The Role and Purpose of the Accounting Function in an Organization - Coursework Example

ACCOUNTING By of the of the School L1. The role and purpose of the accounting function in an organization Introduction Organizations, both for profit and nonprofit, public and private, large and small, are usually driven by numbers. Brilliant managers are aware that without a soling accounting function, tasks like management of inventories, tracking of sales or making payroll can become an organizational nightmare (Duska, 2011: 12). Businesses therefore are looking for a well-rounded accounting function by considering several aspects of accounting. Accounting is a framework for measuring and summarizing activities of a business, interpreting and analyzing financial information, and conveying the results to management as well as different stakeholders to help them make informed and better business decisions. The primary purpose of accounting is to provide financial information to the stakeholders so as to help them arrive at better decisions. It is difficult to run a business or to settle on sound venture or investment decisions without timely and accurate financial information that is prepared by accountants of an organization (Drury, 2006: 286). More critical, accountants impart the meaningful of financial information and work with people and businesses to help them utilize the financial information to manage or deal with business issues. The overriding role of accounting is businesses are therefore to assist the interested parties, both internal and external, to make business decisions. The main purpose of any accounting function is to offer ongoing financial record keeping. It keeps monetary information of all types ranging from operational expenses, capital expenditures, salaries, cash flow, investments, donations, to utilities that should be tracked on a given period, for instance, on a month to month basis at a minimum. it is this ongoing results that can be used in a variety of ways because it is the creation of the financial history of an organization. It also gives managers a depiction of the financial health as well as wealth of the firm at any given time. Purpose of accounting function Accounting function is divided into three main fields, namely management accounting and financial accounting as well as a third field known as financial management. Each accounting field has different role and purpose in an organization but all aim at providing financial information that can be used by stakeholders to arrive at informed decisions. Managers usually break the accounting function in the above grouped so as to allow them use the collected data properly (Duska, 2011: 12). Even though management accounting and financial accounting rely on the same underlying stream of financial data, the difference between them lies in their time and focus orientation. Management accounting The main focus of management accounting is internal and looking forward. It provides information as well as analysis to internal decision makers so as to help them operate the business. Therefore, the main purpose of management accounting is to help management in keeping the organization running. Management accounting plays a noteworthy role in assisting managers perform their responsibilities and obligations (Drury, 2006: 286). Since the data or information that it gives is often intended for company-wide use, the format for reporting is very flexible. Management accounting reports are customized to the needs of individual mangers as their main function is to provide accurate, relevant and timely information in an easy to understand format so as to help managers make better decisions. Accounts are, therefore, required to work with all people from all functional areas of the organization in preparing, interpreting or analyzing and communication such information (Jackson et al. 2009: 184). Managerial accounting helps mangers to plan and move the business forward in a financial sound manner. It also helps smart mangers to predict the financial future of an organization as well as making sound decisions based on such expectations (Drury, 2006: 287). Management accounting also acts as a motivating factor to managers as well as other employees to work tireless toward realizing or achieving the goals of an organization as motivated staff tend to perform better and are also more productive. Well motivated employees tend to utilize resources of an organization in an optimum way thereby preserving and protecting the assets of an organization. Management accounting allows mangers to prepare ad hoc accounts that are used in controlling the performance of an organization (Duska, 2011: 12). This allows them to make short-term decisions regarding the use of such resources thus avoiding inherent risks. Management accounting also helps managers in costing and pricing their respective products. Further, it helps them in budgetary planning and control thus avoiding the wastage of company resources. Finally, management accounting helps managers in longer term investment decisions such as investment appraisal. Financial accounting Financial accounting, on the other hand, plays a vital