Full-Accrual Accounting Systems, Modified Accrual Accounting and Cash Budget - Coursework Example

Full title topic Introduction The entire paper is divided into three main portions; the initial part describes the difference between the full-accrual-modified accrual and cash budget, the next section include the issues of transparency and the last section describes the two major accounting tools and techniques mainly used all over the world. What is the difference between Full-accrual accounting systems, modified accrual accounting and cash budget? Full-accrual accounting system This is an accounting system1 in which the financial accounts are record on economic activity rather financial activity. Under this system the revenues are recorded when they are actually realized and earned rather when they payments are actually received. The expenses are matched with their revenues rather when they are paid. This full accrual accounting system actually belongs to the matching principle of the accounting in which the expenses are matched and recorded with their revenues regardless when they are paid. This accrual accounting system is according to the US GAAP (generally accepted accounting principles)2. This system is specially use for the profit income measurement as in this accounting system the matching of expenses with the revenues is very important. The major aim of the model is to elaborate the total cost that occurs in the firm and matching this exactly with revenue of that period. This include Employment cost (recruitment cost, additional production cost, and education cost), Operating cost (Wages and Overheads), Work environment cost (cost of absence, sickness benefits, rehabilitation cost and disability pension cost). It also include the cost of labour per hour, the cost occur on the injuries and number of absenteeism. The aim of the model is to optimize the total cost that occurs on labour during its life time period. The cash flow statement for the accrual accounting system is very essential. Modified accrual system Modified accrual system3 clearly shows the amount of funds that are available for the firm. This accounting system can not define the profit determination but actually defines that how much fund is available for the firm. Under this system the word expenditures are used instead of expenses. The modified accrual system do not elaborate that how much he firm earns a profit rather it informs that how much amount the firm hold for its further funding system. In this system the organization accounting activities are divided into separate funds that are also viewed as separate entity. Cash Budget Cash budget4 informs the firms that how much cash inflow in the firm and how much the cash outflow from the firm. The cash budget informs that either the firm has enough cash for its future transaction or not. Cash budget informs the total budget of the firm and includes different tools and techniques. The cash budget, budgeted income statement and cash flow statement. It does not relate the expenses and revenues rather involve total expenses and revenues to inform the total cash in hand of the firm. An example of cash budgeted income statement is given that will provide a clear sense of the cash budget. Example of cash budget statement Cash Budget statement for the Month may Cash Beginning 220000 Add receipt collection from customer total cash from customers less disbursement direct material 44000 direct labour 17600 overhead 355200 selling and admin cost(2 per unit) 88000 equipment purchase 20000 total disbursement 524800 Cash Budgeting for the month -304800 Issues of Transparency The accounting system remain a major issue at global level as it remain unsuccessful in providing harmonized system of accounting and this is due to many reasons. These reason are provided as below Cost structure of the firm Accounting system in the world introduces different accounting structure that holds different cost structure5. These cost structures varies with region to region and from firm to firm. That is the reason that the transparency in the accounting system remains a major issue as these are not providing an accurate and valid data to the stakeholders. Standard accounting system The standard accounting board is specially organized at global level that provides a standardized system of accounting. Basically the accounting is divided into many branches and among them financial accounting and management accounting remain an important area. The financial accounting though gain harmonization and transparency in tits system but management accounting still lacks transparency and harmonization and the reason is that different firms possess different cost structures to avoid their major cots. Reporting The accounting system actually develops to provide a report to the internal stakeholders like managers and employees where as financial accounting deals to provide clear results to the outer stakeholders6. This accounting information has direct impact on the economy of the country. Therefore, the transparency in such system is must as the more the clear information and accurate information provided by the accounting system, the more the outer stakeholder and government will be able to make a better decision. Therefore, the major issues in this transparency are to use the standardized reporting system that can provide clear information about the firm. Quality information The other major issues in the transparency of the accounting system are to provide a quality reports and information to different channels and this information to different channels must be same and reliable. This quality information is required by different stakeholders, government and media and thus the transparency and harmonization in these systems is required to provide better quality information to the readers. This quality information should be same while providing to different channels and must hold effective analysis that can provide a better end results. Accounting tools Though, there are many accounting tools that are used all over the world to make and end result. Different accounting tools are used by the firms that are based on different principles to result out total cost and total benefits of the firm. The accounting tools are sued to summarize the total cost, expenses and cash of the firm. These accounting tools use the different accrual system that shows that how they took accruals in their firm. Below two main accounting tools and techniques are described in brief showing the real example that how they are sued in the firm. Marginal Costing The marginal costing analysis actually took three variables fixed cost, variable costing and contribution margin to understand the firm position. This technique divides the cost into two variables as variable cost and fixed cost. The Marginal costing actually helps the manager to make decision by answering four questions as 1. What product to manufacture? 2. What should be the price strategy? 3. What marketing strategy should be adopted? 