The Knowledge of Management Accounting and Financial Control - Assignment Example

Introduction Management accounting and financial control is a vital function in every organisation as industries become more and more sophisticated and competition becomes more intense. Thus, learning management accounting and financial control is key for every organisation in order to come up with vital information that will aid it to come up with better decisions. This paper aims to serve as to demonstrate the knowledge of management accounting and financial control that is learned by solving the three questions that come with the exercise. The first question that aims to identify management accounting relevant entities within the organisation such as cost centres and main functions by studying a company in greater detail. P&G was the chosen company, with its major functions and cost centres identified. The distinction between the direct costs and indirect costs, as well as how a given cost can be identified as both direct and indirect cost was also described. Questions two delves with budgeting production costs, determining the trends, as well as identifying the three methods of budgeting as well as their respective advantages and disadvantages. Question three deals the break-even analysis and its application through a set of problem. Various computations that are associated with the analysis are solved. Lastly, limitations of the break-even analysis are discussed. Question 1 Select an organisation either where you work or one with which you are familiar. a) Identify the main functions of the organisation and the costs incurred by each section. Procter and Gamble has three main functions that constitute its global organisational structure. These include its Global Business Unit profit centres, the global Market Development Organisation, and the global shared business services (P&G 2006, 6). These different functions incur different costs. The global business unit profit centres are in charge of developing the strategy for the brands of Procter and Gamble (P&G 2006, 25). These business units are tasked to identify the needs of the global consumers, then create strategies in order to address those needs. The costs that are usually incurred by these functions include the costs to the creative teams that launch the global marketing campaigns, the cost of doing marketing research in various markets, as well as the costs of manpower especially global brand managers who are tasked to head the strategy-formulation for the brands. The global Marked Development Organisation are units that operate in different geographical regions across the world. These units are in charge of delivering the brands to their respective markets in a much faster time than the competition (P&G 2006, 25). They are in charge of distribution of products in their respective geographical region. The costs that these functions incur include the costs to distribute products, the local marketing costs such as in-store materials to promote the merchandise, and the cost of manpower. Production is also included in their costs as regionally-produced products according to the GBUs strategies are then distributed by the global Market Development Organisations. The global shared business services are tasked to take charge of most of the staff function of the business such as information technology infrastructure of the company, etc. (P&G 2006, 25). Because Procter & Gamble is a global company, it utilises IT in order to cut costs in doing business, such as the infrastructure that it uses in order for executives to communicate over longer distances such as video conferencing, etc. These global shared business services also take charge of other staff functions such as recruitment and training of employees, as well as major finance functions. The costs that these functions incur usually include costs related to IT, the costs to recruit and train employees as P&G has a very good employee training program, and cost of manpower. b) Describe the cost units and cost centres used by the organisation. The cost centres that are used by the organisation are the global MDO, or market development organisations and the global shared business services. As distribution and logistics is important in order to bring the product to the market and incurred by MDO, the MDO is considered a cost centre by P&G. The global shared business services, its function which does its staff functions are also cost centres to the company. The cost units for P&G are the costs of producing its product lines as part of the brands that it currently has—the cost for every manufactured product depending on the brand family where it belongs. These costs usually include the cost to manufacture each unit, as well as costs to market those units in different countries. As distribution costs are part of bringing the products to its saleable condition in the market, these are also included. c) Describe how a given direct cost item can be both a direct and indirect cost. A given direct cost item can be both a direct cost and indirect cost depending on the traceability of the costs to the finished product. For example, while utilities can be considered as direct costs and part of the overhead, these utilities which power the plants also provide for the utilities that the plant manager uses, or the other employees within the plant. It may be included in the overhead as traceable to the finished product, by assigning some figures to it, but it is also an indirect cost because it serves another purpose within the plant. Question 2 Monica Manufacturing has budgeted the production costs for 2008 on the basis of an output of 250,000 units as follows: Variable -materials £400,000 -labour £325,000 -expenses £100,000 Fixed Costs - labour £96,500 -Overheads £107,500 The sales department thinks that demand for the product is more likely to be 300,000 units, or could be as high as 350,000 units. a) You are to prepare a schedule of budgeted production costs based on outputs of 250,000 units, 300,000 units and 350,000 units. The schedule is to show total production cost and the cost per unit at each level of output. b) Briefly describe and explain the trend in costs per unit for the three budgeted levels of production. As the