2. Evaluate different classifications of costs (types, behaviour, function and relevance) with examples.
3. Explain the meaning of variance analysis and discuss the most commonly derived variances, outlining the problems and limitations.
4. Identify different operational budgets and explain the advantages of preparing different operational budgets.
1. Importance of management Accounting
The subject management accounting is about to utilize the financial resources of a business organizations. That means finance budgeting is somehow related to this subject. Management accounting is about decision making, organizational control in finance and financial planning for a profit seeking business organization. It is an identification process, accumulation, dimension analysis and understanding used by management to evaluate within a unit to assume accountability of organizations resources. According to Baldvinsdottir et al., (2010), management accounting provides supportive information for control department for planning and decision making are used for presentation of management accounting in terms of theoretical aspects. Scapens & Bromwich (2010) suggested the theory of development model for management accounting and practices to incorporate in the actual theory. Granlund (2008) and Malmi & Granlund (2009) have described management accounting as a variation of accounting and non-accounting systems. The above prospects are the most important factors related to management accounting (Scott 2014).
Difference between accounting system
In management accounting is about to manage the financial resources of the company. Financial accounting system is about to calculate the financial transactions for a particular period. The purpose of management accounting is design information to help the respective managers to control and planning for various business operations. Financial accounting is done help creditors, investors and government authority to calculate revenue or expenditure figures. The time line for management accounting is done present days to structure future prospects. However, in financial accounting the transactions are delayed or historical in position to record (F?lbier and Weller 2011). Management accounting is concerned about the reporting format, which affect employees’ job descriptions. Financial accounting is concern about sufficiency of disclosure of accounting figures. In management accounting, primary emphasis is for segment reporting. In opposite for financial accounting is concerned with reporting for the company as a whole (Herman 2011).
2. Classifications of Costs
The term cost belongs to the subject of Cost accounting system. Before discussing about cost little idea about the subject is required for identification of this part of assignment. Cost accounting is a subject that explains and designs the costing structure of business organization. The structural report in standard accounting format for all financial expenses done throughout a year. It is because for doing future financial planning for the respective organizations. There different types of Costs with different functionalities and behaviors are below:
Direct cost belongs to production of manufacturing business unit (Davis and Franks 2011). Some examples of costs are like material purchased, labor introduced, distribution cost for production and other direct expenses etc. Direct Cost is an expenses that handled by the cost accountant and production managers of a company. Cost budget is made to design the direct cost structure for production department. The cost of production is totoaly based on theamount of direct cost. At the time of making budget direct cost are focused for the purpose of reduction of product price. Direct cost makes direct and huge affection on cost of product for sale. The purchase management department increases direct costs for purchase of quality raw material for quality production. Direct costs come under ‘Trading Account’ in the books of accounts of a business organization (Adams et al., 2011).
Indirect cost comes under the head of ‘Profit and Loss account’. These kinds of cost are not related to production or service. Some examples of the indirect cost are like administrative cost, advertisement cost, other indirect expenses that comes in debit side of the Profit and Loss Account’. At the time of making budget this kind of cost are always to reduce to increase profit volume at the period end. Indirect cost cannot be traced for reduction according to need. Administrative department is responsible for this kind of cost. The cost of goods sold is calculated after incurring all the indirect costs (Bonte et al., 2012).
Fixed cost is not directly incurred for production volume. This kind of cost is incurred at the time installation of production phase. Some time it is taken as one time investment cost for a particular production unit or goods or service. Fixed cost remains same except some case like at the time of calculation Break Even Point (Mariotto, et al., 2011). In this case, a production measurement point is calculated for tracing the production volume. Sometimes the productions cost is increased but still the fixed cost need to hike for the purpose to meet customer demand and hold the market position. In this case, fixed costs are responsible for decrease of gross profit but not the net profit.
Variable cost is positively co-related with the production volume. If production volume increases then variable cost also increases. There are two types of variable cost i.e. semi variable and fully variable (Brynjolfsson and Simester 2011).
2. Variance analysis
Variance analysis is a type of quantitative analysis to calculate the difference between planned amount and actual amount incurred. It is more effective when the reviewed amount for variance is on a trend on line therefore required changes for t level of variance from month to month are more actively evident. Variance analysis involves for investigating the differences to create outcome is a statement differed from expectation and understanding of why the Variance happened (Penny et al., 2011). Managers can compare the operation with the planned by analytical tool by doing variance analysis. So many standard of cost variances are there used for analysis of variance. Material variances, labor variances, overhead variances and cost variances are the factor to analyze. The managing authority also keep focuses on quantity variances and price variances.
Most common derived variances
Most common derived variances used for variance analysis are as follows:
Labor rate variances: Actual cost incurred for the production minus its standard cost multiplying with the unit for production, is called labor rate variance (Liang, et al.).
