Managerial Control Techniques and Auditing - Assignment Example

Management Control and Audit Introduction: The world of business in the modern era is competitive and a judicious management of both human and non-human resources by a business enterprise is the most essential element for its survival and growth. The rapid growth in the number of business units and the consequent increase in the problem of internal control have made the functions and the strategy of management more complex. As a result of this complex environment, the modern managers require meaningful and judicious data in decision making. The implementation of adequate and effective control measures and the arrangement of audit work also have become decisive part of modern management. Management accounting at present mainly includes managerial control techniques and auditing. Question 1 Calculate the price and efficiency variance In statistical concept and probability theory, the term ‘Variance’ is of great significance. Standard costing is used as a control technique. It refers to the preparation of standard costs and application of these in order to measure the variations from standard costs and analyze the causes of variations to maintain maximum efficiency in production. Such data is presented to management by means of variance analysis. Variances among price and efficiency are important in standard costing. Material price variance means, the part of material cost variance which is due to the difference between standard price and the actual price paid. Price variances will occur due to- Changes in price. Uneconomical quantity of the material purchased. Uneconomical transportation cost. Failure to obtain cash discount. Failure to undertake the purchase of adequate resources within the appropriate time. Price variance is mainly related with the material concepts, where as efficiency variance is mostly related with labor concepts. Efficiency variance in relation to labor means, that portion of labor cost variance which arises due to the difference between standard hours specified for the actual output and the actual hours spent. For computing the Labor Efficiency Variance (LEV) = Standard rate*(standard time_ Actual time). Moreover, efficiency variances arises due to- Lack of proper supervision. Lack of sufficient training. Poor working conditions. Increase in labor turn over. Failure to maintain the machinery in proper condition. Change in the production process. Price variance is for the material purchased, and the efficiency variance is on for the direct labor. “Price variance is the difference between actual unit price and standard unit price, multiplied by actual quantity of input used. It reflects a change between the expected price and actual price of input. Price Variance = (Actual Price - Standard Price) x Actual Quantity where a positive result indicates an increase in costs (i.e., an unfavorable variance), while a negative result means a reduction in costs (i.e., a favorable variance).” (Business Definition For: Price variance. 2007). In case of an organization, there are mainly two types of control: budgetary control and financial control. Budget and budgetary control are related concepts in the theoretical aspects of Cost and Management accounting. It mainly deals with the preparation of budgets and the approval of the effective use of budgets. Budgetary control means comparing the actual with the budgeted concepts. If there is any deviation or variance, it is essential to adopt suitable remedial or corrective measures as early as possible. In addition to this, the budgetary control and organization’s responsibility centers like revenue and expense centers, and profit and investment centers are closely related. It is because these concepts help the management in taking the most appropriate business decision concerned with the future. It is possible only through effective co-ordination and communication measures in the entity as a whole. “Difference between inputs (materials and labor) that were actually used (i.e., actual quantity of inputs used) and inputs that should have been used (i.e., standard quantity of inputs allowed for actual production), multiplied by the standard price per unit. Efficiency (quantity, usage) variance = (actual quantity - standard quantity) x standard price per unit of input. The efficiency variance is unfavorable if the actual quantity exceeds the standard quantity: it is favorable if the actual quantity is less than the standard.” (Efficiency Variance. 