Management Accounting and Decision Making - Essay Example

A STUDY TO MANAGEMENT ACCOUNTING AND DECISION MAKING TABLE OF CONTENT PAGES Introduction 3 Management accounting & Decision Making 3 Budgeting 4 Sales and Production Budget 5 Purchase and Labor Budget. 5 Capital Expenditure 6 Cash Budget 7 Master Budget 7 Linda' Behavior 8 Defer in Sales. 9 Padding to Achieve the target 10 Acceleration of Recognition 11 Conclusion 12 Bibliography 12 References 13 INTRODUCTION (1) This study will show what is decision making and how the management accountants play a vital role in decision making. (2) It will grab the understanding of budgeting and its different types. (3) Study elaborates how an intelligent and sharp manager takes decisions which are equally beneficial for him/her and for the corporation. (4) Study will answer the four main questions which are asked in the case study. (5) It reveals what course of action should be adopted by the organization in order to attract the employees and get the maximum out of them. MANAGEMENT ACCOUNTING & DECISION MAKING: The process of choosing the best alternatives whether it is short term or long term is known as decision making (McWatters, 2008). A manager's main aim is to reduce the cost of the corporation and increase its surplus through his expertise. A manager is fully equipped with all the relevant tools to mitigate the cost and enhance the bottom line. Manager's expertise like analysis, forecasting and budgeting plays a vital role in decision making. Managerial decision making is no doubt a complex problem-solving process; which consists of a definite series of stages (Garrison, 1985). Corporations expect from their key persons that they generate cash for the entity by their expertise and the decisions they make should be for the sake of the organization. Generally, decision making consists of the following six steps (Glynn, 2008): Identification and detection of a problem in the corporation. Find the major causes of the problem, and search for an existing model applicable to the problem. Keep an eye over the alternatives pertaining to the problem and make a delineation of alternative course of actions in the light of the problem. Evaluate the quantitative and qualitative data which relates to the problem, and an analysis of those data relative to the alternative course of action. Suggestions of different remedies of a particular problem then choose the best remedy to be implemented which is consistent with the goals of management. Before taking the final decision, managers need to get an idea about the effectiveness of the course of action or remedy they intend to apply on a particular problem, so a post decision evaluation via feedback can be worth while. In the managerial decision making process, the management accountants play a decisive role although they neither indulge in making nor in implementing the final decision, the management accountant is held responsible for providing the information at each of the six stages mentioned above. Management is not concerned about how and from what procedures an accountant uses in his analysis and evaluation; eventually the main concern of the management is the information regarding the problems and on the basis of this information, management reaches on a decision (Steffan, 2008). Management accountant is responsible to elaborate the management that the data that is been taken is relevant to provide the information. Relevant data are the single most important ingredient in decision making (Drury, 2007). Relevant data usually consist of relevant cost and relevant revenue which must be considered by the accountants while choosing the alternative course of action; make sure only those cost and revenues will be incurred which are relevant to the decision making. BUDGETING: The budget is a quantitative expression of management objectives and a means of monitoring progress towards achievement of those objectives. The budget must be well coordinated with related management and accounting. A budget is a forecasted statement of the financial position that a business hopes to achieve in future (Bhimani, 2008). Budgeting decision involves the long term commitment of a firm's scarce resources. We have heard about the government budget, in this kind of budget, the government mentions about their expected earning and expenses in the fiscal year. If we apply the same opinion on a corporation then we can say that the corporation prudently reviews their past performance and on the basis of these performances they make a budget to estimate the future cost, expenses and the net income. "Budgeting is a plan, not a forecast" (Dawkins, 2007) A firm can create a number of below mentioned budgets to broaden its forecast: SALES AND PRODUCTION BUDGET: In sales budget the accountant forecasts how much sale will increase in the next year. But sales are dependent on the production. Production will urge sales to increase or decrease from the prior year. The more the production enhances then eventually it helps to increase the level of sales. PURCHASE AND LABOR BUDGET: How much material the corporation may require in this year is all elaborated in a purchase budget. The amount of raw materials that the organizations have to purchase to increase their productions will influence the sales graph. The amount of money needed to buy the forces of labor pertains to labor budget (Hopper, 2007), for instance, a corporation estimates that in order to achieve the production budget, we need 30 more workers in our entity so the corporation makes a budget in which they account for the 30 worker salaries and the relevant benefits. This phenomenon comes under the Labor budget. CAPITAL EXPENDITURE BUDGET: Capital budgeting decisions involve long term commitment. When such decisions are made, the firm will be committed to a current and possibly future outlay of funds for which it expects to receive benefits over a period of time greater than 1 year. This outlines