role for organizations. It furnishes information to individuals as well as groups both outside and inside the organization so as to help those interested parties assess the financial performance of the firm. It tells how the business is doing in a race. However, its main focus is external as well as looking back (Drury, 2006: 287). Financial accountants normally prepare the financial statements, such as statement of financial position, income statement and the statement of cash flows thus summarizing the past performance of a company. In addition, it evaluates the financial condition of an organization. Financial accounting requires accountants to adhere to uniform set of rules commonly known as generally accepted accounting principles (GAAP) when preparing financial statements to allow for easy comparisons of companies across the globe. In addition, principles for financial reporting established by an independent agency known as Financial Accounting Standards Board (FASB) must also be adhered to by the accountants. This universality ensures accuracy of reported information. The main objective of financial accounting is to help in determining a company’s value as a whole (Drury, 2006: 286). Financial accounting provides information that assists stakeholders to know about the resources of a company so that they can be able to assess the future prospects of the organization’s net cash inflows as well as identifying if the firm is managed effectively and efficiently. Financial accounting provides information to the following interested parties for control planning and making decisions. Management requires financial information to help make decisions regarding the future development of the company (Drury, 2006: 286). Shareholders and investors uses such information to assess whether the company is overvalued and should be avoided or undervalued and is worth investing in. Creditors on the other hand, use such information to decide if the company is a good risk before lending money, they require solvency of the company. Government agencies require such information to levy taxes. They also check if the company complies with the set regulations to avoid legal issues (Duska, 2011: 12). Customers also require financial information to assess the financial position of the company as an assurance of the firm’s continued existence. Employees requires information regarding the firm’s stability, profitability, financial position as well as financial performance to assess their ability to provide employment opportunities, remuneration, retirement and other benefits. Finally, financial accounting provides information to the public regarding their recent developments and trends on their prosperity indicating their ability to make substantial contribution to the local economy through corporate social responsibilities. Financial management Financial management refers to planning, directing, organizing and controlling the organization’s financial activities such as procurement as well as utilization of funds (Drury, 2006: 288). It means applying general management principles to the organization’s financial resources. This third field of accounting function helps in assessing the investment decisions of an organization. It requires the use of accounting rate of return, payback period, and Internal Rate of Return (IRR) and Net Present Value (NPV) techniques to assess investment decisions. Financial management supports accounting in that it typically reviews financial information for validity and accuracy because accounting information is usually used to secure external financing necessary in financing investment decisions. Finally, financial management helps in risk management. It provides business owners as well as other individuals with useful, accurate and relevant information for making business decisions. Organizations are therefore able to identify business opportunities that provide sufficient returns thus making the company to absorb the least amount of risk (Kapil, 2011: 72). L2/ L3. Summary of performance highlighting profitability, solvency and use of assets Analysis of John Doe PLC Liquidity ratios Year 2 Year 1 Current ratio 1.65:1 1.84:1 Quick ratio 0.9:1 1.0:1.0 Liquidity ratios highlight its ability to meet its short term obligations (Dyson, 2007: 98). Even though JOH Doe’s current ratio decreased in year 2, the company is still liquid and is therefore able to meet its near-term obligations. As far as quick ratio is concerned, the firm is relatively able to meet its short term obligations using its most liquid assets, however, the ability decreased in year 2. This is an indication of reduction in ability to meet short term obligations. The ability to meet short term obligation using the most liquid assets indicates that most of the company’s current assets are in the form of inventories (Kimmel et al. 2008: 290). Profitability Year 2 Year 1 ROCE Return On Capital Employed 20.7% 26.4% Gross Profit Ratio 27% 28% Net Profit Ratio 6.3% 8.3% Profitability ratios determine the bottom line as well as the returns that a company gives to the investors. These ratios show the company’s overall performance and efficiency (Brigham and Ehrhardt, 