Accountants and Management Accountants - Essay Example

?Accountants and Management Accountants By Presented to Location Due Accountants And ManagementAccountants Accounting is a continuous process in all business entities. It is applied in every operation within an entity or organisation so as to determine its progress in relation to its making profit. This should be done at the end of each period as determined by the entity. There is a cost incurred whenever an item is sold. This cost is however, hard to estimate when parts of the inventories were purchased at different prices (Roychowdhury 2004). This calls for adoption of an inventory accounting method so as to assign each item an expense so as to avoid losses. The costing method adopted always does not affect inventory physical flow but affects the value of the inventory. Accounting methods adopted are FIFO, LIFO, and Weighted Average Cost (WAC) among others (Drury 2012).  FIFO (First in First Out) is based on the assumption that the inventories that are bought first are sold first and those bought later are sold later (Roychowdhury 2004). FIFO is commonly used by entities that deal in goods with sh lifespan. These goods need to be sold before their expiry dates so as to avoid losses that may result. FIFO method is common in small business entities. As the Roychowdhury (2004) reports, use of FIFO is advantageous because of its usefulness in cases where small numbers of transactions are involved and where price of materials is falling. Customers are likely to buy more products at low prices and hence exhausting the stock. It also helps in sorting out the difficulties associated with bulky goods with unit prices and consequently avoiding loses while maximizing profits. The business may be able to avoid quality deterioration of the stored goods as the goods are sold in the order of their arrival. This makes perishable goods and other goods with short shelf life to be sold before the expiry date. In addition FIFO facilitates the implication of current market price in the value of the closing stock of materials. This makes FIFO be sensitive to the market changes. It is very useful where the prices are falling. This is because the product demand is likely to rise and hence attracting more customers. With FIFO, materials are utilized in the order of their purchase hence making it to be a logical process. This is the most economical procedure of utilization of materials as the cost of their handling is greatly reduced. On the other hand, FIFO is disadvantageous as it is not useful in the situations that involve many inventories bought during same period but at different prices. This is because their flow rate is not the same hence some may expire still in stock. FIFO method cannot be used to achieve the objective of matching current costs with the current revenues. In the events of inflation, FIFO leads to exaggerated profit. Also if the material’s prices rapidly rise, the production cost may be understated hence causing enormous losses. When consignments are received frequently at varying prices, there is increased possibility of errors if the store ledger clerk does not carefully ascertain the prices to be charged on goods. It can also lead to a confusion in the of charging prices of goods produced at the fluctuating cost of materials as they need different pricing which may interfere with the demand. This is per the Roychowdhury (2004). LIFO (Last-In-First-Out Method) is based on the assumption that the last inventories bought are sold first while those bought first are sold last (Roychowdhury 2004). The materials are valued as per the latest purchase prices. The earliest price of materials is used to value the closing stocks. LIFO is very useful in cases of rising prices as the material is issued at current market price. The application of the LIFO is advantageous as Roychowdhury (2004) points out. It is very beneficial in cases where matching of cost and revenue is required as the goods can be sold at any time but long enough to be appropriately valued. It helps to achieve complete recovery of both production and material cost. Also LIFO is easy to operate and therefore most suitable for cases when transactions are not very many and the prices are steady. It allows the effects of the prevailing market prices of materials to be reflected in the sales in the event where materials are recently purchased. Since the materials are issued form the latest consignment, the production is charged at the recent prices. In the event of rising prices, LIFO is very useful as the materials are issued at the current market price which is high. This helps in the reducing burden of income tax as the lower profits are recorded with increased cost of production. The Weighted Average Cost Method is based under assumption that all inventories are sold simultaneously irrespective of the time they were bought (Drury 2012). It is commonly used in manufacturing businesses where inventories cannot be sorted out as they are mixed up. This method is specifically applied in working out an average cost of each unit after purchase. The use of this method is associated with many advantages as Drury (2012) acknowledges. Firstly, the cost of the products is consistent. This is because the cost of all units is averagely calculated hence making other accounting calculations very easy. It requires less paper work compared to other methods. As only one cost is applied in all the calculations, the accountants use only few papers for both calculations and documentations. This method is very simple compared to other methods. This is because it involved fewer steps unlike other methods which involve multiple steps. Lastly, it helps in neutralizing the effects of fluctuations in the market. On the other hand, weighted average is not suitable for costing jobs because each job need to be priced at every stage of completion. The three accounting method are effective in different areas. For the highly perishable goods it is advisable to us the FIFO as it will eliminate the charges of