The Development of Accounting Theory - Essay Example

Assignment Section Management/Financial Accounting) Identify and evaluate the importance of management accounting and financial accounting in the business environment and consider the role it plays in relation to decision making. (30 Marks) Management accounting is concerned with providing information to management about costs, sales revenue and profits, so that they can be able to make informed decisions. It aims at providing detailed financial information for internal management to aid in the planning and control. Management accounting information also provides relevant information to help managers make better decisions and provide information for planning. Management needs to plan its activities to maintain its operations as a going concern perspective. This will involve determining in advance the future course of action on the part. The information obtained from management accounting system help facilitate this objective. For example the management of an organization can use management information to determine which products to drop outsource or produce in house. The information used in planning can then be used as standards against which future performance can be evaluated. This then forms a basis for controlling output or inputs ad determined from the variance. In management accounting, the decision maker is able to forecast an activity and the required input, such as labour time and cost for production, which helps in planning to determine the feasibility of the project. During actual production, he costs incurred are used to evaluated performance and determine the necessary course of action through control mechanism (Needles, Crosson, & Powers, 2002). Management accounting information is also used in decision making is to; generate information that is useful in helping the management allocate costs between costs of goods sold and inventory for internal and report profit to external users Financial accounting is a term used to describe the process of maintains a system of accounting records such as revenues, and exoenses for business transactions and other items of financial nature and reporting the financial position and fianacial performance of an entity. The main purpose of financial accounting is to provide information to external users such as investors, banks and shareholder (Needles, Crosson, & Powers, 2002). The scope of financial accounting concretes on the external users of financial information of the company. Therefore accounting information is useful in acquisition of financial resources from lenders banks and other financial institutions that depend on such information to make decisions. From a company’s financial information a bank is able to determine the ability of a firm to pay interest on bonds. Financial accounting information is also useful in the determination of tax to be paid by a company to the tax department. This is a sign that the company is earning profits and that it is a contributing towards the national growth through addition to the GDP of a country (Gaffikin, & Aitken, 2014). Financial accounting information is used by the shareholders and those charged with governance in evaluating the performance of their company in relation to other company’s within the same industry. For example, the share prices of a company’s stock will decrease as a result of reporting losses in the financial statements of company, which in turn reduces shareholders net worth. Those charged with governance can use the financial accounting information to evaluate their managers in terms of performance and achievement. It also ensures that all assets and liabilities are accounted for, that helps in the comparison with other organizations for different financial years. They are historic in nature by showing what has already been done and exact data are keyed in, in their respective financial accounts. While the auditors of a company use the financial information as a source of financial proclamation for use in audit development (Gaffikin, & Aitken, 2014). Financial accounting information is also useful to other users such as regulators, auditors and the general public. The regulators need financial information because they are the genially available financial data of a company form with they can determine compliance with set regulations and requirements. For example, bank regulator can infer from the balance sheet to determine if a bank complies with capital requirements. The auditors of a company use the financial information as a source of financial assertion for use in audit process. The general public uses rely on the financial information to determine whether they should or should not invest in the company’s stock. It is defined and is prepared at a specific date for example statement of financial position (Needles, Crosson, & Powers, 2002). Comparison between Management Accounting and Cost Accounting. Basis of Evaluations Financial Accounting Management Accounting Time Span It is defined and is prepared at a specific date for example statement of financial position as at 31 December 2013 The period is set by management and determined when it is fit for analysis