Management accounting can be defined as a system of identifying, measuring, accumulating, analyzing, preparing, interpreting and communicating financial data utilized by stakeholders in planning, evaluating and controlling (Otley, 2016). This will help them in ensuring transparency and optimum utilization of the organizational resources.
The information prepared is utilized by management in action plan formulation, optimal resource allocation, activity disclosure to stakeholders, communicating with workers and protecting organizational resources. Management accounting is aimed at ensuring effectiveness in decision making, coordination, and planning in the organization.
Different Types of Management Accounting Systems and Their Essentials
Some of the management accounting systems include cost accounting, inventory management, and job costing and price optimization systems.
Cost accounting systems
A cost accounting system is part of management accounting responsible for past, present or future information analysis. It provides management with necessary information for decision making. It does this by identifying various costs and relating them to various products or variables in the organization. It offers foresight and enables management to turn costs into revenues. The cost accounting information forms the foundation for management accounting to enhance value and enables functionality of management. A good costing system needs to match with the nature and the size of the manufacturing firm. It needs to have an economy in that the costs incurred by the system should be less than the incomes realized from the system. It should have high flexibility to cater for changes likely to occur in the operations of the business. It should also be characterized by high simplicity to create ease in understanding and operate. Its implementation should be based on the efforts of all staff and stakeholders in the organization (Fullerton, 2014).
About manufacturing, the system should have proper management of raw materials, labor, overheads, and grouping need to be carried at the recording level. Implementing Activity-Based Costing systems will raise preciseness in allocating, apportioning and absorbing overhead costs which in turn enhances accuracy in cost per unit produced. When initiating the costing system, the objectives, goals, and visions of the manufacturing firm need to be laid down. It needs to prioritize on important variables of the manufacturing department like to influence its operation. For instance, wage variable has eased in amenability whereas costs related to marketing depend on the situation.
Inventory management systems
These aids in managing costs associated with inventory damage, obsolescence, and theft (Fullerton, 2014). Products can either perish due to the inadequacy of better storage. For instance, if the milk processing firm lacks proper refrigeration systems, the milk is likely to spoil. The system needs to be economical in that it should enable generation of high returns as compared to the costs associated with its implementation and operation. It should also be understandable in that the staff should have ease in operating and performing with the system. The inventory management system should also be productive. It should generate results intended for its implementation. On initiating the system, the organization has to list its objectives. These objectives should match the systems obligation.
This involves the accumulation of information that relates to the costs incurred in the production of a particular product (Fullerton, 2014). This information is useful since an organization needs to calculate profits that will be obtained from that production. Information is obtained from direct materials and the costs that are incurred in their purchase. Reminder materials that are not used are returned to the warehouse and their costs deducted from the production process.
Direct labor: This is the cost of labor that is used to provide services during the process of process.
Overhead: They are other costs incurred unexpectedly for example costs of depreciation.
An example in the scenario is all the costs that are involved in the process of milk processing into yogurt. There will be raw materials that are milk and flavors such as strawberry, vanilla, among others that are to be used. The labor is the human resource needed to process the milk.
Chosen scenario- Manufacturing Firm
Explain different methods used for management accounting reporting that can also be used for the chosen scenario.
Management uses various modes of analyzing organizational information. They carry this out through costing reports, budgets, and reports relating to performance.
Under the costing reports, there are various methods used in manufacturing for management account reporting. They include the high low method, the accounts analysis method, the visual analysis method, and linear regression method.
High low activity method: In this method, determination of costs is based on the relationship between historical costs and historical or past activities. The total variable is the cost determined by differentiating the expense between the highest and lowest activity states. The difference when divided by the change in output states in both high and low scenarios results in the unit variable cost.
Accounting method: In this method, the ledger accounts are analyzed and grouped as either variable costs, fixed cost or mixed costs. In case they are mixed, they are divided into both fixed and variable costs. The divisions are based on the intuitiveness of the accountants or past behavior analysis of the cost components by the accountants.
Engineering method: This method incorporates high-level analysis on all operations in manufacturing. The analysis is based on raw materials, human resource and the production machinery. The total costs of production are determined by looking at the costs of materials, labor, and machinery.
Visual fit method: Costs in this method are determined by plotting cost against output amounts on a graph. When the variables are plotted, the line of best fit is drawn to go through as many points as possible. The y-axis represents the costs while the x-axis represents the output. When the line of best fit intersects or cuts the y-axis, it shows the fixed costs. To get the variable cost per unit of production, the gradient of the line of best fit is determined.
The regression method: The regression analysis method utilizes all the available dependent and independent variables in cost estimation. It determines the costs by using the relationships between the variables. It makes use of the impact and effect nature of variables where dynamism in independent variable impacts a dependent variable with a similar change. In the case of manufacturing, the dependent variable may be services and overhead expenses. On the other hand, independent variables may be drivers of cost, that is, time utilized in labor, labor amounts and amounts of material.