2007). Efficiency variance is that portion of fixed overhead volume variance which is due to the difference between budgeted efficiency and actual efficiency. Therefore, Efficiency Variance= Standard rate per hour * (Standard hours for actual production_ Actual hours). OR Standard rate per unit* (Actual production_Revised budgeted units.). In addition to this, efficiency variance is also known as usage or quantity variances. Material price variances and labor efficiency variances are crucial in this regard. Similarly, fixed overhead efficiency variance is- Fixed overhead efficiency variance= Standard fixed overhead rate per hour*(Standard hours for actual production_Actual hours.) Direct Material= £18.0_£15.0*500units. =£1500 is the price variance of the estimated product. By applying the marginal costing techniques, 1. Contribution = Sales(S) _ Variable Cost i.e. C=S_V 2. Profit= Contribution- Fixed expense i.e. = C_F 3. P/V Ratio= Contribution/Sales*100 4. BEP= Fixed expenses/P/V Ratio 5. Sales volume required to earn a given profit= Fixed expenses+Profit/P/vratio- Sales price_variable cost=fixed cost + profit [Assume sales price as variable ‘a’.] Aspen= a – variable costs = fixed cost + profit; i.e. a– 18 = 6.00 + 4.80 (20% of £ 24.00) a -18 = 10.80, or a = £28.80. Sycamore = a– 13 = 3.00 + 3.20 (20% of £ 16) a -13 = 6.20 , or a= £19.20 Elm = a – 24.00= 9.00 + 6.60 (20% of £ 33) a -24.00 = 15.60, or a = £39.60 Statement showing the impact of marginal cost Selling price of Elm (3000units*£30) Less: Marginal costs: Direct material Direct labor Contribution Less: fixed costs(3000*£9) Pofit/Loss £90000 £18,000 £45,000 £63000 £27,000 £27,000 Nil (i.e. Break even Point) Computation of additional order cost of Elm is 3000units for £30 per init, which cost £90000. Assume that while producing 3000units, the fixed cost also getting changed. Similarly, in future customer of Aspen decided to purchase 200units @of £20 per unit for the coming five years. Such as, 200units @of £20 per unit= £4000per year. In addition to this, budgeting helps also to improve the liquidity position, long term solvency, operating efficiency, and the over all profitability. Budgeting plays an important role in taking the most effective financial decision of an entity. Question2 Controllable Variance: Variance is the difference of standard cost and actual cost. Analysis of variance means, carrying out the appropriate investigations to identify the reasons for the variance. It indicates to the management whether the costs are under control or not. Variances can be controllable and uncontrollable. When the variances arises due to inefficiency of a cost centre, it is referred to as controllable variance. On the other hand, uncontrollable variances arise due to external causes like increase in cost of material etc. As far as the cost concepts are considered, controllable and uncontrollable costs are very important. In the case of variable factory overhead, controllable variance is the difference between the actual variable overhead incurred and the budgeted variable overhead. While computing the overhead controllable variance, it is necessary that we stress the overhead incurred, overhead applied and the overhead budgeted for the standard hours also. Assume if the actual overhead is £46000, overhead applied is £44200, and overhead budgeted for the standard hours allowed is £50800; then the overhead controllable variance is £4800, i.e. the difference of actual overhead and the overhead budgeted for the standard hours. “The controllable overhead variance is expressed as (actual overhead - flexible budget level of overhead) for actual level of production. It is referred to as controllable because managers are expected to control costs so they are not substantially different from budget.” (Controllable Overhead Variance). But if the actual overhead is greater than the budgeted overhead, the variance is unfavorable, and if the actual is less than the budgeted, then the variance is favorable. Certain difficulties related to the controllable variance is reduced through effective management control and other budgetary techniques. Overhead variance is the difference between standard overhead cost charged to production and the actual overhead cost incurred. Overheads are controllable and uncontrollable variance. Overhead cost is the sum total of indirect material, indirect labor, and indirect expenses. Overheads are fixed and variable, and its cost variance is split in to variable overhead variance and fixed overhead variance. Variable overhead cost variance= Actual output* Standard variable overhead rate_ Actual variable overhead. OR Variable overhead cost variance= Standard hours for actual output*Standard variable overhead rate per hour_Actual variable overhead. In addition to this, capacity variance as well as efficiency variance is also crucial in case of variance analysis. Question 3 Standard