Management Accounting Assignment Help

Qualification - Level 5 Higher National Diploma in Business

Unit Name - Management Accounting

Unit Number - Unit 5

Unit level - Level 5

Assignment Title - Planning tools used in Management Accounting

Learning Outcome 1: Explain the use of planning tools used in management accounting

Learning Outcome 2: Compare ways in which organisations could use management accounting to respond to financial problems.

Case Scenario

XYZ Company manufactures and sells two different brands of electronic products, known as ‘Pebble 101' and ‘Stone 101'. ‘'Pebble 101'is produced in department 1 and ‘Stone 101' in department 2. The business has a capital investment of more than RO 700,000, with 450 employees working in manufacturing and administrative units of the company. The financial statements of last two years (FY 2019 & FY 2018) of XYZ Company has revealed an overall decline in sales, profitability and liquidity position. The directors of XYZ Company are concerned about this sudden decline in the performance and prospects of the Company.

You have recently joined as a trainee management Accountant in XYZ Company and are now a part of the Management Accounting team.

Directors want company's management accounting team to prepare functional & master budgets for the Financial year 2020, calculate relevant financial ratios considering benchmarks, key performance indicators and budgetary targets, identify variances for last two financial years , apply relevant strategic planning tools , financial governance to monitor strategy, management accounting skill sets and effective strategies and systems and compare the ways in which Company can respond to financial problems effectively and efficiently.

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Solution:

Introduction:

Being a Management Accountant in XYZ Company, the role is to prepare functional and master budgets for the company for 2020. This will involve calculations of relevant financial ratios and their variances with the benchmark ratios. Planning tools shall be implemented to prepare the budget for 2020 and the management shall be guided on how to achieve the targets. The ultimate motive is to respond to the financial problems which the company has faced in the previous two years effectively and efficiently.

Comparison of Profits - Budgets with Actual for 2018 and 2019:

The planning work shall begin with analysing previous year data and their comparison with the budgets. Below is an analysis of budgets versus the actuals for the years ended 2018 and 2019.

Beginning with the Profit and Loss Statements of the two years,

On seeing the above data, it has been observed that profit variance for 2018 is adverse to the extent of RO 45,840. The profit variance of 2019 is favourable to the extent of RO 9,740.

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Reason of Variances:

2018: The sales is lower by 3%. This could be due to reduction in sales prices since the number of units in case of budgets and actuals are same. There is a huge variance in Cost of sales which is higher by 40%. This has led to an adverse Gross Profit Variance of 35%. There is insignificant variance in administration cost. Distribution and Interest Cost are lower by 3% and 2% respectively. The overall Profit before tax has an adverse variance of 48%. Such swayed actuals from the budgets are a cause of concern for the company. The major component attributing to the variance is the cost of sales. Since, there is no change in the number of units produced, the reason for variance is the price of raw materials. XYZ Company should look for cheaper raw materials or try to obtain discounts from current vendors. High purchase prices have severely impacted the profitability of the company.

2019: 2019 has observed a favourable variance which indicates that the actual results of the company are better than its budgets. Sales has risen by 3% compared to budgets. Cost of Sales are almost aligned to the budgets. This indicates that either the company has been able to negotiate on purchase price with vendors or has made amendments to its budgets. The gross profit is thus higher by 10% as compared to budgets (Saputra and Putrayasa, 2018). There are minor variances in administration, distribution and interest costs. Overall, the profits are higher by 24% than the budgets.

Comparison of Financial Position of 2019 - Budget vs. Actuals:

There are huge variances in the comparison on budgeted balance sheet of 2019 versus the actual financial position of XYZ Company. The Non-current assets are lower by RO 332,022 which could be possibly due to loss on revaluation of sale of an asset. The receivables and cash balance are higher than forecasted while the inventory is lower than budgets. Seeing the share capital variances, it appears that the company had planned to split the existing shares and buy back a portion of it which did not materialise. The plan of repaying the loan also did not materialise. Rather, the company has taken anadditional long term loan of RO 60,000 as compared to 2018. There are accruals of RO 42,000 while the trade payables is down by RO 36,200 against the budgeted numbers.

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Preparation of Budget for 2020:

Other items forming part of Balance Sheet:
Cash:RO 43,841 (Opening Balance + Receipts - Payments)
Note: It is provided in Question that the opening Cash balance is RO 9,500 while as per actuals of 2019, the opening cash balance for 2020 should be RO 65,000. Here, RO 9,500 has been considered as provided in question.
Inventory: RO 7,28,149.9 (Raw Materials + Finished Goods)
Non-Current Assets:RO 390,000 - 65,000 = RO 325,000
Receivables after adjusting accruals: RO 1,563,750
Trade Payables: RO 234,192
Note: All computations are available in the working file (Excel Sheet).
The above budget preparation is done using the information available.

