the start of the budget. c) Manufacturing Cost Budget There are three aspects of manufacturing cost budget which are as follows: Direct Materials Budget: The materials needed for the production schedule are estimated. Purchase is then made of the materials required depending upon production cycle. Direct Labor Budget: In preparation of this budget, production requirements are translated into labor requirements. The labors required to manufacture the product are estimated from the production budget. The standards hours are calculated from past records or past performance and are then adjusted for set-up time, idle time and other time that may have taken place. d) Manufacturing Overhead Budget: The manufacturing overhead budget consists of three important parts, namely: indirect materials, indirect labor and indirect expenses. This budget provides management with ways and means of controlling overhead cost. e) Selling Expenses Budget: Selling expense budget deals with the budgeting of the sales department and involves selling expenses like sales salaries, sales commission, advertising, sale supplies, etc. f) General and Administrative Expenses: The general and administrative expenses are classified into fixed and variable costs so that this budget can be used as a means of controlling these costs. g) Cash Budget: The cash budget shows the budgeted receipts and cash disbursements for a future period of time. The inflows and cash outflows are brought together in a cash budget to show expected cash flows of the company. This summary of estimated cash flows helps the company to plan future cash availability. Reference List Bhimani, A. (2012). Introduction to management accounting. Harlow: Financial Times Prentice Hall. Busco, C., Quattrone, P. and Riccaboni, A. (2007). Management Accounting. 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