Advanced Management Accounting - Assignment Example

Advanced Management Accounting Advanced Management Accounting Part A: Management accounting A costing system is a combination of aseries of principles, techniques and systems that are used to solve problems in a controllable internal environment that is in a position to respond to changes in the external environments (Coombs et al. 2005, p.251). A costing system provides information that is used when making decisions and for planning purposes. In order to have an efficient accounting system some environmental factors that affect the operations of the organization should be reviewed. These are factors like the organisational structure and the market condition. Management accounting applies the realisation concept. The realization concept defines revenue as the cash receivable from the customers for the services or goods delivered or used. A costing system is made up of categories such as the absorption costing, marginal costing, activity based costing, throughput accounting, and environmental accounting. Absorption Costing This is an accounting system that comprises of the direct costs and the overhead costs that are added up to the cost units through the overhead absorption rates. The overhead absorption rate distinguishes the overhead of a product or service based on factors like the direct hours, machine hours and the direct labor costs (Coombs e al. 2005, p. 201). In an absorption costing the fixed costs of production are equally distributed throughout a given period. The cost of production will cover the variable costs in addition to the fixed overhead costs of production. Some fixed costs are usually carried forward to the next financial period. The fixed production overhead is absorbed by dividing the total overheads in a financial period by the output in the same period. The overhead costs are absorbed in different ways like as per the director labour hour. The total overhead costs of a financial period are divided by the labour hours of the same period. The overhead costs are also absorbed through the percentage rate on the direct labour cost. The overhead cost in a financial period is divided by the direct labour costs. This is represented as a percentile. The information based on absorption costing encourages the managers to use their resources in a limited way. If a company would want to limit their labour based on this, they could use the direct labour hours. This would mean cutting back on the labour hours in every unit. The absorption costing is used because it motivates the managers to limit on their use of the production factors like labour based on absorption costing. The absorption costing is also advantageous as it applies the principle of stock and work in progress valuation criteria. The limiting factor of the absorption costing is that the method of absorption of the overhead costs is arbitrary and subjective (Izhar 2001, p.322). This will cause the managers to waste time on trying to decide which absorption option is most suitable. The whole process of absorption costing is very complicated. The information gotten from this whole process is sometimes misleading and can affect decision in making in a major way. Another disadvantage of the absorption costing is that production could be increased as way of cutting the unit costs causing a waste of resources. Marginal Costing This is an accounting system that monitors the behavior of costs hence influencing decision making. It comprises of the variable and fixed costs. The variable cost of a product is its variable production cost which includes units that are not sold. Contribution is the revenue without the variable cost of sales. The variable costs involve commission, packaging, delivery, materials, direct labour and royalties (Izhar 2001, 111). Variable costs vary with the output involved. The fixed costs are deducted in the profit and loss account of a financial period. They are grouped as fixed selling, fixed administration costs, fixed production overheads and fixed distribution. Marginal costing is beneficial because it is easy to tell variable and fixed costs apart. Marginal costing expounds on contribution which acts as a guiding tool for managers to use when deciding to produce goods and services for stock compared to producing them to increase the sales volume. The limiting issue with the marginal costing is that it stresses on the in maximising contribution rather than maintaining a balance. This will mean emphasizing on increasing the selling price and reducing the variable cost and in the end neglect the fixed costs. Activity-Based Costing (ABC) An activity-based system is focused on tracing the expenses of the organiz\sation and their origin. These include the direct and indirect costs that are incurred in the production of goods and services and by customers. The indirect expenses distort the direct expenses as a result of advanced technology and better equipments. ABC links the indirect costs to products, services and customers by monitoring the economic activities of the organisation and the expenses that are involved in the resources used to achieve those (Cokins 2002, p.201). Some of these expenses include depreciation cost of equipments, salaries and electrical power. The resources are tracked using the resource drivers and activity costs by activity drivers. ABC does not change the attributes of coats but apportions them into either value added or non-value added. This helps the management in making decisions. ABC looks at the historical costs and therefore will be helpful in predicting, understand and focusing on an unknown future. Throughput Accounting Throughput accounting is a method of accounting where emphasis is put on maximising the throughput and at the same time be able to maintain and reduce the inventory and operating costs. The theory of constraints complements throughput accounting. It stresses that every organisation has a constraint (Bragg 2012, p. 54). A constraint is a resource, policy or thought of an organisation. A products throughput is the sales value of the product less its material costs. In throughput accounting, not all the non-critical machines are run as there is no point in doing so when the output from is not fully utilised. Throughput accounting stresses on the importance of avoiding production of excess products and services and work in progress. It encourages the business to be flexible to the ever changing external environment. However, there are some few drawbacks related to throughput accounting. It can only be used on