2013: 126). The company’s profitability ratios have decreased in year 2. This implies a reduction in profitability of John Doe PLC. A reduction of ROCE in year 2 to 20.7% from 26.4% in year 1 indicates a reduction in effectiveness and efficiency with which Doe PLC deploys funds. It also shows a reduction in the efficiency of the company in its operations. A reduction in gross profit margin to 27% in year 2 from 28% in year 1 indicates that a greater portion of the company’s revenue for year 2 goes towards cost of sales hence reduction in effectiveness with which it manages expenses. Even though the profitability ratios reduced, the firm is still relatively profitable to meet its operating expenses and other expenses and still realize some earnings from its operations (Khan & Jain, 2007: 6.2). Use of assets (activity or efficiency ratios) Year 2 Year 1 Inventory Turnover 5.8 times 5.9 times Receivables Collection Period 45.7 days 41.1 days Payables Payment Period 63 days 41.8 days Efficiency ratios show how well the company manages its liabilities and/or how effectively it utilizes its assets (Kapil, 2011: 125). These ratios show how efficiently the assets of the firm are working to generate sales revenues. From the above ratios, it is clear that the efficiency with which John Doe PLC uses the assets reduced over time. A reduction in inventory turnover indicates that the company is less efficient in turning over its inventories. An increase in receivables collection period shows that Doe PLC takes more time to realize the accounts receivable hence reduction in efficiency. An increase in payables payment period is beneficial or quite good because the company uses free finance provided by suppliers. In general, the efficiency with which John Doe PLC uses its assets reduced in year two due to low efficiency in their operation. Solvency ratios Year 2 Year 1 Gearing Ratio 34.7% 28.9% Interest Cover 5 times 7.9 times This category of financial ratios indicates the degree of financial risk that the business faces. An increase in gearing ratio indicates an increase in the proportion of the debt to equity. However, the company is very solvent as the financial risk is relatively low (Kapil, 2011: 125). Even though the interest cover decreased, the company is still able to meet its interest payment obligations with lots of ease. Hence, the company’s ability to pay debts is very high making John Doe PLC very solvent. Analysis of Phelps PLC Ratios Liquidity ratios 31.12.09 31.12.08 Current Ratio 1.75:1 1.92:1 Quick Ratio 1.36:1 1.16:1.0 Phelps PLC liquidity ratios increased in year 2009 indicating an increase in the ability to meet its near-term obligations. As per the quick ratio, the company is very able to meet its short term obligations using its most liquid assets (Dyson, 2007: 98). This is an indication of an increase in the ability to meet short term obligations. However, the reduction in current asset is very minimal. Profitability 31.12.09 31.12.08 ROCE Return On Capital Employed 12.1% 7.1% Gross Profit Ratio 52.7% 47.3% Net Profit Ratio 19.3% 10.9% Phelps’ profitability ratios show an upward trend implying a rise in profitability of the company. A rise in ROCE in 31.12.09 from 7.1% to 12.1% is an indication of an increase in the effectiveness and efficiency with which it is deploying its funds. This results in high returns for the stakeholders due to a rise in the efficiency of the company in its operations (Khan & Jain, 2007: 6.2). Phelps PLC is very profitable since more percentage goes towards dross revenue and net income. It is very profitable as it is able to meet its operating expenses and other expenses and still realize substantial earnings from its operations (Brigham and Ehrhardt, 2013: 126). Use of assets (activity or efficiency ratios) 31.12.09 31.12.08 Inventory Turnover 5.4 times 3.8 times Receivables Collection Period 65.7 days 25.5 days Payables Payment Period 170.6 days 131.1 days The above inventory turnover shows that Phelps is very efficient in managing its liabilities as well as very effective in utilizing its assets. It shows an increase in the efficiency with which Phelps turns over its inventories. However, receivable collection period and payables payment period indicates quite the opposite (Kapil, 2011: 125). An increase in receivables collection period shows that Phelps takes more time to realize the accounts receivable hence reduction in efficiency with which it collects its receivables. An increase in payables payment period is beneficial or quite good because the company uses free finance provided by suppliers. Generally, the efficiency with which Phelps PLC uses its assets reduced in year two due to low efficiency in their operation. Solvency ratios 31.12.09 31.12.08 Gearing Ratio 14.7% 16.7% Interest Cover 13.2 times 6.8 times From the above ratios, it is clear that Phelps PLC is very solvent. It has low financial risk due to reduction in gearing ratio. It is able very able to pay for its interest expense due to the increase in interest cover. This indicates an increase in its operations (Kapil, 2011: 125). Areas that need development and their solutions for both the companies Areas that need