Management Account - Assignment Example

Management Account Management Account Answer Variances for actual and budget terms, in absolute values and percentage, are calculated for all the items and listed in the following table. Budget £ Actual £ Variance in absolute terms £ Variance Calculated in % Raw Material stocks 150,000 186,000 36,000 +24 Finished stocks 45,000 66,000 21,000 +46.6 Debtors 60,000 90,000 30,000 +50.0 Bank 4,500 -39,000 -43,500 259,500 303,000 7,500 +16.7 Creditors 66,000 51,000 15,000 -22.72 Working Capital 193,500 252,000 58,500 +30.23 From the table above, variances calculated give indication about the factors bringing change in working capital requirement from the budgeted figure. The inference drawn can be enumerated as per the following. 1. The raw material stock in absolute terms has increased by £36,000 that amounts to 24 percent. The report also states that there is no increase in production cost; this simply implies that the increased spending in raw material procurement is not due to higher raw material cost; otherwise, it would have resulted into higher production cost too and that is not the case hence the only reason could be that either: A) More number of units of raw material has been procured or B) It is simply carryover of the stock from last inventory or method has been changed from FIFO to LIFO while taking the stock of raw material inventory. 2. Percentage wise the major impact has come from the debtors, which have gone up by 50 percent, in absolute terms this rise is to the tune of £30,000. It has also been informed that actual sale income has been very near to the budgeted figure. This simply implies that debtors have not paid in time. The short fall in collection from debtors has made huge impact (50%) when compared with budgeted figure in working capital requirement. Stricter measures need to be deployed in collection of the money. 3. The third major impact has come from finished stocks, which shows its inventory has risen by 46.6%. In absolute terms, this has increased the working capital requirement by £21,000. Again, it has been reported that sales income has remained same. It could be due to the following reasons: A) The reduced sale in units, realizing higher sale price per unit thus keeping same sales income. B) Higher production has been done then budgeted thus accumulating inventory of finished products or it could be mix of A and B. C) Change in method of valuation. Remedies lie either in increasing the sale or reducing the production as per budget. 4. Creditors too have impacted resulting into an increase in the working capital requirement by £15,000. Efforts are needed to avail higher credit periods than already scheduled. Looking at above issues, it appears that no proper method of inventory control is administered with respect to item segregation on the basis of its importance, which needs to be incorporated for immediate and in-built control in stocks and money spent. The situation cannot be allowed to continue for long as that will lead to financial crisis and running the company will increasingly become difficult. There is a negative balance in the bank also indicate that money has been overdrawn from the bank and that will increase the interest burden and reduce the profitability of the company. It will put severe strain on the company’s financials. Procedure to Control the Various Elements It is better to employ some inventory control methods so that realistic or optimum, and not maximum, inventory levels are maintained that are necessary for smooth production processes. 1. ABC Analysis of Inventory It is based on the fact that some items are more important than others. It helps us which kind of inventory should be given more attention in stocking and controlling. a. A group items will be those, which constitute almost 70% of value and 10% by items. b. B group items are important but not as critical as group A items. They constitute 20% in value and same percentage by numbers. c. Group C items are less important and constitute 10% of value and 70% by numbers. Item C does not require stringent control as by value they are less significant items. Total control is required in group A items because they are of highest value and exert greater influence on budget allocation. Group B items require moderate control. 2. Min-Max Inventory Control System Two limits of inventories are set, minimum and maximum. On reaching minimum level, new order is issued. Stocking at any given time should not cross maximum level of inventory. (Jessop, 1994) Answer 2. The various methods of valuation of inventories are employed under the accounting systems based on the type and nature of industry and products. 