Demonstrating and understanding of management accounting system

Qualification - Higher National Diploma in Business

Unit Name - Management Accounting

Unit Number - Unit 5

Unit Code - HB405

Assignment Title - Management Accounting

Learning Outcome 1: Demonstrating and understanding of management accounting system

Learning Outcome 2: Appling a range of management accounting techniques

Learning Outcome 3: Explaining the use of planning tools used in management accounting

Learning Outcome 4: Comparing ways in which organisations could use management accounting to respond to financial problems

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Scenario

ABC Co. Ltd. specialises in manufacturing electronic products. The range comprises of 2 products, Personal Computers (‘PC') and Video Players (‘VP').

Question 1:
1. You need to advise the manager the following issues:

Explain the meaning of management accounting, various management accounting tools and role of management accountants

Management Accounting:

Management accounting can be defined as a method of accounting that helps the management of the company to take important decisions regarding the company(Banerjee, 2021). It generates reports by integrating financial accounting and value-adding to highlight the sectors that require the management's immediate attention. The management accounting tools that are generally used consist of budgets, marginal costing, standard costing, variance analysis, etc.

Budgets are used for management by exception in management accounting. The values, costs, and units in the pre-determined budgets are strictly followed by the different departments. The actual values, costs, and units are compared with such budgets and the departments that deviated from the budgets are highlighted. This helps the company in realizing the areas that require revision.

Standard costing also works in a similar way of management by exception (Berry, Broadbent,and Otley,2019). Standard costing also works in a similar way of management by exception(Berry, A., Broadbent,J. and Otley,D., 2019). The standards that are predetermined are compared with the actual results and its variance is noted. The management of the company realizes the weaker areas of the company and where to improve with such a method.

Marginal costing provides the amount of increase in cost that the company will bear due to one extra unit in the production process. It helps in determining selling prices and the number of units to be sold to earn the target profit.

The role of management accountants include:
- The planning for future events, market research, formulation of strategies for both long and short-terms(Alsharari, 2019).
- The designing of frameworks for financial as well as cost accounting and generating reports that aid the operational decision-making.
- Developing efficient MIS (Management Information System) and maintenance of optimality in the company's capital structure.

Explain the classification of costs that would help the management decision-making

Cost Classification:

The classification of costs that aid in management decision-making:
• Marginal Cost: This is the aggregation of all the variable costs.
• Differential Cost: The change in cost caused by a change in the level of activity.
• Opportunity Cost: This is the cost that is foregone due to alternative use of the resources(Ax and Greve, 2017).
• Replacement Cost: This is the assets' current market cost for replacement.
• Sunk Cost:These costs are historical in nature and are already incurred.
• Relevant Cost: This cost is derived from the relevance of any specific usage.
• Imputed Cost: These costs are hypothetical in nature. They are notional and aids in decision-making.

Calculate the unit costs of PC and VP based on absorption costing and marginal costing methods

Calculation of Unit Costs:

Table: 1

The cost per unit under absorption costing is $1160 and $1720 for PC and VP respectively. The fixed cost per unit is calculated using the overhead absorption rate as follows:

Table: 2

Table: 3

which costing method should be used for the accept or reject decision;

The fixed cost per unit is calculated as per the total hours required to complete the monthly demand for both products.

Table: 4

The estimated total fixed cost given is $2.4 million. The fixed cost per unit is calculated using the formula: ((Total Fixed Cost) *proportion of Total Hours Required)/ Monthly Demand(Collis, Hussey and Hussey, 2017).

The cost of unit per product is higher in the case of absorption costing. This is due to the overhead absorption rate. Thus, it is recommended to evaluate products based on marginal costing.

calculate the costs using the costing method recommended above;

Special Order:
The special order of 10,000 units of PC at the selling price of $1050 should be evaluated based on marginal costing. The company suffers from the constraint of limited direct hours of 30,000 hours. Hence, it is vital to determine the contribution per direct hour of each unit.

The contribution and contribution as per direct hour are also significantly lower in the case of the special order. Hence, the special order should be rejected. The cost per unit of the special order is $1048 ($1000+$48).

given that direct labour available is limited to 60,000 hours per month, advise the optimum production mix of PC and VP to maximise profit

Optimum Product Mix:
The optimum product mix with 60,000 direct hours per month is as follows:

Table: 6

calculate the break-even units of IP and if the manager is confident that a target profit of $1,200,000 is achievable, what would be the corresponding target units sold

Break-Even Analysis:

The following is the break-even analysis of product IP for three months of production:

Table: 7

evaluate the proposal to spend an additional $600,000 to promote the IP so that selling price can be increased by $60 per unit to sell 6,300 units per month and discuss the corresponding pricing decisions

Proposal Evaluation:

Table: 8

The P/V ratio of the product increases to 82.50% from 81.08%. The BEP Sales (Units) increaseto 4545 from 2000. Thus, the proposal should be accepted as it decreases the P/V ratio(Weetman, P., 2019). The company will also have to sell more to reach break-even. Thus, with greater profit amount the proposal looks highly profitable.

The company has the constraint of limited direct hours. Thus, the company should consider such factors while formulating cost structures for the products.

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Question 2:

Analyse and evaluating ABC's financial performances by using the various management accounting technique, and make the possible recommendations in dealing with the financial problems and the price strategies in revising its price.

Part A:
The performance of the two products PC and VP are evaluated using profit/loss per unit.

