Management and Cost Accounting

Questions: 1. Discuss the importance of management accounting for your selected organisation and differentiate between management accounting and financial accounting.2. Evaluate different classifications of costs (types, behaviour, function and relevance) with examples.3. Explain the meaning of variance analysis and discuss the most commonly derived variances, outlining the problems and limitations.4. Identify different operational budgets and explain the advantages of preparing different operational budgets. Answers: 1. Importance of management accounting Management accounting primarily refers to the reporting to the internal stakeholders primarily the higher management with regards to the functioning of the company so that they can indulge in prudent decision making. With regards to Tata Jaguar and Land Rover, management accounting is critical since it is used to keep a regular tab on the sales which thus can be used to alter the marketing strategies. Further, management accounting is also critical with regards to inventory management and minimisation of various costs especially indirect costs in order to maximise the profit margins. Thus, periodic reports to management are helpful with regards to estimation of future sales estimation which is imperative as it guides the manufacturing capacity of the company. Besides, management accounting also enables the management to come to terms with the possible new markets that could be explored with regards to extending the product (Bhimani et. al., 2008). Difference between management accounting and financial accounting The major difference between management accounting and financial accounting is that management accounting caters to the internal stakeholders of the firm particularly senior management unlike financial accounting that caters to the external stakeholders of the firm particularly the investors. Management accounting enables the management to take prudent decisions with regards to the functioning of the firm which enables in fulfilment of the various strategic and financial goals. On the other hand, financial accounting enables the investors and shareholders to be appraised about the performance of the company and thereby make a rational choice with regards to stay invested in the company. Also, management accounting provides flexibility to the firms with regards to structure, type of reports etc. since it is not regulated while financial accounting lacks flexibility especially for listed companies such as Jaguar Land Rover since the reports need to adhere to a particular pattern (Drury , 2008). 2. Classification of costs There are a plethora of costs involved in the manufacturing of cars. These costs can be classified based on various parameters namely type, behaviour, function and relevance. The costs as per the above mentioned criterion are discussed below. Classification on the basis of type There are various types of costs, however considering the manufacturing operations of the company, the type of costs are material costs, labour costs and overhead costs. The material costs pertain to the cost of the various raw materials that are used in the manufacturing of cars. The raw materials for car manufacturing would comprise of the various components that are required for its assembly along with the body. Further, during the manufacturing or assembly of cars, the man-hours of labour would be consumed which would be contribute to the labour cost. Besides, there would be other costs related with the maintenance of machines, supporting labour etc. which would constitute as overhead costs (Bhimani et. al., 2008). Classification on the basis of behaviour The underlying behaviour of various costs with regards to volume tend to differ and hence they can be classified as fixed costs, variable costs and semi-variable costs. Fixed costs may be defined as those costs which do not change with volume. The administrative costs along with costs such as rent of various buildings are fixed costs since the underlying output would not alter their magnitude. However, the direct material cost and direct labour cost for the car manufacturing along with sales commissions would be variable costs since these would proportionately increase or decrease with changes in the output of the cars. However, there are certain costs which have the characteristics of both fixed and variable costs and thus are known as mixed costs. For instance, electricity costs would be mixed costs or semi-variable costs since some electricity would be required even if the production is zero but as the production increases the capacity utilisation increases, thus increasing the el ectricity consumption (Drury, 2008). Classification on the basis of function On the basis of function, costs may be sub-divided into production, administration, distribution, finance, sales, R D and quality check. The costs that are incurred for the production of the car are called production costs. However, the costs incurred in selling these cars are known as selling costs or sales costs. Further, the cost incurred in research for new car designs and better safety features would be classified as R D costs. Besides, the costs that are incurred in the inspection of cars and conducting various quality tests would constitute quality check. Additionally, there are various costs incurred for different department such as finance and administration which are critical support systems and thus, they would be classified as finance and administration cost respectively. The finance department provides critical support in the form of budgeting and monitoring the financial performance (Seal, Garrison and Noreen, 2012). Classification on the basis of relevance It is noteworthy that not all costs are relevant for managerial decision making. The costs which are taken into consideration for decision making are known as relevant cost which those which are not considered are known as irrelevant costs. For instance, with regarding to shutting down a particular manufacturing facility, any cost that has been prepaid and would not be refunded would essentially be an irrelevant cost since it cannot be avoided even by closing the manufacturing facility. However, in this given case, the variable costs incurred for the manufacturing facility particularly material and labour costs would be relevant costs since these could be saved in case the manufacturing facility is shut down. This concept is deployed frequently in capital budgeting wherein non-relevant costs are also called as sunk cost and would depend on the individual project (Bhimani et. al., 2008). 