losses due to the expiry of commodities. This makes it help companies to sell their merchandises in time so as to beat the expiry date. The LIFO is suitable in the situations were goods involved have long shelf lifespan. There are no losses even if the commodities are stored for long. Also the storage of these commodities may add value to them hence enabling the sellers to make more profits. The weighted average is helpful in the event where no perishable goods are available in the stock.. Each of the three methods of accounting is beneficial when applied in the right categories of goods. The companies operate with changing production rates. For them to be effective in their production, they need to adopt the most suitable production rate which is likely to give them more profit (Drury 2012). The cost of production is effectively examined for every decrease or increase in the units produced. This is very beneficial as it makes the production companies obtain maximum return from production of commodities. The value inventory statement and profit statement needs to be produced so as to create a clear picture of what is expected from a given production rate of a company. The most effective Marginal Costing and Absorption Costing are two methods used in preparation of value inventory and profit statements as well as assisting in pricing decisions (Roychowdhury 2004). Marginal costing is a system which involves charging variable costs to cost units while the fixed costs are written off (Drury 2012). In marginal costing, the variable cost and the fixed costs are shown differently so as to give a clear guideline in decision making. It tries to find out the effects of output changes to profits. On the other hand, absorption costing refers an accounting system in which a share of both the fixed and variable costs is included in every inventory or unit produced (Hoare, 2011). This technique is applied when preparing a financial statement for external use. The two systems of accounting show considerable differences in the valuation of the inventories. In absorption costing, all production costs are incorporated into inventory valuation (Hoare, 2011). The production costs entail direct expenses, labour, material, fixed overheads variable overheads. In contrast, marginal costing considers variable costs only in the valuation of an inventory. Also, the two methods of costing differ based on the approach which is implied in the reported profits with the changing inventory levels. It is possible to vary fixed costs using the absorption costing until the sales are made (Hoare, 2011). When the stock level is rising, the absorption costing reports higher profits compared to the marginal costing. Given that absorption costing can defer fixed costs up to when sales are made, it means that as the level of stock goes up, it reports that the profits rise compared to when marginal costing is applied. On the other hand, marginal costing reports higher profits when the stock level is decreasing (Drury 2012). The marginal costing is useful in all the events where the companies what to maximize their profits and minimise their production expense (Atrill and McLaney 2012). It can be used in the perfect competition market so as to make sure that the cost of prices of the products of every company is in line with the prices of products from other companies which forms the basis of effective competition. In the events of rising demand the marginal costing is very useful in determining whether extra production to cater for the rising demand will bring the desired returns (Proctor 2012). The marginal costing can fit in every market as it ensures relatively steady prices that can compete favourably. This costing is applied with accordance of the law of marginal return. Absorption costing is very useful in the case of a monopolistic market as it takes no care about the cost of production of extra units but make sure that the production costs are compensated fully in the pricing of the products (Proctor 2012). It is not applicable in the perfectly competitive market especially where the cost of producing commodities is high hence translating to high market prices of the products. In such an event the high priced commodities may not have market hence causing losses. It is very much applicable in all situations where no decision need to be made based on the cost of production (Atrill and McLaney 2012). The two methods of costing may be used alternatively based on the changes in the market. The marginal costing saves the companies against high costs of production while the absorption costing is insensitive in the production cost as it is implied in the prices of commodities hence being compensated by customers. In the fitting market environment each method is capable of producing the desired returns. This saves the companies from high cost of production. With the increased sophistication in production processes, the traditional costing is being replaced by the activity based costing (Horngren, Bhimani, Foster & Data, 2011). The increased automation in the market which has replaced direct labour, has called for a better mechanism of costing so as to cater for increased depreciation of machines employed in the production processes. Activity based costing has facilitated the retrieval of maximum compensation from selling of the products (Ozbayrak, Akgun, and Turker 2004). Traditional costing is a costing system which creates a single overhead pool out of accumulating costs that are not necessarily product cost or labour. These costs include maintenance and supply expenses, management salaries and depreciation among others (Horngren, Bhimani, Foster & Data, 2011). Traditional costing method is used to allocate all products their respective overheads by many companies (Akyol, Tuncel, and Bayhan 2007). The volume metric is assumed to be the determinant of the manufacturing overhead cost. The manufacturing cost is the only cost assigned to products. Other costs such as administrative expense that is not included as they are considered