4. What type of productive facilities should be used? The answers of these four questions with the help of Marginal costing will help the manager to decide what strategy should be used. The Marginal costing used different techniques and these are 1. Variables cost is the sum of the marginal cost, the cost that do not remain the same while changes with time 2. Fixed cost is the portion or ratio of cost that remains fixed through out the operation period in a firm. Contribution margin The contribution margin7 is the amount gain after deducting the variable cost from the sales. The contribution margin is the amount from which the fixed cost and rest of the expenses are deducted. If the amount contribution margin is unable to cover the fixed cost then it shows that the firm is in loss. Usually the firm uses the contribution margin ratio. The firms specify their contribution margin ratio; the ratio that must be gained. The contribution margin ratio helps the manager to know that what actual strategy should be used if the firm is facing the loss in the year. With the change in sales, price, volume, variable cost and fixed cost the contribution margin ratio of the firm changes. Break even Analysis The break-even8 is the point at which the firm gain neither profit nor loss. The break-even point analysis helps to target the profit of the firm. The break-even analysis is calculated from two ways; the equation method and the contribution margin method. The break-even analysis helps the firm to know that how much extra units must be sale in order to gain the expected or target profit. The margin of safety The margin of safety9 helps the firm to know the excess of budgeted sales; it helps to know the amount of sales drop before getting any loss. The margin of safety helps the firm to know that how much sales must be done to avoid the loss. The implementation of these tools in reality Contribution margin Suppose the sales of the one of the Organization subsidiary is 452 million where as the variable cost of the subsidiary is 534 million. This will help the firm to know that the company is in loss. Similarly, the manager can decide that he must earn the contribution margin ratio up to 40% of the sales. This will help the manager to maintain and manage the activities in a way to earn that much ratio. Taking above example, the manager must earn contribution margin equal to 180 (40% of 452). Break-even analysis Break-even analysis helps the managers to know that what exact number of units will provide the targeted profit to the firm. For instance, if the firm per unit price is 4 and wants to earn the profit of 4 million than the manager need to sale million of product over break-even analysis. Suppose the 1000 units provide the break-even analysis, than the firm needs to sale million units above the 1000 units. The margin of safety The margin of safety helps the firm by showing that dropping too much sales may cause loss. For example, in above-mentioned example, if the sales of the firm start decreasing from million then the managers must know that how many sales must be maintain to avoid the loss. The sales below 1000 units will provide the loss to the company in we concern the above given example. Benefit from the above mentioned techniques Garrison Noreen argued that the marginal costing technique benefits the firm in different ways. If we use the contribution margin technique than the manager knows that how much amount must the firm required to meet the fixed cost and other expenses. The contribution margin provides the manager an idea that how much money is required to fulfil the obligations. The managers use the contribution margin techniques to target the profit. The firm required to use the contribution margin to know that how much cost is incurred on the variable overhead and how much cost is incurred on fixed overhead. This contribution margin provides a clear difference between the different costs. This helps the managers to know that where the extra cost is incurring and thus helps to reduce the cost. When taking the break-even analysis then the managers use this to target their profit. The break-even analysis provide the information that at which point the firm will gain the zero point; where the profit equals to the loss. At this point, the firm knows that how many extra units will provide the targeted benefit. The break-even analysis technique is used in all firms that help the firm in different ways. Each firm has to know that how much drop in sales is allowed that defines the margin of safety. The extra unit in drop of sale causes loss. Therefore, the firm should mention their margin of safety in order to remain away from the loss. Limitation of the technique Garrison Noreen and Peter C. Brewer (2007) stated that the marginal costing technique is applied only in limited conditions; the selling price of the product must be constant. The price of the product should not change with the change in the volume of the product and this limit the use of the technique. The cost of the firm must be linear if you want to apply the CVP technique. This means that that the cost must be divided between the variable cost and fixed cost. When there is the multi product company than the sale, mix should be constant if you want to apply the CVP technique. Last per not least, the inventories must remain constant if the firm wants to apply the CVP technique. Absorption costing method The absorption costing technique10 informs the manager about the cost of production. It includes 1. Cost of labour: the first cost of the labour incurred in the firm. 2. Cost of material: the cost of raw material directly involved to form the finished goods 3. Factory-overhead: the expenses that directly and indirectly incurred to produce the goods. The absorption costing technique uses three types of systems and these are given as: 1. Job-order costing: In job order, costing techniques the cost is allocated or assigned with each lot or batch. It means that the cost is associated with each type of job performed during the production. For example, cost of forming each part of the car is found out separately. 2. Process costing is the technique in which the cost is allocated totally to whole of the product. No batches or lots are formed rather the total cost is associated with the whole product. For example, oil distillation or soda manufacturing. 3. Activity Based costing technique enables the firm to allocate the cost from the cost centres to the product. In this technique, the cost is allocated with each activity. Implementation of techniques on Organization The absorption costing technique is very simple. The managers must know that what is the direct cost incurred on purchasing the material, the cost of labour and the overhead cost. The manager can use three systems for absorption costing technique that are mention above. For example, the manager can use the job order costing in the Organization then he has to allocate the cost of raw material used to form the product; it will be the cost of all the ingredients that are used to form the Organization daily milk chocolate or beverage. Then the manager will allocate the labour cost; the cost of labour with respect to time in manufacturing the product. Moreover, in last the manager will allocate the cost and expenses that indirectly or directly used to manufacture the product. The above three when added will provide a total cost associated with the product manufacturing. 2.2) Benefits of absorption costing The major benefits of the absorption costing are that the firm is bale to know that at which job more cost is incurring. The manager is able to use different systems of absorption costing according to the type of firm or production. The absorption costing helps manager to know the cost of each activity and later he is able to manage that activity causing extra cost. 2.3) Limitations of the technique The absorption costing technique is unable to calculate the actual cost if the extra units are formed and are not sold. In this case, the absorption costing technique is not use full. It provides the actual cost of the firm, but did not deal with the effect of cost on profit. Therefore, its use in the accounting is very limited. It did not show any relation of cost with profit, cost with price and cost with volume. 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" Reform of Budgeting and Finacial Management", Public Sector Management in Australia, 2nd ed, Macmillian, South Yarra, Chapter 8, pp 126-144. Read More