Costing: Standard costing is a technique of cost ascertainment and cost control. It means the preparation of standard costs, and applying them to measure the variations for the purpose of maximizing the operational efficiency. This technique is applicable in those industries where products are standardized. It is widely applicable in manufacturing industries. Standard cost is a pre determined cost for evaluating the actual performance. It is the expected cost of producing one unit. It is a targeted cost, and not an average of previous costs. Standard costs are not the same as budgeted costs. Standard provides cost expectations per unit of activity and a budget provides the cost expectation for the total activity. Standard costing is the system of comparing the actual cost with the standard cost. It also analyzes the variances and takes remedial actions to solve the deviations. It is an effective way to measure the overall performance of an entity as well as controlling the cost. Standard costing is an important managerial tool for undertaking the estimation of overall cost of production. “Assigns costs to products based on expected costs of resources used, which may differ from both normal and actual costs. Under a standard-costing system, standard costs are used for product-costing purposes as well as for control purposes. The costs entered into Work-in-Process Inventory are standard costs. From that point forward, standard costs flow through all the manufacturing accounts. When goods are finished, the standard cost of the finished goods is removed from the Work-in-Process Inventory account and transferred to the Finished-Goods Inventory account. When goods are sold, the standard cost of the goods sold is transferred from the Finished-Goods Inventory account to Cost of Goods Sold.” (Standard Costing Definition). But in recent times, the tool of standard costing has certain limitations in its application. In order to set up standards of a particular project it requires a lot of technical knowledge and skill. So, the efficiency of the operating personnel is important in setting standards. More importantly, it is an expensive method. Due to the non availability of appropriate standards, there should be a difficulty in getting the correct variance. Moreover, it is suitable for only those industries dealing with standardized products. Even though the techniques of standard costing is good enough to apply in both managerial and cost effective decision, it is facing certain difficulties in the present manufacturing environment. So, implementation of proper and effective steps is crucial to developing the standard costing technique and they include- 1. Determination of standards. 2. Evaluate or setting up the standard costs. 3. Determination of favorable and unfavorable variances. 4. Computation of variances. 5. Taking up of remedial measures. Conclusion: Both management and cost accounting play equal roles in making the suitable decisions regarding the management control and auditing procedures. So, it is crucial for every organization to design an appropriate costing system. Effective management and better cost accounting plans are crucial in order to attain the overall development of an entity. Bibliography Business Definition For: Price variance. (2007). [online]. All business. Last accessed 29 November 2007 at: http://www.allbusiness.com/glossaries/price-variance/4945090-1.html CHADWICK, Leslie (1993). Management Accounting 2nd Edition. Other Strategic Issues. The Balanced Scorecard. [online]. Google Book Search. Thomson. p.173. Last accessed 29 November 2007 at: http://books.google.co.in/books?id=TfkMzyT1mcEC&dq=Operating+costing&pg=PA171&ots=vSCVJ78Qn8&sig=Wr7Ifh1wgHy-xQwR8cvu8siZC6c&prev=http://www.google.co.in/search%3Fhl%3Den%26q%3DOperating%2Bcosting%26btnG%3DSearch%26meta%3D&sa=X&oi=print&ct=result&cd=3&cad=legacy#PPP1,M1 Chapter4 Budgetary control. Advantages of Budgeting and Budgetary Control. [online]. FAO Corporate Document repository. Last accessed 29 November 2007 at: http://www.fao.org/docrep/W4343E/w4343e05.htm Controllable Overhead Variance. [online]. Last accessed 29 November 2007 at: http://www.sba.pdx.edu/faculty/michaels/213/Ch09/tsld015.htm Efficiency Variance. (2007). [online]. Answers.com. Last accessed 29 November 2007 at: http://www.answers.com/topic/efficiency-variance?cat=biz-fin Standard Costing Definition. [online]. Lean Advisors INC. Last accessed 29 November 2007 at: http://www.leanadvisors.com/Lean/glossary/definition.cfm/Word/Standard%20Costing.cfm Variance Analysis. (2005). [online]. Interactive Training Technologies. Last accessed 29 November 2007 at: http://www.getahead-direct.com/gwpm25-variance-analysis.htm Read More