Management uses past or previous year budgets to enable adjustments in the future projects. An organizations budget contains entire company’s income sources and expenditures. A company operates to meet its targets within the budgeted figures. Management acts by choosing suppliers who are less costly and outsource some services to save on costs. They also implement high revenue generating activities while in turn reducing their expenditure.
Reports on performance
Management utilizes budgets by finding the difference between the incomes and organizational expenditure. The difference is used in creating new budgets, and the deviation amount is listed in a performance report. It is used in planning, cost management, and demand anticipation. It is prepared either monthly or yearly depending on the organization.
Illustration of net profit manipulation using marginal costing
Opening stock nil
Sales price per unit 35
Direct cost per unit
Direct materials 6
Direct labor 5
Variable overhead production 2
Variable overhead sales 1
Production overheads 2,000
Administration costs 7,000
Selling costs 600
Therefore, to get the contribution, find the difference between the sales and the variable cost per unit then multiply the solution by the total number of units.
Contribution (n) = [Sales per unit (s)-variable cost per unit(y)] Total number of units(x)
The net profit is realized by finding the difference between the contribution and the fixed cost
Net profit=contribution-fixed cost
Therefore, net profit=9,300 pounds
Marginal costing statement for the financial period
Per unit Total pounds
Sales 35 21,000
Less; variable costs (14) (8,400)
Contribution 21 12,600
Less; fixed costs 3,300
Illustration of net profit manipulation using Absorption costing
Absorption costing statement for the financial period
Variable costs 8,400
Fixed costs 3,300
Total production cost 11,700
Less; closing stock C/F (700) (11,000)
Net profit 10,000
Therefore the net profit under absorption costing is 10,000 pounds.
The 700 pounds difference in the profits between marginal and absorption costing is caused by the deviation in the cost of products sold which had also been attributed by deviations in cost per unit produced for final products and closing stocks.
The difference between marginal and absorption costing
In the case of marginal costing, fixed costs are treated in full against the realized profit in the time they are encountered, and final closing stocks are determined variable production cost. On the other hand in absorption costing, the fixed costs are incurred when stock sales occur, and closing stocks are only determined at a complete full cost of production. In marginal costing, only the variable costs are used in manipulating the cost of production. Fixed costs, in this case, are only treated as product cost. On the other hand, in absorption costing, when determining the production cost of a product, both the fixed and variable costs are utilized in manipulation (Braun, 2014).
Advantages and Disadvantages of different types of planning tools that can be used for budgetary control
Budgetary control is a method of achieving financial control of a firm where the results obtained are compared to the results indicated in the budget. This enables the comparison of variances, and hence there is the formulation of measures to correct the differences. Therefore, a budget must be set in advance to enable evaluation in the future and provide more room for control and coordination. Budgets are therefore tools for budgetary control. There are various types of budgets that a manufacturing firm can use. These are:
Manufacturing overhead budget which provides schedules for all costs of production other than direct materials and direct human resource
Material purchase budgets; this ensures that the raw materials are purchased as indicated in the budget to meet the requirements of production. This ensures that materials are purchased at the right time, quantity and estimated price.
Production budget; this is set to ensure that the production meets the demand. For example, if the firm is producing yogurt, the amount produced should be able to meet the demand that is in the market without any deficiency.
The direct labor budget; this is used to determine the number of individuals and time that will be used during production. This is so that there efficient, fast and reliable production. For example, if there is need to produce 50,000 units and each unit takes 10 minutes to be produced, it means 5000 minutes will be used in production by one person. If 50 people are employed, it means the time taken will be reduced to 100 minutes. Therefore, it’s necessary to plan on the labor that is to be employed.
Cash budget; this ensures that there is the availability of cash during a time of need for example in the purchase of raw materials, payment to the laborers and meeting overheads. This reduces imbalances and brings control in the firm.
However, there are various methods that are used in budgetary control since the fixed budgets cannot be fully relied upon. They help in eliminating wastage and boosts productivity. These tools used in budgetary control include:
This is a budget which is updated continuously even after expiration of the earlier accounting period. The changes made could be due to:
(1) Organizational change, which includes terms of labor, the management structure, and working conditions.
(2) The changes in the methods being used by competitors
(3) Technological advancements and change
(4) The economic conditions of the country the firm is set
(5) The number of activities that are being undertaken by that firm (Weygandt, 2015)
The rolling budget is, therefore, more viable to manufacturing firms. For example, during a boom and recession periods of the economy, the firm can be able to estimate the number of items to produce. With technological advancement, the firm can produce a higher number of items. Let’s say its producing yogurt, there are times especially cold seasons when not many people will buy yogurt, therefore it will be able to adjust the budget to be coherent with the seasonal demands. The competitors’ will also affect this budget since If there is an introduction of new flavors of yogurt in the market, the rolling budget should be able to include this in the period added.
