Management Accounting Functioning of a Business Organisation

Question: Discuss about the term for management accounting plays an immense important role in the functioning of a business organisation. Answer: Introduction Management accounting holds an important place in the functioning of the management of a company. The management comprising of senior managerial personnel and the board of directors refer to the reports of management accountants in order to make important managerial decisions (Clinton and White 2012). Management accounting is the interpretation of financial statements drawn up by financial accountants of the company. This report is directed towards bringing out the importance of management accounting, its types and the manner in which analysis is done for helping the management. For the purpose of this report, Associated British Foods PLC (ABF) has been chosen and this report will be discussing matters related to the company. The issue that the report will address is to improve profitability by curtailing costs of the company. The Concept of Management Accounting and ABF The significance of the interpretations and analysis made by a management accountant cannot be overemphasized. In the present scenario, the business environment has become very competitive and companies are required to evaluate their performance at regular intervals. The primary aim of this is to keep a balance between the pre-determined objective of the organization and its current performance (Hemmer and Labro 2016). Management accounting helps an organisation to evaluate its status of its operational activities by comparing it with the previously budgeted figures. As far as the operating activities of ABF is concerned, there is a decrease in the operating profit of the company from 1080 million Euros to 947 million Euros. This difference and variation can be analysed and interpreted with the help of management accounting tools such as variance analysis. Therefore, it can be said that there is a difference between preparing financial statement and interpreting them. In essence, fol lowing are the differences between financial accounting and management accounting (Bennett, Schaltegger and Zvezdov 2013): The reports of the management accountant are for the use of managers and the board of directors of a company in order to have an idea about the performance of the company. Financial statements prepared by a financial accountant are for the use of various external stakeholders rather than for any internal use. Preparing financial statements is a legal obligation of companies under the Corporations Act 2006. Preparation of management accounting reports is for the reference of the internal management. Financial accounting is related to the performance of a company at the end of a financial year. It compares the financial situation of the present year with that of the previous year. Management accounting report is generally concerned with the performance of a department and forecasts future trends for the company (Ter Bogt and Scapens 2014). Financial statements are required to be submitted to the government in a fixed format and have to follow accounting standards, IFRS and GAAP. On the other hand, management accounting report is used internally and does not have to comply with any fixed standards. Financial reports and statements are prepared for a certain period of time namely quarterly, half-yearly or annually. Management accounting reports are made according to the requirements of the organisation. Classification of Cost Cost of an element is the amount of resources sacrificed by the buyer for acquiring the element. In the course of business, companies have to incur various types of costs depending on the requirements of the organisation. Classification of such costs is necessary to have a clear idea about the total resource sacrifice made by the company in order to carry on its business activities. The overall cost of production determines the extent of operating profit made by a company (Chak and Fung 2015). The following chart below illustrates the types of costs that a company has to incur. Costs based on Types Labour Costs: This is the amount expended by the company on labour used to manufacture a product or service. This is further classified as direct labour and indirect labour. Direct labour costs are costs that are directly involved in the manufacturing process of the product. Indirect labour is not directly attributed to the manufacturing process (Katsikas, Dixon and Woodhead 2014). Material Costs: A manufacturing company to procure materials that are required in the manufacturing of products incurs this cost. Material costs can be further classified as direct material and indirect material. Direct material are costs that can be directly attributed to cost of the product. Indirect material costs are costs that cannot be directly attributed to the final product (Johnson 2013). Overhead Costs: These are costs that a manufacturing concern has to incur other than material and labour costs. For example, an accountants salary, electricity expenses, cost of stationery, depreciation of fixed assets, etc. Costs based on Behaviour Variable Costs: Variable costs are costs that increase with an increase in the level of output. The effect is similar in the opposite case. This means there is an increase in the overall variable cost amount when there is an increase in the total manufactured level of products. For example, the cost of raw materials increase when there is an increase in the number of units produced by the manufacturing company (Lopez-Valeiras, Gomez-Conde and Naranjo 2015). Fixed Costs: These costs remain unchanged irrespective of the level of output of a company. Therefore, these costs are self-determining. For example, interest on loans availed remains constant whether the output level of the company is 100 or 0. Fixed costs per unit decreases when there is an increase in the level of output as the total fixed cost amount remains unchanged (Kastberg and Siverbo 2016). Mixed Costs: These are also known as semi-variable costs and constituted the characteristics of both fixed and variable costs. For the convenience of accounting, these costs are separated according to their extent of being fixed and variable. Costs based on Functions Administrative Costs: These are expenses incurred in the general administration of the whole business concern and the general management of the business. These are mostly indirect in nature and are also known as administrative overheads (Sands and Lee 2015). Selling Costs: Selling costs are costs that are related and incurred for selling the goods and services produced by a company. These are also known as selling overheads and are indirect in nature. Production Costs: These costs relate to the expenses incurred in the production process. It consists of material costs, labour costs and research and development costs. All these constitute the total cost of production of the manufacturing concern. Distribution Costs: These indirect costs