the assets which may be added next year in the premises of the corporation and its relative expenditure (Dawkins, 2007) like whether or not an airline should purchase a 747 jet, whether or not a manufacturing company should build a factory etc. There are three stages of the capital budgeting process. (1) Project definition and cash flow estimation. (2) Project evaluation and selection. (3) Project performance review. Capital budgeting includes the information regarding addition of new assets in the corporation and its relative cash flows as to how much will it cost to buy a particular asset and what can we earn from this asset. CASH BUDGET: After reviewing the past consequences of the corporation, cash budget is made. It includes information regarding the cash flows that how much the entities will receive cash in the next year and how much they will spend. It may then be used in planning your short-term credit needs (Atrill, 2007). Cash budget is as beneficial for the individuals as it is fruitful for an entity. For an individual, creating a cash budget is an excellent method to determine where their cash is going to be spent regularly. MASTER BUDGET: A summary of all budgets which we have mentioned earlier are accumulated here to forecast the profit and loss for the upcoming year. The step by step preparation of the various segments of the master budget demands careful consideration by management with many key decisions concerning pricing, production, capital expenditure, research and development and other areas (Khan, 2007). The task which is outlined in the paper elaborates the behavior of Linda, analyzes her behavior from the case study and extracts a meaningful result that weather or not her behavior and decision are good enough to be implemented. Linda took many decisions and steps which are elaborated in the case study like increases expense which definitely effects the net income and will reduce it, but on what basis she is induced to do that is our requirement and during this study we will find answers to such questions. LINDA'S BEHAVIOUR: This section pertains to the answer of the first question of the case study. Linda is the kind of person who emphasizes on the consequences which are beneficial for her and for her assistants as well. We can assess her nature after looking over major actions which Linda took during her job. She knows very well that the management will reward the employees with bonuses and perks if profit complies with the conditions which are imposed on Linda and her assistants. Linda, her assistants and the plant manager are all eligible to receive a bonus. Linda is cognizant with the conditions imposed by the organization on them. She intends to get the bonuses while put a nominal amount of effort. The corporation assures them that if the projected revenue target is achieved then the corporation definitely will facilitate the employees by bonuses and other perks. If the corporation resist their story till here then its good but the issue arises when Linda's team achieve way more than their budgeting because the management are only willing to facilitate the employees up to a certain level of 120 percent. For instance, if the organization earns a profit in its accounting year which is the same as the projection of Linda's budgeting then legitimately Linda and her assistant will qualify in the region where they must be rewarded and every percent increase from the projection will increase the bonus percentage. For instance, if Linda estimates that the corporation will make a profit of $100,000 in this accounting year, let's suppose in the end of the accounting year the net profit of the organization becomes $110,000 which is $10,000 or 10% above the projection; then as per the commitment of the entity, they have to increase the percentage of bonuses and make sure the bonus is appropriate with respect to the increase in the net profit. But the thing which creates conflict in Linda's mind is that the corporation has applied a cap or upper limit on the bonuses to be rewarded up to 20% (not more than that) means if the organization earns a profit which is 30-40% above Linda's projection then their bonus will not be increased with respect to the increment in net income because of the upper limit applied by the organization. So the decision that Linda took is perfectly right. If the organization lifts the upper limit from the bonuses then it will help to boost up the morale of the employees and it will eventually affect the net income. We are well aware with the fact that 95% of a human's necessities are fulfilled by money, so if the organization is willing to reward their employees as per their performance then it automatically enhances the efficiency of the entity and proficiency of the employees is well. DEFERING SALES: If I am the marketing manager of a corporation where Linda is my division manager then I will give my decision after prudently evaluating the whole situation. In this scenario, I will go with my division manager because it is clear that the corporation is looking to facilitate the employees with respect to the achievement of the budgeted net profit. Linda overestimates the expenses and underestimates the revenue which will condense the profit margin and the net profit to a lower level. Linda is well aware with the fact that the organization is liable to pay the bonuses if the projected net profit is being achieved. Linda wants to keep her and, her assistant to be on a safe side, from a position where they must be rewarded with the bonuses, that's why she overestimates the expenses which will abate the budgeted profit. Overestimation of expenses and underestimation of revenue will be done up to a certain level which is conveniently achievable. Now assume that Linda saw that the division would not achieve the budgeted profits then she will instruct me (marketing manager) to defer the closing of sales in the next year because she assumes that achieving the