The profit/loss per unit as derived from Marginal Costing:

Table: 9

The profit/loss per unit as derived from Absorption Costing:

Table: 10

It is seen that allocation of fixed cost according to marginal costing provides better results than that according to absorption costing. Thus, the company will show better performance if it adopted the marginal costing technique. The evaluation of the product IP as done in Table: 7 also shows that the financial performance of the company will excel with the usage of the marginal costing technique(Nan,2019). The only constraint noticed is the limited number of direct hours. Hence, the company will have to decide on a proper product mix. The ranking of the three products according to such constraints is IP, PC, and VP. The company should look at more production of IP as it defies this constraint and PC because it ranks better than VP in terms of contribution per direct hour.

Budgeting Process:
the major functions of budgeting process
the advantages and disadvantages in operating a budgetary control system

Part B:
The major functions of the budgeting process are as follows:
• The foremost function of the budgeting process is forecasting and planning.
• It is prepared for the facilitation of communication as well as coordination on the overall organization and its various departments.
• The optimum allocation of resources available to the company can be done with the help of budgets(Drury, 2018).
• The budgeting process also helps in the evaluation of the performance of the departments and the overall organization.
• The principal budgeting factor that limits the budgeting process is also determined and helps in proper control of profit as well as operations
Advantages of the budgetary control system are as follows:
• Optimum usage of available resources(Shtiller et al., 2017).
• Maximization of profits.
• Dynamic monitoring of organizational objectives.
• Fixation of responsibilities of various departments.
• Management by exception of areas deviating from the budgets.
Disadvantages of the budgetary control system are as follows:
• It can be rigid at times(Mohd Ali, 2021).
• It is prepared based on historical data and projected data. Thus, the estimation may not reflect the current values.
• Proper ascertainment of costs and other values may not be possible perfectly.

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Part C: Budgetary Planning:
• whether fixed or flexible budgets should be prepared for the coming January to March
• based on information provided in question, prepare the monthly budgets as follows:
o sales budget
o cash collection budget from sales (assuming 40% of current month sales being paid within the same month with the remaining 60% payable in the following month)
o production budget (assuming monthly production units equals to monthly sales units)
o raw material purchase budget (assuming the company purchases the exact quantity of raw material in each month to meet the monthly production requirement)
o cash payment budget for raw material purchases (assuming payment being made in the month following the month of purchase)
• prepare the monthly cash budget (assuming that the only other item is cash payment of $300,000 in January for the purchase of production equipment and that the projected cash and bank balance as at 1 January is $20,000)

Part C:
The company should prepare a "Flexible Budget" during the three months starting from January till March. The fixed budget does not alter with the alterations in the level of activity of the company(Charifzadehand Taschner, 2017). Thus, the company will have to prepare flexible budgets as the level of activity in March differs from the other two months.

The following are the relevant budgets that are prepared with the given information:

Table: 11

Table: 12

Table: 13

Table: 14

Table: 15

Table: 16

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Part D: Budgetary Control:
• if the actual purchase and usage of raw material amounted to $435,600 in January, calculate the raw material variance
• it is found that the actual purchase price of raw material is $66 per unit and the actual purchase and usage quantity is 6,600 units to produce 3,000 units of IP in January. Compute the raw material price and usage variances to analyse the raw material variance in question
• prepare a cost reconciliation statement reconciling budgeted and actual raw material costs for the month of January
• it is discovered that raw material was purchased in January from a new supplier not on the company's approved vendor list. Report your findings to the manager in accordance with the responsibilities of the relevant departments and recommend possible corrective actions for the identified variance.

Part D:
The raw material variance as calculated below uses the standard costing and variance analysis technique. It helps in determining whether the aspects have performed better than or worse than the expected pre-determined standards or values(Lambovska, Rajnoha and Dobrovic, 2019). The marking of (A) equals "Adverse" which indicates worse than or lower than the standard expected. The marking of (F) equals "Favourable" which denotes better than or higher than the standard expected.

Table: 17

The variance derived is "Adverse". This indicates that the actual total cost of raw materials used was more than the estimated.

Table: 18

This shows that the price of raw materials was less than the estimated price but more units of raw material were required in the production process than the estimated amount.

The cost reconciliation statement that is prepared is the reconciliation between the budgeted and the actual values in the production process.

Table: 19

The statement shows that there was a reduction in the cost of $2400 due to the lower price of raw materials. However, the number of actual units of raw materials that were required in the production process exceeded the estimated number. Thus, the additional cost incurred in the production process is $39600. This led to an increase in the actual cost of raw materials used by $15600.
The Procurement Department is to be held responsible for the mishap of acquiring raw materials from outside of the approved vendors' list. This led to an increase of $15600 in the purchase of raw materials. The procurement department acquired such raw materials due to the attractive price and ignored the quality of such raw materials. The poor quality led to extra usage of such raw materials which in turn increased the cost of raw materials purchased.

Part E: Compare ways in using management accounting tools

In addition to the budgeting and variance analysis methods stated above, discuss other possible ways in using management tools to respond to financial problems

Solution:

The following are the other tools the management of the company can use against financial problems:
• The management can use financial statements such as cash flows statements, fund flow statements, etc. The analysis of such statements will help the management in preventing financial problems(Alborov, et al, 2017).
• The analysis of the financial statements through the process of ratio analysis will also help the company in countering financial problems.
• Revaluation accounting is another tool used by the management of the company to determine the return (fair) on the amount of capital employed.
• The management can also use throughput accounting(Das, 2019).