statutory This is required by international standards such as IFRS and IAS It depends on managements choice but records are recommended for documentation Format Defined by the statutes and standards It is dependent on the managements choice and necessity for information details Facts and figures are holistic and aim at providing material summaries Facts and Figures are detailed into meaningful data to help in decision making process Type of information Items in the financial statements are mostly in monetary terms The records include non-monetary, measures such as labour hours Use Ensure all assets and liabilities are accounted for, Helps in the comparison with other organizations, They are historic in nature by showing what has already been done Help in decision making, it is an internal measure of evaluation and control, thus focuses on past present and future data Explain the different types of cost a business can incur and give examples of these to support your explanation. A cost unit can be anything for which it is possible to ascertain the cost (CIMA). Costs that can be incurred by an organization are categorized into two broad categories namely; Direct and Indirect costs (Needles, Crosson, & Powers, 2002). Direct costs are those costs that can be specifically and exclusively with a given cost object, while indirect costs are those costs that cannot be identified specifically and exclusively with a given cost object. In the production of a product the cost object is the product include, direct material, all the materials that can be identified with a specific product and indirect material in which materials cannot be exclusive identified to the product. Direct labour consist of those labour costs that can be specifically traced to the particular product such as wages and salaries and indirect costs, which are costs that cannot be exclusively identified to the product such as supervisors salary. Manufacturing overheads are costs which consist of all manufacturing costs other than direct labour, direct material, and direct expense. It therefore consists of indirect manufacturing labour, indirect material and indirect manufacturing expense (Needles, Crosson, & Powers, 2002). (ii) Critically evaluate the possible ways in which the company could value stock. (10 Marks). FIFO This method of assigning costs to both the inventory and cost of goods sold assumes that inventory items are sold in the order in which they were acquired. When sales occur the cost of the earliest unit acquired are charged to cost of goods sold FIFO assigns the lowest amount to cost of goods sold which yield the highest gross profit and net income. It is usually preferred in circumstances where costs are rising and there exist incentives by management to report higher incomes. In situations in which the costs regularly decline FIFO gives the highest cost of goods sold yielding a lower gross profit (Horngren, Datar, & Rajan, 2012). It also results to a lower COGS on the income statement that results to higher earnings and this makes after tax earnings lesser. LIFO This method of assigning cost that assumes that the most recent purchases are sold. The most recent costs are charged to the cost of goods sold and costs of the earliest purchase are assigned to inventory. This principle deduces that most new purchases of portfolio are sold at first, this because during the period of inflation most traders reinvest money within their businesses by acquiring inventories within the current market prices instead of saving money by selling old and less luxurious inventories (Horngren, Datar, & Rajan, 2012). LIFO assigns the highest amount to cost of goods sold yielding the lowest gross profit and resultant net income. This has a tax advantage on the current year as most income is deferred to later years. Financial statements are adjusted to reflect the duration-specific for the effects of acquiring new inventory valuation methods. The inventory regulators are needed in financial systems to generate or set financial data to determine compliance with the set regulations in acquiring new inventories for the business Horngren, Datar, & Rajan, 2012). Weighted Average Method This method requires that one uses the weighted average cost per unit of inventory at the time of each sale. The weighted average cost per unit at time of sale equals the, cost of goods available for sale divided by the units available. It usually smooth’s the differences between LIFO and FIFO. It has however been criticized because recent costs believed to be more relevant for decision making (Horngren, Datar, & Rajan, 2012). Specific identification The specific identification method identifies the cost of each item in ending inventory. It can only be used when it is possible to identify the units in ending inventory as coming from specific purchases. It can be used by companies that deal in high priced items. Specific identification has the disadvantage of being impractical to keep track of the purchase and sale of individual item and when a company deals in item that are identical but with different prices. This method can raise or lower income by choosing the lower – or – higher priced items (Needles, Crosson, & Powers, 2002). It also allocates the maximum amount to cost of properties sold acquiescent the lowest gross profit and resulting to the net income. This has a tax benefit on the recent year as peak income is delayed to later years (iii) Identify an appropriate method of stock valuation and complete the stock record card using this method. Justify your reason for choosing this method. (15 Marks) The Method used is Weighted Average This is because it assumes that all units are issued at the current weighted average cost per units and is preferable for use in valuation of inventory on a continuous basis (Needles, Crosson, & Powers, 2002). Receipts Issues Balance Qty Cost @ Qty Total Qty Cost @ Qty Total Qty Total cost/unit 1-May 2000 4000 2 5th May 6000 2 12000 8000 16000 2 10-May 4000 2 8000 4000 8000 2 2oth may 8000 2.2 17600 12000 25600 2.133 2th may 4000 2.133 8533.33 8000 17066.66 2.1333 3. You are required to: i). Calculate the number of jars sold needed to be achieved in order to break even. (10 Marks) %age Cost @ Unit Sales 100% 16 Variable Cost 60% 9.6 Contribution Margin 40% 6.4 Break Even Point = Fixed Cost Contribution Margin Fixed Cost= 80000 Contribution Margin = 6.4 Break Even Point = 12500 ii. Calculate the effect on annual profits if the cost per jar decreases to �12.00, but sales rise to 300,000 units. (Assume annual fixed costs and average percentage contribution made on sales do not change) (10 Marks) Cost @ Unit Units Sold Total Sales 100% 20 300000 6000000 Variable Cost 60% 12 300000 3600000 Contribution Margin 40% 8 2400000 Less Fixed Cost 80000 Operating Profit 2320000 If 60% = 12 Therefore 100% = (100%*12)/60% = 20 iii. Evaluate the relationship between cost volume and profit, using the above example, and suggest strategies that Medi-Service may adopt in order to maximize their profit in the production of Ossimosis. (15 Marks) The graph above is a CVP graphical analysis of the firm operation. The x axis is the units of goods sold and the y axis is the amount realizable or incurred from the operation. The breakeven point is the point of intersection between the Total cost and total revenue, that point is 12500 units. The region above the break-even point is the area in which the firm is able to realize profit. This are the units sold in excess of 12500. The total cost line is not starting at point zero, this is because; fixed costs are incurred even in absence of production (Gaffikin & Aitken, 2014). Strategies available for the firm in order to maximize the profit Decision to Advertise CVP analysis helps in the determination of goods to be sold to breakeven or achieve a preset income. It is a function of fixed costs and incremental variable cost. Decision to advertise involves incurring a fixed cost, which is not dependent on the level of goods produced or sold. Other factors kept constant the new advertising cost will increase the fixed cost by a similar amount, which in turns increases the amount of units to be sold to break even. For example when an advertising cost has been introduced of 45000, the new fixed cost will be 125000 while the contribution margin remains constant. This leads to an increase in units to break even to 19531 units, which is still below the current production capacity of 300,000 units. Therefore the firm can increase its fixed cost by introducing advertising cost but still be profitable, with the probability that the advertising may increase prices for much greater profits (Gaffikin & Aitken, 2014). Decision to reduce the selling price A firm can reduce the market price of its commodity if it believes that its strategy will be attained. Such strategies can include, deliberately pricing below the competitor or selling at a lower price to gain a large market share. The price of an item affects the affect the quantity sold such that the higher the price the lower the quantity sold and the lower the price the higher the quantity sold, for normal goods. The firm will there determine the prices below the current set prices but still achieve its target income. Reducing the price reduces the contribution margin but does not affect the fixed expense. For example the firm decides to reduce its selling price to $12, with its contribution margin at 40%, the contribution per unit of product will be 4.8 which is lower than when prices are at $16. This therefore increases the break-even point to 16667 units from 12500 units. With the production at 300000 units the firm is therefore able to reduce its price on the commodity without incurring losses (Needles, Crosson, & Powers, 2002). References HORNGREN, C. T., DATAR, S. M., & RAJAN, M. V. (2012). Cost accounting: a managerial emphasis. Upper Saddle River, N.J., Pearson/Prentice Hall. GAFFIKIN, M., & AITKEN, M. (2014). The Development of Accounting Theory (RLE Accounting) Significant Contributors to Accounting Thought in the 20th Century. Hoboken, Taylor and Francis. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=1619629. NEEDLES, B. E., CROSSON, S. V., & POWERS, M. (2002). Study guide for Principles of accounting, Principles of financial accounting. Boston, Houghton Mifflin. 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