as non-manufacturing (Drury 2012). For external financial reports, the traditional accounting methods are preferable as they give the cost of goods sold. In activity based costing, the costs resulting from activities are summed up. The activities considered are those which facilitate the manufacturing of the product as well as transport activities (Ozbayrak, Akgun, and Turker 2004). Activity-based costing gives a better view of product cost. This system determines every activity used in the production process of a product and allocates some cost to every activity which are summed up to be the cost of the product. The traditional costing and activity based costing (ABC) have a number of differences as acknowledged by Akyol, Tuncel, and Bayhan (2007). While the activity based costing determines the activities to be involved before undertaking the production process, the traditional costing identifies the cost first before undertaking the production process. The former emphasizes on the activities involved in the production process while the later emphasizes on the cost incurred in the production process. Cost drivers determine the cost of any particular activity in ABC as the cost unit determine the allocation and determination of costs in the traditional costing. ABC uses these cost drivers to assign overheads to the products as the departmental overhead allocation rate determines the overhead allocation in traditional costing. The variable overheads are appropriately identified for individual products in the ABC but the standard or actual cost serves as the basis of cost allocation in the traditional. In ABC, it is not important to allocate and redistribute overhead of service but it is important to do so in traditional costing because it aids in the determination of total cost of production. Generally, ABC is based on the assumption that the variation of fixed overhead costs and changes in the volume of output are proportional while traditional costing is based on assumption that changes in volume do not cause any change to fixed overhead cost. Activity-based costing is the best accounting method for companies dealing with various outputs involving various levels of operational intensity (Akyol, Tuncel, and Bayhan 2007). As well, it is suited for business entities that supply their customers with different levels of services or goods. Activity-based costing allows such entities to correctly determine the amount of funds and resources employed any given project (Akyol, Tuncel, and Bayhan 2007). This allows these companies or entities to come up with exact picture of which product is beneficial and those which are not based on the level of return. The manufacturing industries, with the increasing technology and production improvement, was the main target of this system of costing due to the increased indirect costs and reduced direct costs of materials and labour. This is because the increased automation and reduced labour led to increased depreciation and hence needed to be included in charging the prices (Horngren, Bhimani, Foster & Data, 2011). Financial institutions with their diverse services and customers, applies this accounting method so as to make sure that the costs charged are commensurate to the products and customers (Drury 2012). The many products in the financial institution may cause cross-product and cross-customer subsidies. This makes the involved companies to charge appropriate prices for their products as it can assure them commendable profit while being fair to the customers. Companies may change from other methods of accounting to the activity based costing so as to scrutinize its operation (Atrill and McLaney 2012). This facilitates making the right choices over the products to discard and those to adopt. The companies may decide to use this system accounting so as to optimize their prizing. This is because the system involves examination of each step undertaken in the production process hence making the best judgment (Horngren, Bhimani, Foster & Data, 2011). With the increased technology, it has been hard to use other methods in the determination of the prices of products. This is because automation has eliminated labour greatly and has instead created very high depreciation rates which make it hard for prices to be accurately determined using traditional methods of accounting (Ozbayrak, Akgun, and Turker 2004). The change of companies from manual operations to automated operation has served as a call to change to activity based costing to cater for much depreciation created. This implies that the manufacturing companies that are automated and financial institutions are the most suited to apply the activity based costing as it will enable them to be fully compensated for the services involved in the provision of goods and services to their customers. The activity based costing is the most effective costing for these companies as the cost of their prices cannot be determined using volumetric measures applies traditionally. References Akyol, D. E., Tuncel, G., and Bayhan, M. G., 2007, A comparative analysis of activity-based costing and traditional costing, World Academy of Science, Engineering and Technology. Atrill, P. and McLaney, E. (2012) Management accounting for decision makers. 6th ed., Harlow: Financial Times Prentice Hall. Drury, C. 2012. Management and cost accounting, 8th ed., London: Thomson Learning. Hoare, R, 2011, Absorption Costing V’s Marginal Costing, Formation 2 Management Accounting. Horngren, C.T., Bhimani, A., Foster, G. & Data, S.M., 2011. Management and cost accounting, 5th ed., Harlow; Financial Times Prentice Hall. Ozbayrak, M, Akgun, A and Turker, A. K., 2004. “Activity-based cost estimation in a push/pull advanced manufacturing system,” International Journal of Production Economics, vol. 87, pp. 49–65, 2004. Proctor, R., 2012. Managerial accounting for business decisions, 4th ed., Harlow: Financial Times Prentice Hall. Roychowdhury S., 2004, Inventories Accounting, Sloan School of Management Massachusetts Institute of Technology Read More