a short term basis. At times it might be regarded to be an irrelevant method of accounting. It is not exclusively dependent. Target Costing Target costing is the total cost that is incurred on a product or service while the company still earns the target profit from it. In target costing the cost of a product or service is approximated even before it is produced (Izhar 2001, p.384). This is important as the costs can be cut back even before the product or service is produced. Target costing involves two types of costs namely the allowable and achievable cost. The allowable cost is the maximum amount that can be used in the production of a product or service. The achievable cost is an estimation to predict the capacity of the products or service to meet the targeted cost. The products in target costing are designed to meet the customer requirements. Target costing causes occurrence of behavioral changes. Some of these changes include the organization gave more power to suppliers compare to the procurement department. The organisation can cut back on its costs by eliminating the parts which are not necessary and by combining some processes in order to save on time. Environmental Accounting Environmental accounting is a managerial tool that aids in internal decision making. Environmental costs are the costs that the business undergoes when providing goods and services for their customers. Some environmental costs are irrelevant like the wasted raw materials and hence the organization writes them off during decision making. They can either be accounted for in the overhead accounts or be written off (Aronsson & Lofgren 2010, p. 145). Environmental costs include the capital equipment, utilities, salvage value and materials costs which might be written off and there not accounted for when making internal business decisions. The other approaches discussed earlier in this paper blend in with environmental accounting and helps in integrating the environmental information into business decisions. The main function of the environmental costing is to identify the environmental costs and provide ways to reduce or eliminate them completely while simultaneously achieve the objective of providing quality environmental quality. Environmental accounting is considered in the budgeting process of an organization. This will help the organisation realise investment in preventing pollution and using the green technology. In conclusion, a costing system is a series of principles, techniques and systems that all determine the decisions made. It helps in the identification of economic activities in the organization that do not attract any profit. The costing system provides a guideline to the management on how to tackle problems like choosing between manufacturing their own products or to purchase already made products. Cost accounting influences the choice of pricing of the products and goods. Part B: Cost Accounting Operating profit percentage An operating profit is a measure of income that predicts the percentage revenue to be converted into profit. The interest expense, non-recurring items, and the costs in the income statement, which do not affect the business operations are omitted here. Different companies have different sizes of material costs or labour available and therefore it is important to compare their efficiency by comparing their operating costs. Operating profit percentage = (1042-914)/1042 =0.12% Dribbles ltd uses 0.12% in its operating profit for every 1 Euro in sales. The operating profit is a measure of efficiency and therefore the higher the percentage of operating profit the more profitable a company is. It is also a measure of flexibility especially during hard economic phases. Return on capital employed This the ratio of the net operating profit of an organisation to its capital employed. The operating profit is expressed as a percentage of the capital employed. Return on capital employed = Net operating profit/capital employed Year 2012 = 9813/534 = 18.38% Year 2013 = 10268/575 = 17.86% In the year 2012, Dribbles ltd was more favorable and generated more earnings per Euro of the capital employed. In the year 2013 it had lower profitability. Current ratio This is the ratio of the current assets to its current liabilities. It used by organization to measure if it can repay its debts over a financial period. Current ratio = current assets/current liabilities Year 2012 = 4926/1508 = 3.27 Year 2013 = 7700/5174 = 1.49 In both 2012 & 2013 the current assets exceed the current liabilities. The current ratio is higher than 1 for both years and therefore the company is more liquid and is able to pay its debts. Gearing ratio This is the ratio of the company’s debt to its equity. This illustrates the financial risk that a business faces. Gearing ratio = non-current liabilities/equity Year 2012 = 1220/9813 = 0.12 Year 2013 = 3675/10268 = 0.36 Dribbles ltd can reduce the gearing ratio by selling its shares, exchange their debts for loans, reduce the working capital and generate more income. Trade receivables collection period This is the evaluation of the average number of days that outstanding amounts are held before they are paid. Trade receivables collection period = average accounts receivables (annual sales/360) Average accounts receivables = (2540+4280)/2 = 3410 Year 2012 = 3410/9482*360 = 129 days Year 2013 = 3410/11365*360 = 108 days The trade receivable collection period of 108 days in the 2013 is better than the 129 days in the year 2012 as the risk of customers defaulting in their payments is less. Asset turnover ratio The asset turnover ratio is a measure of Dribbles ltd assets’ ability to generate sales. Asset turnover = Net sales/average total assets Year 2012 = 9482/12541 = 0.76 Year 2013 = 11365/19117 = 0.60 Asset turnover ratio measures the company’s capacity to generate sales. The ratio of 0.76 is better than the ratio of 0.60. In the year 2012 Dribbles ltd used its assets more efficiently. In the year 2013 Dribbles ltd did not use it assets efficiently and were most likely facing production or management issues. References Aronsson, T & Lofgren, K 2010, Handbook of environmental accounting, Edward Elgar Publishing, Cheltenham. Bragg, S 2012, Throughput accounting, John Wiley & Sons, New Jersey. Cokins, G 2002, Activity-based cost management: an executive’s guide. John Wiley & Sons, New Jersey. Coombs, H, Hobbs, D & Jenkins, E 2005, Management accounting: principles and applications, Sage, New York. Izhar, R 2001, Accounting, costing and management, Oxford University Press, New York. Read More