are related to the distribution of the goods and services of the company. These costs are incurred while transferring the goods to their point of sales. Costa base on Relevance Relevant costs are costs that are relevant to the managerial decision making process. It has not other classification per se. These costs are accounted for and analyses based on the requirements of the management. Relevant cost can be any type of cost that the management of the company thinks to be crucial to their business activities (Li, Sawhney, Arendt and Ramasamy 2012). Variance Analysis Variance analysis is one of the most important tools of management accounting. It is based on the financial results available to the management accountant. The analysis is done by comparing the budgeted figures of a company and the actual financial results of that company at the end of the budget year. Variance analysis emphasizes on the importance of preparing a budget for the operations of the company and set standards for actual performance (Yap et al. 2013). Practically there are differences in the budgeted figures and the actual figures. Variance analysis critically examines these differences and arrives at a proper conclusion as to the reasons for those differences. In the present business environment, constant monitoring and evaluation has become utmost necessary and the management of a company is in a constant endeavour to expand its scope of operations and maximise profits. Periodical evaluations of business performance prepared the company to counter exigencies arising out of its business activities. In order to achieve this goal, management accounting and variance analysis plays a pivotal role. Classification of Variance Analysis As mentioned earlier, variance analysis has become an integral part of a business organisation. There are various types of variance analysis that a management accountant has to perform. This helps him/her to present a true picture of the company to its management. Each analysis is related to a separate business activity of the company. Following are the types of analysis that are performed (Boyns and Edwards 2013). Material Variance: It is the analysis of the difference in the budgeted figures of expenses on material and its actual figures. It encompasses all the costs that have been expended during the budget year for procuring materials required for manufacturing of goods and services. Labour Variance: It is the variance analysis of the total amount expended in labour that was required to manufacture goods and services by the company. It compares the budget amount fixed and the actual expenses that were incurred during the budget year (Nielsen, Mitchell and Nrreklit 2015). Sales Variance: This analysis takes into account the expected sales figure and the actual sales that were generated during the year. It tries to find out the reasons for the difference in the sales figures of the year (Siverbo 2014). Overhead Variance: As mentioned earlier, overheads are the expenses that are incurred by a company other than expenses on material and labour. This category includes all the other types of expenses that are required to be done by an organisation in order to undertake its business activities. Overhead variance analyses the difference between the budget set for these expenses and the actual amount expended under the head (Chen and Lin 2015). Limitations of Variance Analysis Variance analysis is depended on the budget made by the company for a particular year. The assumptions on which the budget is made are subject to various changes. This change affects the actual financial figures of the year. This is one of the major problems faced in doing variance analysis. However, variance analysis faces several other limitations. The first problem that a management accountant faces is the performance of the managerial personnel (Van der Stede 2015). Managers are entrusted with the responsibility of making and overseeing the budget process. The budget helps in establishing standards for the performance of the company. Therefore, it a very important job as the future performance of the company depends on it. If this responsibility is not performed in a proper manner, formulation of strategies and policies beneficial to the company cannot be developed and implemented. The second problem in variance analysis is drawing up of improper financial data. The financial acc ountants are responsible for drawing up budgets based on the results of the previous year. On many occasions, it has been found that forecasting has been done improperly (Taipaleenmki 2014). This affects goal settings to a great extent. Setting of targets is very crucial to the performance of a company and these targets are required to be established practically after analysing the capacity of the company in a proper manner. Thus, if the basis on which variance analysis is to be done is faulty, the results of the analysis will also be wrong. Operational Budgets and its Types Operational budgets are very important for the functioning of an organisation. This budget determines the manner in which valuable resources of an organisation will be utilized. This budget is prepared annually and is very crucial for the evaluation of the operational performance of the organisation (Cooper, Ezzamel and Qu 2012). It mainly includes three elements namely, revenue, expenses and profits. Revenue budget is concerned with evaluating the revenue generated from operational activities of the previous year and the expected revenue for the next year. Expense budget in a similar manner related to the figures of the previous year and the forecast for the next year with respect to the expenses required to be incurred by the organisation. Profit budget measures the operational profits made during the previous year and the expected profit for the next year (Arroyo 2012). Conclusion It can be inferred from the above discussions that management accounting plays an immense important role in the functioning of a business organisation. It deals with the interpretation and analysis of the financial statements prepared by financial accountants and provides guidance to the management of the company to make important managerial decisions. Variance analysis is a tool of management accounting that is used to spot the differences between the budgeted and actual figures of various financial data. Both financial management and management accounting are related but have a few differenced from an analysts point of view. Recommendations Following are the recommendations with respect to management accounting in manufacturing organisations: Accountants should make proper assumptions while preparing the budget based on historical data. Curtailing of expenses will increase operational efficiency and generate greater revenue if alternative sources of material is utilised. A proper market research should be conducted including a study on the competitors in order to get a view of their operational activities. 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