Sales Price variance: Actual selling price less the standard selling price multiplying the no of unit sold is called the selling price variance.
Labor efficiency rate variance: actual labor hour incurred minus the standard labor hour multiplying the actual labor rate paid per hour.
Purchase price variances: The actual price paid for raw material purchased for the production minus the standard rate of material multiply the no of unit of production (Torella, et al., 2011).
Variable overhead spending variance: Subtract from the actual variable overhead incurred per unit minus the standard variable overhead rate multiply the unit production.
Limitations of Variance analysis:
Non-quality production: variance analysis are done to reduce the over expenditure incurred in the production. In this case, the production unit will not be good in quality (Li, et al., 2014). Sometimes the market price of the material is high for the quality material. Quality will hamper if the product price is compromised at the time of purchasing.
Service organization: Variance analysis is most difficult for service industry. The cost control an not be done the time of providing service. If the cost of service reduces the service, quality will hampered directly.
Just before the time of making annual budget, variance analysis is done (Ainsworth and Buchan 2011). Variance analysis is done for the purpose of decision making by the management department, but there is delay for reporting the analysis report because variance analysis takes longer for its process and finally the reporting dead line delayed by it.
In standard costing and variance analysis, responsibility of accounting has major functions. In variance analysis, responsibility accounting fails to calculate the increase rate of wages. At the time of calculating labor there major mistake can happen in amount figure (Asilt?rk. and Akku?? 2011). So the argument is about that responsibilities and causes for variance analysis can get blurred at times.
The behavioral issues associated for variance analysis can manage by involving employees during making of budget so that they do not review the process as unreasonable. Variance analysis in terms of standard costing can influence other sub-optimal behavior for among the stuffs for incorporating budget slacks (Kaplan and Atkinson 2015).
4. Types and Advantages of operational budget
Budget helps business management and tracking the finance resources. Organizations use various budgets for development and expenditure strategies to maximize revenues and assets. Some advantages for making different operational budget are as follows (Bierman and Smidt 2012):
Managing current expenses: Staff salaries and office rent, this kind of fixed overhead costs are the starting point of operating budget. This kind of expenses cannot reduce but the working hours for staff can reduce. Some considerable savings can be done from operating expenses like office supplies. This will benefit total budget and simplicity to some financial strain (Hope and Fraser 2013).
Projection for Future expenditure: Past expenditure can evaluate for the profit and loss account for last years. The estimate for expenses can be done form last years experience. Now extra expenses can trim for new project or for new period. This can be done by making the cash flow budget before starting new project or nee period (Lee, et al., 2012).
Increasing company Reserve amount: Company reserve is one of the important factor to maintain. All the company tries to increase the profit and some proportion of profit goes to different reserves. Operating budget is liberal instead of following restriction. This kind budget will help to reduce debt at the collecting capital and liability of fixed rated interest will also reduce (Hjalmarsson and M?rtensson 2011).
Master budget is prepared for a company’s individual budget design to present a total scenario of financial health and activity. In large company, master budget is made to keep all different managers aligned. Master budget is a combination like all kind of incomes, expenditure, sales and assets to reach companies ultimate goal and evaluate overall performance (Kelly and Rivenbark 2014).
Static budget is made for changes in some factors like sales volume or revenue and this kind of budget is fixed. As an example a production company first of all calculates its Breakeven point to determine production volume, for instance to meet supply for high demand more production cost need to incur. In this case some static budget need to make for other factors except financial figures, but indirectly finance is involved to make static budget as it objectives.
Cash flow Budget
Cash flow budget is made to trace about the cash inflow and out flow amount. This kind of budget made for specified time period or short project. It can help a company wisely about the management of cash (Pearson 2011). Cash flow budget consider such heads like accounts receivable and accounts payable when a company is handling ample amount cash transactions, the extent to that, cash productivity is using properly. As an example a contraction company make a cash budget before starting a project for making a bridge and the mangers can budget for daily amount of cash expenses for work before giving payment (Talpin 2012).
Operating budget is made for a specified period. Operating budget are usually created for yearly, monthly or basis. It is made to compare performances between specific period or departments. Some incomes and expenses heads are taken to make accurate amount of calculations these are like administrative expenses, production cost, labor cost, material cost, overhead and sales. A manager can compare financial performances for a month if the company is over spending in supplies (Lim, et al., 2011).
Financial budget is made to assume economical scenario of a particular organization or state or country. It indicates upcoming financial transactions are to be happen. Financial budget is made for a particular period, generally for whole year or month or quarter. Every kind of Financial amounts are assumed to expend in financial budget. It is made on the basis of present year transactions. Many times past year financial transactions are taken to analysis and made for upcoming year financial budget. Gross Domestic Product is depends on financial budget made for the particular year. Financial budget is very necessary for any organization to for future assumptions.
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