3. Variance Analysis Common Types, Problems Limitations Variance analysis may be defined as the quantitative analysis of the difference between the budgeted figures and the actual figures. It is imperative to indulge in variance analysis so as to understand the deviations from the budgeted numbers and ascertain their root cause. In the event, the deviation is negative and adversely impacting the profitability of the firm, then it requires that the firm takes corrective actions to ensure that efficiency of the organisation enhances. Further, through the usage of trend line, the various variances can be tracked and any major anomalies could be analysed further. The most commonly derived variances are discussed below (Seal, Garrison and Noreen, 2012). Purchase Price Variance The above variance tends to compare the actual purchase price with the budgeted purchase price and hence is an indicator of cost of sales. In the event that this variance is positive, it implies that the budgeted gross margins would be negatively impacted since this would lead to an increase in the cost of goods sold. Labour Rate Variance The above variance tends to compare the actual labour rate with the budgeted labour rate and hence is an indicator of cost of sales. In the event that this variance is positive, it implies that the budgeted gross margins would be negatively impacted since this would lead to an increase in the cost of goods sold. Variable Overhead Spending Variance The above variance reflects the difference between the actual variable overheads as compared to the budgeted variable overheads which tend to impact the budgeted profitability of the operations. A positive variance is considered unfavourable while a negative variance is deemed as favourable. Material Yield Variance The above variance deals with the efficiency of usage of material which is critical to gain competitive edge as price is increasingly becoming a significant parameter even amongst premium customers to which the company caters to. Labour Variance Efficiency The above variance deals with the efficiency of usage of labour which has become a significant consideration especially in the wake of increasingly outsourcing the production to low cost destinations such as India for reducing the overall labour cost. Even though variance analysis is a useful tool, but there are certain weaknesses and limitations of this technique that limit its usage. Some of these are outlined below (Bhimani et. al., 2008). It is imperative that the root cause of the variance analysis should be taken into consideration before reaching any conclusions. For instance, at times the deviation may be caused due to incorrect budgeting targets which may be either too aggressive or too slack and thus deviations may lose their meaning. Further, external factors may be responsible for the deviation and hence may not assist in variance analysis. The adherence of variance analysis leads to the managers having a short term horizon and driven more by these goals rather than by the long term objectives of the company. This may defeat the overall objective of incorporating variance analysis. The data required for conducting variance analysis essentially causes delay and reduces to a periodic activity which is typically carried out once a year and corrective measures may be advocated only afterwards. 4. Operational Budgets Types and Advantages Managerial accounting aims to provide information about the financial position of the firm which enables managers in effective planning and designing control procedures. There are various types of operational budgets which are discussed below (Drury, 2008). Master budget It denotes the most elaborate projection of the expected operations of the firm over the fixed period which is usually a year. It usually consists of budgeted balance sheet along with cash flow and income statement. This is most widely used by large companies such as Jaguar and Land Rover. Cash Flow budget Cash flow budgets are useful in predicting the actual inflow and outflow of cash which may be significantly different from the income statement and thus would enable in identifying any shortfall in financing. As a result, it becomes possible for the management to arrange for any financing well in advance which ensures Financial Budget Financial budget tends to indicate how the revenue is earned and the underlying cost that are incurred. These are primarily used by managers for evaluating the proposals for mergers and acquisitions. Static Budget Static budget is that budget where the corresponding items do not undergo a change with the sales level and thus has limited utility. It is primarily used for markets and sectors where the overall budgets are static. Flexible Budget Flexible budget is the budget where the various items tend to change with the alteration in the overall sales volume. This is highly useful especially in markets where there is significant alteration in the overall sales volume. The main advantage of this budget is that it is more effective in planning and controlling.as compared to static budget. It is apparent from the above discussion that different kinds of operational budgets have their own advantages and play critical role in the planning and controlling function. The master budget is the most useful for a company like Jaguar Land Rover since it presents a complete picture of the financial performance of the company. This is also used for conducting the variance analysis which in turn enables the company to enhance the efficiency of operations (Seal, Garrison and Noreen, 2012). References Bhimani, A, Horngren, CT, Datar, SM Foster, G 2008, Management and Cost Accounting 4th edn, Prentice Hall/Financial Times, Harlow, Drury, C 2008, Management and Cost Accounting, 7th edition, Thomson Learning, London Seal, WB, Garrison, RH and Noreen, EW 2012, Management Accounting, 4th edition, McGraw -Hill Higher Education, Maidenhead