budgeted target looks impossible this year, and deferring sales to next year can become worthwhile to increase the profit and the chance of bonuses as well in the next year. She also decides to write off some inventory and defer its revenue to be recorded in the next accounting year which will enhance either the chance of achieving the projection or the chance of bonuses. Conversely Linda also instructed her sales department to defer the sales if she feels that the organization easily surpasses the projected level. Let's say, against the projection of $100,000 profit and it looks that the corporation can easily earn profit of around $140,000, then Linda will instruct her sales department to stop making more sales right now because it will not facilitate us anymore because the organization applies an upper limit on the profit and the entity will not increase the bonuses with respect to the increase of profit after reaching on an optimal level of $120,000 or 20% above from the projection. The sales which are being halted are supposed to incur in the next accounting period which will increase the possibility to qualify for the bonuses again. PADDING TO ACHIEVE THE TARGET: If I am a plant manager of a corporation where Linda is heading me, then in this situation I will look broadly into both sides of the situation. Although the budget has been padded by the division manager but if supposition exists that padding is a common knowledge among plant manager then first I will assure my division manager that if we take certain actions then we can achieve the targets and can qualify for the bonuses. Certain actions like changing the territory and condensing the prices and little bit of the product changes can make a difference or we can also attract the people by giving them proposal like "buy one get one free". But remember one thing, whatever course of action I decide it will be pertinent for the organization means, although I am increasing the cost of organization by taking certain major steps but I am sure the additional cost will not harm the organization; yes, it will reduce the profit margin but it will not throw the organization into the pit. If the above mentioned course of action is taken, then it will help to increase the sales and profit as well. On the contrary, if I also think similarly like Linda then I'll prefer to go with my division manager because the strategy she applies is absolutely perfect before me. ACCELARATION OF RECOGNITION: If my division manager instructed me to accelerate the recognition of some legal expense to a future period in this scenario then I will definitely obey my division manager because Linda observes that towards the end of the accounting period the organization is unable to earn the profit which was projected by Linda. She already instructed the sales department to defer the closing of sales in the next accounting period, this gives you an idea that Linda knows that the projection will not be achieved and she is also aware of the fact that she and her assistant will not qualify for the bonuses, so she intends to record the future period lets say next quarter of the same accounting period's legitimate expenses in this accounting year which stresses the projected profit to be reduced, expenses like Audit fees or professional charges and income taxes all come under the umbrella of legitimate expenses. Suppose I (division controller) accelerate the recognition of some legal expenses which belongs to future period then it will disqualify us from the bonuses this year but it will increase the probability to qualify for the bonus in the next accounting period. Assume that after the sales are halted and the acceleration of recognition of legal expenses of future period has taken place, the projected profit reaches on a level which is easily achievable then we may qualify for the bonuses this year and will increase the chance to qualify for the bonuses next year as well. CONCLUSION: The study and the answers pertaining to the study reveals that the division and upper level manager must be intelligent enough to keep a hawk's eye over the different strategies which facilitate both; employees and the entity, but the main thing I grab from this study is that the organization must not take such steps which induce the employees to intervene in the profit. If Linda's organization is suppose to facilitate them through bonuses and different facilities with respect to continuous increment in the actual profit with comparison of the budgeted profit, and then there will be a very good chance to earn more profits for the organization. Upper limit urges the employees to give their expertise to organization in a limited level. REFERENCES: 1. Atrill, Peter & McLaney, E. J. 2007, Management Accounting for Decision Makers, 5th Edition, Financial Times Prentice Hall. 2. Bhimani, Alnoor, Horngren, Charles T., Datar, Srikant & Foster, George 2008, Management and Cost Accounting, 4th Edition, Prentice Hall/Financial Times. 3. Dawkins, Simon 2007, Management Accounting Decision Management, 3rd Edition, Butterworth-Heinemann. 4. Drury, Colin 2007, Management and Cost Accounting, 7th Edition, Cengage Learning EMEA. 5. Garrison, Ray H. 1985, Managerial Accounting: Concepts for Planning, Control, Decision Making, 4th Edition: 4, Business Publications. 6. Glynn, John, Abraham, Anne, Murphy, Michael & Wilkinson, Bill 2008, Accounting for Managers, 4th Edition, Cengage Learning EMEA. 7. Hopper, Trevor, Northcott, Deryl & Scapens, Robert William 2007, Issues in Management Accounting, 3rd Edition, Prentice Hall. 8. Khan, M Y 2007, Management Accounting: Text, Problems and Cases, 4th Edition, Tata McGraw-Hill. 9. McWatters, Cheryl S, Zimmerman, Jerold L. & Morse, Dale 2008, Management Accounting: Analysis and Interpretation, 3rd Edition, Pearson Education Limited. 10. Steffan, Belinda 2008, Essential Management Accounting: How to Maximise Profit and Boost Financial Performance, Kogan Page Publishers. Read More