costs are given for the level of output of 250,000, in order to get the unit direct costs, the total cost per variable cost should be divided by the level of output. By dividing the direct material cost of 400,000 by 250,000, the unit direct material cost is 1.6. The direct labour cost of 325,000 is divided by 250,000, the unit direct labour cost of 1.3 is derived. The other expenses figure is divided by 250,000, which results in 0.4 in unit expenses. These figures determine the unit variable cost associated with each item, which will be used to determine the total variable cost for the subsequent schedule. The production cost projection uses the above figures to arrive with the total costs for each item. The direct material at the level of 250,000 units is 400,000. The direct labour at 250,000 units is 325,000, and the other expenses at the level of 250,000 units is 100,000. The total variable costs at the level of 250,000 units is 825,000. Fixed labour and fixed overhead remain the same, which results in a total fixed cost of 204,000. The total costs for the company at 250,000 units is 1,029,000. For 300,000 units, by using the derived direct material unit cost of 1.6, it is apparent that direct material costs have risen to 480,000. The direct labour unit cost of 1.3 multiplied by 300,000 units result in 390,000. As for the other expenses, the increase in units results in an increase in the other expenses to 120,000. The total variable costs for 300,000 units is 990,000. With the same level of fixed costs, the total costs for the company to manufacture 300,000 is 1,194,000. As the company increases its production to 350,000 units, the direct material unit cost of 1.6 results in a total direct material cost of 560,000. With the increase in production, the total direct labour costs increase to 455,000. The other expenses increase as well to 140,000. The total variable costs for the level of production at 350,000 units is 1,155,000. With the same level of fixed costs, the total costs for the company to manufacture 350,000 is 1,359,000. Looking at the trends of costs, as production increases the total cost for the company increases. This increase is apparent in the increase in total variable costs, which is tied up to the number of units the company produces. However, the unit fixed costs have been decreasing as the level of production increases. c) Explain 3 methods of budgeting and the advantages and disadvantages of each method. In developing a budget, corporations can resort into three key approaches: the top-down budgeting process, bottom-up budgeting process, and the zero-based budgeting process (Shastri & Stout 2008). The top-down budgets are budgets that are prepared by the top management during the strategic planning process of the organisation (Shastri & Stout 2008). These budgets are usually planned according to the companys long-term, mid-term and short-term goals. In line with these goals, planned forecasts and expenditures are prepared by management in order to put the companys activities according to their financial implication to the organisation. The major advantage of the top-down approach is that it is very much in line with the goals of the company (Shastri & Stout 2008). Because the top management has made it in line with strategic planning, the top-down budget must reflect the strategy of the organisation in order to fulfil the goals in the coming years. The disadvantage of this approach is that because it is set by the top management, figures seem to be less realistic and usually too high for people who will execute them to reach and comply with. As top management does not have concrete idea about the day-to-day operations of the business, these figures can be too high and unreachable, which can lower the morale of employees out of frustration. The other approach to budgeting is the bottom-up approach where the front-line managers create budgets, which are then aggregate into a master budget for the company (Shastri & Stout 2008). The major advantage in this approach is that it reflects the day-to-day operations of the company as inputs are provided by front-line managers and up, thus it is more accurate as regards execution. This can also boost the morale of employees are they become involved in the planning process, thus making them more concerned about the operations of the business. A major disadvantage however is that because the focus is on the day-to-day operations of the company, it may not reflect the strategy that is chosen by the top management in order to adapt to the business environment as well as the competition. It focuses on the current which is assumed to be applied in the future, in contrast to future-looking budgets. The third method of budgeting is called the zero-based budgeting. Zero-based budgets are created usually once every planning period, which requires managers to start from scratch and determine all the relevant activities of the organisation and record them in the budget (Orlando 2009). The major advantage of this is that as the company moves along its strategy over the years, the need for expenditures differ from each period or each year. Therefore, by employing zero-based budgeting, the company has a better grasp of the what really needs to be included in the budget, in order to reflect the needs of its operations. A major disadvantage of it however, is that because managers need to start from scratch, it is very costly especially in terms of time in preparation for the budgets. Question 3 Jason Ltd started business on the 1st of April. He has made the following estimates for next month: Items Selling price £25 per unit Variable cost £10 per unit Fixed costs for the month £300,000 Forecast output 30,000 units Maximum output 40,000 units As an accounts assistant, you are to carry out the following tasks: a) Calculate: i. The profit volume ratio (80) Profit-volume ratio = contribution per unit/selling price per unit *100 Profit-volume ratio = (Selling price-variable cost)/selling price *100 Profit-volume ratio = (25-10)/25 *100 Profit-volume ratio = 60% The profit volume ratio is computed by dividing the contribution per unit by the selling price, which results in a figure of 60%. ii. The break -even point in units (80) Break-even point in units= fixed