Management accounting - Assignment Example

? Management Accounting – Ash PLC AFFILIATION: Management Accounting – Ash PLC Question Preparean operating statement that reconciles the budgeted profit with actual profit for Product RS8 for the last month. You should calculate variances in as much detail as allowed by the information provided. Answer 1       ? Sales volume (Actual volume - Budgeted volume) x Standard profit per unit (2100 - 2130) x 8.67 261A Sales price (Actual selling price - Standard selling price) x Actual units sold (14.5 - 15) x 2100 1050A M3 - Material Price Variance [(Actual quantity purchased x Standard price) - (Actual quantity purchased x Actual price)] [(1050 x 1.55) - 1680] 52.5A M7 - Material Price Variance [(Actual quantity purchased x Standard price) - (Actual quantity purchased x Actual price)] [(1470 x 1.75) - 2793] 220.5A M3 - Material Usage Variance (Standard quantity to be used - Actual quantity used) x Standard price (1260-1050) x 1.55 325.5F M7 - Material Usage Variance (Standard quantity to be used - Actual quantity used) x Standard price (1428-1470) x 1.75 73.5A Labor rate Variance (Standard Rate - Actual Rate) x Actual number of hours (7.2-7) x 525 105 A Labor efficiency (Standard Hours - Actual Hours) x Standard Rate (483-525) x 7.2 302.4A Variable overhead expenditure (Standard Variable overhead cost - Actual Variable overhead cost) 1102-1260 158A Variable overhead efficiency (Standard Hours - Actual Hours) x Standard Rate (483-525) x 2.1 88.2A Fixed overhead expenditure Budgeted Fixed Overhead cost - Actual Fixed overhead cost (4409-4725) 235A Fixed overhead volume efficiency (Standard Hours - Actual Hours) x Standard Rate (483-525) x 9 378A Fixed overhead volume capacity (Budgeted Hours - Actual Hours) x Standard Rate (490-525) x 9 516A Reconciliation Statement             ? Budgeted Profit 18467 Sales volume (261.0)   ---------- Flexed budgeted profit 18206 Sales price (1050.0)   ----------   17156   Adverse Favorable Material price - M3 52.5   Material Usage -M3 325.5   Material Price - M7 220.5   Material Usage - M7 73.5   Labor rate 105   Labor efficiency 302.4   Variable overhead expenditure 158   Variable overhead efficiency 88.2   Fixed overhead expenditure 235   Fixed overhead volume efficiency 378   Fixed overhead volume capacity 516     ----------- -----------     2129.1 325.5     (2129.1)     ----------     (1803.6)             ------------ Computation of the Unit Cost Units (Kg/Number of labour) Total cost (?) Per unit cost (?) Total Production (units) Units required for actual Standard production Units required for Standard Direct Material M3 1050 1680 1.6 2100 0.5 2130 1065 Direct Material M7 1470 2793 1.9 2100 0.7 2130 1491 Labour 525 3675 7 2100 0.25 2130 532.5 Variable production overhead 1260 2100 based on labour hours 2130 532.5 Fixed production overhead 4725 2100 based on labour hours 2130 532.5 Profit calculation of actual units: Sales (2100 x ?14.5) ? 30,450 Direct Material M3 (? 1,680) Direct Material M7 (? 2,793) Direct Labour (? 3,675) Variable production overhead (? 1,260) Fixed production overhead (? 4,725) Net Income 16,317 Profit calculation of budgeted profits: Sales (2130 x ?15) ? 31,950 Direct Material M3 (1065 x ?1.55) (? 1,650.75) Direct Material M7 (1491 x ?1.75) (? 2,609.25) Direct Labour (532.5 x ?7.2) (? 3,834) Variable production overhead (532.5 x ?2.1) (? 1,118.25) Fixed production overhead (532.5 x ?9) (? 47922.5) Net Income ? 17,945.25 From the detailed analysis of the computations of the operating statements and the information provided by the company, it is evident that the company is producing and selling units less than its budgeted figures show. The variance analysis is the most commonly used tool for evaluating the performance of a business by comparing its costs and revenues against the industry standards (Needles, Powers & Crosson, 2011) and ensure that right steps are taken for any kind of deviations or variances so that it can make necessary changes and reap the benefits of being the part of the respective industry (Weetman, 2009). Variance of calculations depicts a broad picture of how much the organisation has deviated from or remained within their calculations of budget for the firm. It is evident from the analysis that the company has to pay higher costs for its direct materials and direct labour. For instance, the standard cost of Direct Material M3 is ?1.55 per kg and the company is being charged ?1.6 per kg. Similarly, the industry standard cost of Direct Material M7 is ?1.75 per kg and the company has to pay ?1.9 per kg. Even the labour cost per hour varies significantly as the standard charges are ?7.2 per labour hour and company is paying ?7 per hour to the labour. It is even apparent from the calculations of the Net Income that if the company produces and sells the budgeted units then it will be able to earn higher amount of profit i.e. 9.97% which can be rounded of 10%. One other point that needs to be highlighted here is that the firm is selling the unit at the price of ?14.5 and the industry standard is ?15 which shows that the company is having a huge variance in terms of its revenue and costs. The