improvement involve the use of assets. A decrease in current ratio is caused by an increase in average inventory collection period. It can be remedied by offering high discounts on cash purchases as well as prompt payment for receivable (Khan & Jain, 2007: 6.2). A reduction is quick ratio is caused by inventory glut which can be solved by adopting just-in-time method to manage inventory for them to receive inventory when needed instead of maintaining high inventory levels. Reduction in profitability can be solved by efficient methods so that fewer costs are incurred in generating high revenues (Kapil, 2011: 125). Reduction in efficiency of using assets can be solved by reassessing credit policies to ensure timely collection of imparted credit thus decreasing receivable collection period. Reduction is inventory turnover can be remedied by adopting proper inventory management methods like JIT. In general the company should adopt proper asset management methods to ensure that assets are effectively, efficiently and fully used in revenue generation. Benefits of marginal costing Marginal costing is simple to operate and understand and can easily combined with other forms of costing like standard costing and budgetary costing. It makes it very easy to determine and control costs of production. It allows management to concentrate on achieving and maintain a consistent and uniform marginal cost by simply avoiding the arbitrary allocation of the fixed overhead costs. Because fixed overhead costs are not usually charged to the production cost, marginal costing allows for the elimination of cost variance per unit (Conkling, 2004: 25). Further, marginal costing helps in short term profit planning. It allows for easy assessment of comparative profitability thus bringing it to the notice of managers for decision making. Marginal costing eliminates large balances that are left in overhead control accounts thus making it very easy to ascertain an exact overhead rate. Finally, it ensures that the decisions that are taken yield the maximum return to organizations because it allows for easy assessment and appreciation of alternative sales or production policies. Limitations of marginal costing Marginal costing provides an inaccurate picture in case costs or production is increasing because it is based on historical data. It cannot also be used for external reporting because it does not have a complete view of all overhead and indirect costs (Khan, & Jain, 2007: 5.10). Also, marginal costing allows for over or under-recovery of overhead costs because the apportionment of variable costs is done on an estimated basis rather than on actual value (Conkling, 2004: 25). Marginal costing excludes or incorrectly analyses semi-variable costs leading to distortions. Finally, it gives distorted picture of profits to shareholders because closing stock only consist of variable costs but ignores fixed costs (Khan, & Jain, 2007: 5.10). References Brigham, Eugene F, and Michael C. Ehrhardt. 2013. Financial Management: Theory and Practice. Mason, Ohio: South-Western. Conkling, R. L. (2004). Marginal cost in the new economy a proposal for a uniform approach to policy evaluations. Armonk, N.Y., M.E. Sharpe. Drury, C. (2006). Cost and management accounting: an introduction. London [u.a.], Thomson. Duska, R. F., Duska, B. S., & Ragatz, J. (2011). Accounting ethics. Chichester, West Sussex, U.K., Wiley-Blackwell. Dyson, J. R., Dyson, J., Dyson, J., & Dyson, J. 2007. Accounting for non-accounting students. Harlow, Financial Times Prentice Hall. Jackson, S., Sawyers, R., & Jenkins, J. G. (2009). Managerial accounting: a focus on ethical decision making. Mason, OH, South-Western. Kapil, S. 2011. Financial management. Noida, India, Pearson. Pg. 120-130  Khan, M. Y., & Jain, P. K. 2007. Financial management. New Delhi, Tata McGraw-Hill. Pg. 6.2-6.27 Appendix Question 1 John Doe PLC Ratios Year 2 Year 1 ROCE Return On Capital Employed (500/2420)100= 20.7% (550/2080)100= 26.4% Gross Profit Ratio 1300/4800)100= 27% (1150/4100)100=28% Net Profit Ratio (300/4800)100= 6.3% 340/4100)100= 8.3% Inventory Turnover 3500/600=5.8 times 2950/500= 5.9 times Receivables Collection Period (600/4800)365= 45.7 days (450/4100)365= 41.1 days Payables Payment Period (500/2900)365= 63 days (280/2450=41.8 days Current Ratio 1320/800= 1.65:1 1050/570= 1.84:1 Quick Ratio 720/800= 0.9:1 550/570= 1.0:1.0 Gearing Ratio (840/2420)100= 34.7% (600/2080)100= 28.9% Interest Cover 500/100= 5 times 550/70= 7.9 times Question 2 Phelps PLC Ratios 31.12.09 31.12.08 ROCE Return On Capital Employed (6600/54600)100= 12.1% (3400/47900)100= 7.1% Gross Profit Ratio (12600/23900)100= 52.7% (9500/20100)100=47.3% Net Profit Ratio (4600/23900)100= 19.3% (2200/20100)100= 10.9% Inventory Turnover 11300/2100=5.4 times 10600/2800= 3.8 times Receivables Collection Period (4300/23900)365= 65.7 days (1400/20100)365= 25.5 days Payables Payment Period (4300/9200)365= 170.6 days (2800/7800)365= 131.1 days Current Ratio 9600/5500= 1.75:1 7100/3700= 1.92:1 Quick Ratio 7500/5500= 1.36:1 4300/3700= 1.16:1.0 Gearing Ratio (8000/54600)100= 14.7% (8000/47900)100= 16.7% Interest Cover 6600/500= 13.2 times 3400/500= 6.8 times Read More