costs / (selling price – variable costs) Break-even point in units= 300,000 / (25-10) Break-even point in units= 20,000 The break-even point in units is computed by getting the fixed costs and dividing it by the contribution margin or the difference between the variable costs and the selling price. This results in a break-even point in units of 20,000. iii. The break –even point in sales revenue (80) Break-even point in revenues= fixed costs / (contribution margin percentage) Break-even point in revenues= 300,000 / (25-10/25) Break-even point in revenues= 300,000 / .6 Break-even point in revenues= 500,000 In order to get the break-even point in revenues, the contribution margin figure as the denominator in the original equation is replaced by the contribution margin percentage. This is the percentage of the difference between the selling price and the variable costs in relation to the selling price. By dividing this, the break-even point in sales revenue is 500,000. iv. The margin of safety at the forecast output (80) margin of safety=planned unit sales – break-even unit sales margin of safety=30,000 – 20,000 margin of safety=10,000 The margin of safety is computed by getting the difference between the planned unit sales, in this case 30,000 and the break-even unit sales, which is 20,000 as earlier derived. The margin of safety for the organisation is 10,000 units. v. The number of units to generate a profit of £100,000 (80) number of units = fixed costs + target profit / contribution margin number of units = 300,000 + 100,000 / (25-10) number of units = 26,666.67 In order to compute for the volume of sales to reach a target profit, the target profit figure is added to the fixed costs in the numerator, then divided by the contribution margin. This results in 26,666.67 or 26,667 units in order to generate the desired profit. b) Explain the limitations of break-even analysis As there are benefits to utilising the break-even analysis, knowing the limitations of the analysis would help prevent a manager from jumping into conclusions which could result in unsound decisions which are detrimental to the business. Like other models in business, the break-even analysis has limitations. One of the limitations of this analysis is that the result would only be as good as the source of the data, as it is only going to provide an output with the input that is provided in the analysis (Bradley University 2009). This means that although these relationships between the costs, profits and volume are seen, they are only projections which depend on the data that are gathered in order to make some analysis. Having said this, the break-even analysis cannot be used as the sole analysis to come up with a decision (E-learning and Technology 2009). It helps in the process of the decision-making, providing the manager with information to come up with a sound decision but it does not mean it is perfect, and what the figures are the most accurate. Another limitation of the break-even analysis is that it is only applicable in what in management accounting is called the relevant range (Horngren, Harrison & Bamber 2002). Within this relevant range, costs such as the fixed costs behave as they are expected, which is to remain fixed over time. However, beyond this relevant range, what are considered fixed costs will no longer remain fixed; i.e. when the level of production reaches full capacity, the company has no other choice but to increase the capacity, where what have been considered as fixed costs can no longer remain fixed in the process because additional investments are necessary. Lastly, the break-even analysis assumes a linear relationship between cost, profit and volume in terms of production in the company (Washington State University 2009). This is not always the case in real life, where economies of scale may hold (Ndaliman & Bala 2007), or as the company expands, its costs become lower which results in greater increase in terms of efficiency, and therefore expansion. Thus, break-even analysis tends to sometimes oversimplify the production process in organisations. References Bradley University Foster College Of Business. (2006 May 30). “Improving decision-making with simple break-even analysis .” Turner Center for Entrepreneurship. Date accessed: April 25, 2009 from http://www.bradley.edu/turnercenter/business_resources/simple_break-even.html Brealey, R. A., Myers, S. C., & Marcus, A. J. (2004) Fundamentals of Corporate Finance. New York: McGraw Hill. E-Learning and Technology. (2009). “Accounting and Finance: Break-even analysis .” LSN Learning Technologies. Date accessed: April 25, 2009 from http://www.learningtechnologies.ac.uk/downloads/91/ppt12.ppt Horngren, C. T, Harrison, W. T., & Bamber, L. S. (2002) Accounting. New Jersey: Prentice Hall, Inc. Ndaliman, Mohammed B, & Bala, Katsina C. (2007 July). “Practical limitations of break-even theory.” AU Journal of Technology. Date accessed: April 25, 2009 from http://www.journal.au.edu/au_techno/2007/Jul07/auJournalTech_article09.pdf. Orlando, J. (2009 March). “Turning Budgeting Pain into Budgeting Gain .” Strategic Finance. Date accessed: March 29, 2009 from http://web.ebscohost.com/ehost/viewarticle?data=dGJyMPPp44rp2%2fdV0%2bnjisfk5Ie46bVPtq%2buTLSk63nn5Kx95uXxjL6prUq3pbBIrq%2beTrimtFKvp55Zy5zyit%2fk8Xnh6ueH7N%2fiVbOmrky1qrJRsZzqeezdu33snOJ6u9jzgKTq33%2b7t8w%2b3%2bS7S7Stt0u1qbA%2b5OXwhd%2fqu4ji3MSN6uLSffbq&hid=109 Procter & Gamble. (2006). “Company Annual Report.” PG.com. Date accessed: April 25, 2009 from http://www.pg.com/annualreports/2006/pdf/pg2006annualreport.pdf Shastri, K. & Stout, D. E. (2008 Fall). “Budgeting: Perspectives from the Real World .” Management Accounting Quarterly. Vol. 10 No. 1. Date accessed: March 29, 2009 from http://web.ebscohost.com/ehost/viewarticle?data=dGJyMPPp44rp2%2fdV0%2bnjisfk5Ie46bVPtq%2buTLSk63nn5Kx95uXxjL6prUq3pbBIrq%2beTrimtFKvp55Zy5zyit%2fk8Xnh6ueH7N%2fiVbOmrky1qrJRsZzqeezdu33snOJ6u9jzgKTq33%2b7t8w%2b3%2bS7S7OvtE%2burrI%2b5OXwhd%2fqu4ji3MSN6uLSffbq&hid=109 Washington State University-School of Economic Sciences. (2009). “Management strategies through break-even analysis .” Agribusiness Management. Date accessed: April 25, 2009 from http://www.agribusiness-mgmt.wsu.edu/ExtensionNewsletters/mgmt/BreakEvAnal1.pdf. Read More