organisation in the long term may face effects of the variance that exists in between their revenue and costs. Question 2 Discuss how the operating statement you have produced can assist the managers in: (i) Controlling variable costs; (ii) Controlling fixed production overhead costs. Answer 2 The main purpose of the operating statements of income statement is to help the companies to evaluate their performance on the basis of sales and expenses. The income statement reflects strongly upon the profit and loss occurred in the company according to the sales and expenses of the firm. The main components of this statement are sales, cost of goods sold and expenses; the primary areas of focus are the revenue amount and expenses amount (Slater, 2012). Every organisation tries to keep a tight control on its expenses so that it can fulfil the requirements of its business effectively. Being a cost effective organisation allows the organisation to maintain a strong financial position and also with their savings they can work upon other business strategies such as expansion strategies and forming business units. For instance, if the equipment maintenance cost is increasing, then it can consider replacing it with a new one (Hansen, Mowen & Guan, 2009). Replacing with a new one may seem a heavy expense initially but when compared to the replacement costs on a constant mode, buying the new equipment would be a cost effective choice. In every business, there are two main classifications of costs or expenses i.e. variable and fixed costs and they need to be adequately monitored so that sufficient amount of profit can be earned (Tulvinschi, 2010). All costs and expenses in the business need to be carefully recorded and analysed so that further decision making is according to the current financial scenario of the business. In the manufacturing business like Ash PLC, the variable cost is of utmost importance as it has to ensure that it can produce the units according to the industry standards and within its budget range. From the comparison of industry standards of variable costs such as Direct Materials and Direct Labour, it is obvious that the company is being overcharged in case of materials and offering low wages to the labour. The company will have to ensure that it tries to control its variable cost by negotiating the terms and conditions with its suppliers (Warren, Reeve & Duchac, 2012). It will even have to assure that it is able to offer its products in accordance to the requirements of the customers by offering them the superior quality products that will help them in increasing the sales. This is a challenging situation for the organisation as the cost element needs to be maintained at both ends without compromising on the quality of the product. Likewise, a company has to control its fixed costs because it is the major contributing factor in the expenses (Garison, Noreen & Brewer, 2011). Some of the elements that form part of the fixed costs are equipment, utilities, insurance, rent, salaries and many more that don’t vary with the production of units (Cohen, Venieris & Kaimenaki, 2005). The only way of controlling the fixed production overhead costs is to ensure that the right tools and equipment are installed for production purposes and only mandatory items are included in this category so that they are well-maintained. Using only the required tools and equipment will allow the goals in terms of maintaining cost effectiveness to be achieved in a successful manner. The two key factors that can be used for controlling the fixed production costs are budgeted production and factory capacity (Kenkel, 2010). A company such as Ash PLC has to first calculate the capacity of its factory that is how much amount can it produce and then ensure that it has sufficient capacity to produce the budgeted units. For instance, in this case, the company had a budget of 2130 units but its actual production was 2100 units; in order to control the variance, the company will have to employ more resources so that it is able to meet its budgeted amount effectively. The resource allocation needs to be reviewed by the management as well so that their analysis and decision may also impact the budget calculations of the business in a positive way. Question 3 Mr. Ash has recently heard about Activity Based Costing (ABC) but is unsure what it is and whether Ash PLC could adopt this. You, as the new management accountant, have been asked to provide Mr. Ash with information on ABC, as that he can make a decision whether to introduce it in the company. Your answer should include an explanation of ABC, what the method is intended to do, a comparison with the traditional method and whether it would affect the conclusion in question 1. Answer 3 According to Askarany, Smith and Yazdifar (2007), Activity-based Costing (ABC) system is used to determine the costs of a product for an in-depth analysis of the company’s cost allocation techniques. This technique reflects upon the costs incurred in the business on each and every resource being utilized. In other words, ABC is a method used for assigning the costs to products or the services on the basis of