1. First-In-First-Out (FIFO) Under this method of inventory valuation, it is assumed that goods are accounted for in the order of procurement. That means goods purchased first are used also first in manufacturing operation. It follows the natural flow of inventories, that is, those arrived first will be out first. Advantages of FIFO a. It follows the actual flow of inventory items. b. It does not provide chance of any manipulation of any profit c. In an inflationary period, it can help report higher profits d. It follows simple assumption to effect valuation of inventory e. Closing inventory falls more closer to current cost f. It is easy to follow for its simplicity Disadvantages of FIFO a. It does not reflect current costs against current revenues on profit/loss statement b. It can mislead the shareholders on its current operations for it charges the oldest costs against the current revenue. Higher profit shown does not reflect current scenario of the company. c. Higher profit leads to higher tax payment (Kieso, Weygandt, Warfield, 2004) 2. Last-In-First-Out (LIFO) This method decides that the cost of the goods sold during the given period comes from the most recent raw material purchases. It means that the latest inventory of the goods is the first in line of consumption. Advantages of LIFO The advantages of the LIFO are following. a. In inflationary era, it helps report lower profit and thus helps save the taxes on the profit earned. b. It reflects current costs to match with the current profits. c. It gives shareholders most correct picture of the current state of affairs with respect to the cost and profit. Disadvantages of LIFO a. It does not follow the natural flow of items in consumption. b. It helps management report lower profit during inflationary period. c. It instills the poor procurement habits-- buying more goods to avoid taking into consideration the old cost in expense d. Net profit can be altered by simply procuring high cost item of raw material e. Keeping old cost items in inventory, distorted Working capital needs can be shown to banks. (Chasteen, Flaherty, OConnor,1989) 3. Weighted Average Cost Method Under this method, weighted average cost of the inventory and finished goods is taken into consideration for all the unit purchases and goods sold during the given period. Advantage of Weighted Average Cost Method a. Perhaps, it is the most practical way of costing and easy to apply b. It gives most reasonable picture of the company in its cost and profit figures c. The cost of inventory and finished goods fall in between FIFO and LIFO, thus it gives the most realistic picture of the company. Disadvantages of Weighted Average Cost a. Valuation of inventory and finish products will not quickly reflect the current cost of inventory and the cost of goods sold, particularly in inflationary period. b. Being weighted average cost, it also averages down the given advantage of the LIFO and FIFO. c. It does not reflect the true (Meigs, Williams, Haka, Bettner, 1999). Schematic representation of FIFO, LIFO and Weighted Average methods Source: http://www.principlesofaccounting.com/chapter%208.htm 4. Standard Price It is a predetermined and fixed price taking into consideration the factors that affect the material price such as the likely change in prices as per market conditions. Standard material price can be further bifurcated in current standard price, if taken into account for the short period or known as basic standard when remains unaltered for a long period. Advantages of Standard Price a. Once standard costs are fixed, it is easy to calculate the cost of inventory and the cost of finished goods. b. It is simplest of all the methods and least tedious so far the accounting process is considered. Disadvantages of Standard Price a. In rapidly changing market conditions, it is difficult to fix the standard price. b. The standard cost does not represent actual material cost, which in reality should be charged to a product. (Bannerjee 2010). Thus, it is seen that with all available ways of calculating stock issues, there are merits and demerits involved with each method. The company needs to be consistent with the method throughout so that realistic picture can be assessed for working capital requirement of the company and that subsequently helps devise the ways to arrange for the company’s working capital needs so that the company continues to do with smooth flow of operations. References 1. Principles of accounting. Retrieved on May 13 2011 from http://www.principlesofaccounting.com/chapter%208.htm 2. Kieso, D.E.; Weygandt J. J.; Warfield T. D, (2004), Valuation of Inventories - A cost-Basis Approach, (pp. 383 - 410). John Wiley and Sons. 3. Chasteen, L.G.; Flaherty, R.E.; & OConnor, M.C. (1989), Inventory Valuation: determining costs and using cost flow assumptions. (pp. 398 - 423). Mc- GRAW-HILL Publishers. 4. Jessop, D., & Morrison, A., (1994), Storage and Supply of Materials, Rom-Data Corporation, Falmouti, Cornwall, London. 5. Meigs, R.F.; Williams, j.R; Haka, S.F.; Bettner, M.S.(1999). Inventories and the Cost of Goods Sold. (pp. 330 - 339). Mc-GRAW-HILL Publishers 6. Bannerjee, B (2010). Cost Accounting Theory and Practice, 12th Edition, (pp. 85-97), PHI Read More