The advantages of the rolling budget to the manufacturing firm
- There is concentration on accuracy. As much as this may be short term, the management has more focus, and more profits can be earned.
- Up-to-date budgeting. This budget is coherent with the new trends in the manufacturing field and therefore more reliable.
- More realistic. The plans being put into the budget are real and easily justifiable thus making it more convenient.
- Planning and control are viable. This is because there is up to date information that can be relied upon making the process of planning and control easier.
- Used to communicate the changes in organizational strategies. This budget focus on issues that are current thus it becomes easier for the management to follow up the changes.
Disadvantages of Rolling Budget
- Carelessness in budgeting. The firm may become reckless in their budgeting process since they know that the budget can be changed later on.
- Time-consuming. There is continuous assessment and keeping up with the trends in the market. It takes a lot of time and keenness by the firm so that nothing passes by without their knowledge.
- May lead to increase in costs. Since there is too much focus on the changing trends, there may be incremental budgets other than those set to meet organizational strategies. This may be more costly to the organization.
This focus on the rise is the cost which might be incurred in the next accounting period. For example, the price of milk may rise from 0.3 pounds to 0.5 pounds in the future. This method takes account of the future.
Advantage of Incremental Budgeting
Help in administration. Certain increments in costs can be encountered such as a rise in staff salaries and inflation effects. This leaves room for such changes.
Disadvantage of Incremental Budgeting
Encourage wasteful spending. Most costs included in this budget are not of much importance and can lead to high wastage of the firm’s resources due to greedy ambitions of some individuals.
This is used to rectify errors made in incremental budgeting. It requires justification of every cost incurred (Weygandt, 2015). Each budget should be made from scratch. For example, when making the production budget for the Yoghurt Manufacturing firm, every item identified as raw material and its cost should be justifiable. There should be research on the market price of milk to avoid cash wastage.
Advantages of Zero- Base Budgeting
- Help in identification and removal of errors. There are some activities that are considered inefficient to the firm. This budget helps to correct such obsolete operations.
- Value for money. The method ensures that there are no assumptions made that will cost the firm money that is unnecessary. It works with facts.
- Avoiding wasteful expenditure. Employees become limited and cannot perform tasks that bring losses to the firm at all.
- Performance appraisal of the organization’s activities. This is because there is less wastage and control is established.
Disadvantages of Zero-Base Budgeting
- May focus on short-term benefits only thus disregarding the long-term needs. This may render unhealthy for the organization in future. For example, if the price of a liter of milk is 0.3 pounds today, the budget to be consistent at that time but in three months, the price might go up to 0.5 pounds. The zero-based budgeting does not put this into consideration.
- Limits management. The decisions made are limited to budgets. Thus the management becomes less motivated since they cannot be able to make decisions outside the budget.
- Costs of training. This method may be new to the management thus costs are incurred for training.
How manufacturing firms are adapting management accounting systems to respond to financial problems.
Management accounting systems are beneficial to manufacturing firms. Management accountants work closely with the people in production to report costs incurred.
Use of standard management systems should be encouraged in firms due to the benefits that result. To respond to financial problems, the systems play roles such as:
Planning and budgeting
Manufacturing firms prepare budgets which are a system used in planning. Budgeting enhances control and lack of confusion (Fullerton, 2014). With a clear budget, it’s easier for a firm to account for the costs that have been incurred and plan for the future. Budgetary control methods can be used to fix errors in budgets made for instance the production budget during milk processing.
Decision making on allocation of resources
Uses of systems in management accounting allow accountants to determine the most important areas in the firm (Fullerton, 2014). For example the use of price of the product, this will determine whether the product is worth investing in or not (cost versus revenue). For instance, if the firm wants to venture into butter production, the price of butter in the market will enable the accountants to decide whether it will be important for them to invest.
Evaluation of performance
Management accounting systems it’s easier to evaluate the performance of the firm. For example, there can be the utilization of absorption and marginal costing methods to determine the profits obtained by the firm in a particular period. This will involve looking into costs of all the direct materials, labor and overheads met during the production of yogurt and determining how they have been utilized to make profits.
With the knowledge of managing to account, it’s easier to minimize costs in firms and maximize the profits.
Braun, K.W., Tietz, W.M., Harrison, W.T., Bamber, L.S. and Horngren, C.T., 2014. Managerial accounting. Pearson.
Otley, D., 2016. The contingency theory of management accounting and control: 1980–2014. Management accounting research, 31, pp.45-62.
Fullerton, R.R., Kennedy, F.A., and Widener, S.K., 2014. Lean manufacturing and firm performance: The incremental contribution of lean management accounting practices. Journal of Operations Management, 32(7), pp.414-428.
Weygandt, J.J., Kimmel, P.D. and Kieso, D.E., 2015. Financial & Managerial Accounting. John Wiley & Sons.