the resources that are consumed by them. It has been stated by Cardos and Pete (2011) that ABC is the best way of counting the costs to get a clear picture of the company’s actual ability of managing its operations effectively. It is believed that ABC is a worthwhile replacement of traditional accounting systems that relied on the overhead costs of the businesses (such as lighting, marketing and heating) in which they allocated the costs in accordance to the direct cost of an activity (Horngren et al., 2012). According to Vanderback (2012), the methods were unsatisfactory because of two reasons; one is that the same direct costs were absorbed that were represented in different amounts of the overheads and secondly the time of the workers (which is a heavy overhead) is sufficiently reduced because of efficient use of the systems that helped in reducing the labour cost amount. In the traditional systems used for cost accounting, the main objective is the valuation of inventories along with the cost of goods sold so that the external financial reports can be developed in accordance with the Generally Accepted Accounting Principles (GAAP). It is important to develop financial reports according to a particular system so that the right financial data and analysis can be depicted for all organisations. GAAP is an accepted standards accepted internationally. However, the primary purpose of ABC is to help in understanding the overhead cost along with the profitability of the offered products for the customers and to manage any problems in the overhead costs (Price, Haddock & Farina, 2012). The major factors that make this method better than the traditional costing system are that it takes into account both manufacturing and non-manufacturing costs that can be assigned to the products, a variety of overhead cost pools are used for allocation of the product cost and allows effective measurement of each activity, the allocation bases are entirely different from those used in traditional costing systems and the overhead or activity rates are mainly based on the activity level at capacity as compared to the budgeted level of activity (Akoyl, Tuncel, G. & Bayhan, 2007). Considering both manufacturing and non-manufacturing costs allows for the overhead calculation to be accurate. When more elements are being taken into consideration in this method then the cost calculations performed would be effective than the traditional method. When a new ABC method will be used in Ash PLC, then the conclusion will be impacted but at a very minimum level. However, the company will be able to control its costs effectively and there will be a huge impact on the profitability and performance of the company. Hence, the company should move away from the traditional costing method and implement the latest ABC method for its management of accounting procedures. New methods keep coming in the businesses and it is a wise move to accept the latest methods of conducting business and financial operations rather than implementing the traditional ways. The latest methods may mostly prove to be highly effective and efficient. References Akoyl, D.E., Tuncel, G. and Bayhan, G.M., 2007. A comparative analysis of activity-based costing and traditional costing. World Academy of Science, Engineering and Technology, 3, pp. 580-583. Askarany, D., Smith, M. and Yazdifar, H., 2007. Technological innovations, activity based costing and satisfaction. Journal of Accounting, Business and Management, 14, pp. 53-63. Cardos, I.R. and Pete, S., 2011. Activity-based Costing (ABC) and Activity-based Management (ABM) Implementation – Is this the solution for organizations to gain profitability? [Online] Available at: [Accessed 24 February 2013] Cohen, S., Venieris, G. and Kaimenaki, E., 2005. ABC: adopters, supporters, deniers and unawares. Managerial Auditing Journal, 20(9), pp. 981-1000. Garison, R., Noreen, E. and Brewer, P., 2011. Managerial Accounting. 10 ed. New Jersey, USA: McGraw-Hill. Hansen, D.R., Mowen, M.M. and Guan, L., 2009. Cost Management: Accounting and Control. 6 ed. Marson, OH: South-Western Cengage Learning. Horngren, C.T., Datar, S.K., Foster, G., Rajan, M.V. and Ittner, C., 2012. Cost Accounting: A Managerial emphasis. 13 ed. USA: Pearson Education. Kenkel, P., 2010. Understanding, Controlling and allocating overhead costs. [Online] Available at: [Accessed 24 February 2013] Needles, B., Powers, M. and Crosson, S., 2011. Principles of Accounting. 11 ed. USA: South-Western Cengage Learning. Price, J.E., Haddock, M.D. and Farina, M.J., 2012. College Accounting. 13 ed. New Jersey, USA: McGraw-Hill. Slater, J., 2012. College Accounting: A Practical Approach. 12 ed. USA: Pearson Education. Tulvinschi, M., 2010. Relevant costs for decision in an effective controlling system. Theoretical and Applied Economics, 17(5), pp. 49-58. Vanderback, E.J., 2012. Principles of Cost Accounting. 16 ed. Mason, OH: South-Western Cengage Learning. Warren, C.S., Reeve, J.M. and Duchac, J.E., 2012. Financial accounting. 12 ed. Marson, OH: South-Western Cengage Learning. Weetman, P., 2009. Management Accounting: An Introduction. 4 ed. 12 ed. USA: Pearson Education. Read More