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Comparison of Ratios:

Analysis of Ratios:
Gross Profit Ratio: The ratio measures Gross profit as a percentage of sales. The actuals of 2018 were in line with industry benchmark. 2019 saw a decline of 2%. 2020 budgets foresee a Gross Profit Ratio of 42% which is above industry standards and if the company is able to achieve it, it shall be a positive indication of growth.

Operating Profit Margin: This ratio indicates the percentage of operating profit by the total sales (Peterson, 2020). This ratio is better than industry average for all three years under comparison. The budget of 2020 shows an operating margin as high as 40%. The Company is advised to create a more realistic budget considering the decline in 2019.

ROCE: The Return on Capital Employed have declined in 2019 as compared to 2018 and these are below the industry benchmark. The budget of 2020 forecasts an ROCE of 75% which looks unidealistic. The company should reconsider the budgets.

Current Ratio: The actuals of 2018 and 2019 have outperformed the industry benchmarks for current ratio. The budget of 2020 too forecasts a very high current ratio of 10:1. This is a comparison of current assets versus current liabilities. The higher the ratio, the better it is.

Quick Ratio: Quick ratio is similar to current ratio but excludes Inventories. The quick ratio too is better than industry benchmarks for the actuals of 2018 and 2019. For 2020 too, the company forecasts a quick ratio of 6.9:1 which is over four times the industry benchmark.

Inventory days: This is an efficiency ratio which indicates the holding period inventory before being sold. The lower the inventory days, the better it is for a company. The inventory days of XYZ Company is very high. In 2018 and 2019, it is four times the industry benchmark. For 2020, the budgets show inventory days forecast to be 100 days which is lower than 2018 and 2019 actuals but still much above industry benchmarks.

Receivable Days: This indicates the number of days in which credit sales realize cash. The receivables days have been deteriorating in 2019 versus 2018. The budgets show a further decline with a receivable period of 125 days. This is close to three times the industry benchmark of 45 days.

Payable Days: This indicates the time period for which the payments to creditors is held back. The higher the payable days, the better it is, since holding of creditor's payments help in contributing to working capital for the time being. Thus, additional sources of funds are not required and saves cost to the company. The payables days are better than industry standards in 2018 and 2019. However, the budgets of 2020 show a decline in payable days. This indicates that the creditors are expected to demand quicker payments.

Gearing Ratio: This ratio indicates the percentage of debt over total liabilities.A higher gearing ratio indicates higher debts. A lower ratio indicates lower debt. A well-balanced gearing ratio is most ideal for a company where a balance between debt and equity is maintained.

Purpose of Planning Tools:
Planning tools like Fixed and Flexible Budgets, Variance Analysis, Pricing tools, Product Costing etc. help the company in identifying concerns impacting the operational performance of the company. A break-even analysis is another mechanism which helps to ascertain the level of units of sales or amount of sales required to achieve a break-even point of no profit, no loss. Any additional revenue above the breakeven is profit for the company. Planning Tools lead organizations towards sustainable success. Cash Flow Forecasts help the company to ascertain whether it has sufficient funds for operations and how much of liquid cash is required at any given point of time. This helps the organization to identify the need of any additional funding and the company can arrange for external sources of funds accordingly. Thus, Planning tools help a company in solving its financial problems and achieving growth.

Use of Budgets in Planning for XYZ Company:

In the given case of XYZ Company, the variance analysis between the actuals and budgets of 2018 and 2019 shall help the company in building the forecast for 2020. The company can plan and work towards attaining its goal defined in the budget of 2020. First, the company sets up its long term plans by establishing the objectives and identifying action courses. Once the plan is built in the form of a budget, actual results are monitored (Messer, 2017). Any divergence from forecasted figures is analysed and responded to.

There is continuous review of the budget which goes on in the company. The budgets help the management to communicate their plans and ideas to the employees and motivate them to achieve the budget goals. There are constraints in budgeting like difficulty in estimating revenues and expenses, unrealistic goals being incorporated in budgets, and loss of management flexibility.
XYZ Company has prepared its sales budget, production budget, direct materials usage budget, materials purchase budget, labour requirement budget, labour budget, overheads budget and other expenses budget. These budgets have helped in the preparation of the Master Budget of Profit and Loss. The cash budget too has been prepared by the Company. Using the various budgets and comparing them with Industry benchmarks, the company can ascertain the areas where the budgets need to be revised to meet industry standards.

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Conclusion:
Budget and Budget Analysis, therefore forms a significant part of a company's Management accounting procedure. These tools help the company and its top management to identify potential markets to supply its sales and diversion from planned business. Budgets are like written form of goals of the company and therefore form an important component of its management process. Variance Analysis helps to identify potential loopholes in the on-going business so that they can be corrected and do not impact the operations of future years. Thus, a management accountant's key role is to prepare a fair and true budget which shall help the management in enhancing its operations (Sponem and Lambert, 2016). Any potential scope of improvement identified while preparation of budgets should be brought to the notice of the management. Similarly, any concern found too shall be informed to the management for appropriate actions. This will ensure optimum use of the information in budgets.