Differences between Managerial and Financial Accounting - Research Paper Example

Part One The cost of Raw Materials (cost of hamburgers) is a variable cost since its cost varies with the amount of hamburgers bought. This cost changes with the number of units sold. With each purchase of a hamburger, the cost rises by an equal amount. If no hamburgers are bought, the variable cost will be zero. Building Rent on the other hand is a fixed cost since its cost has to be paid no matter if the building is being used or not. This cost does not change with the level of units sold. A fixed yearly amount (usually paid at the start of the year) will have to be paid. In a case where the building is not being utilized, the cost which is $9000 will be paid. Sales Volume of 1000 Units Raw Material Cost per Unit: 650/1000 = $0.65 Building Rent Cost per Unit: = $9000 Sales Volume of 6000 Units Raw Material Cost per Unit: = $0.65 Building Rent Cost per Unit: = $9000 Raw Material Total Cost: 0.65 * 6000 = $3900 Building Rent Total Cost: = $9000 Sales Volume of 8000 Units Raw Material Cost per Unit: = $0.65 Building Rent Cost per Unit: = $9000 Raw Material Total Cost: 0.65 * 8000 = $5200 Building Rent Total Cost: = $9000 Explanation: The variable unit cost (unit cost of hamburgers) remains the same even if the number of units sold change. However the total cost increases as the increased number units is multiplied by the unit cost. On the other hand the unit fixed cost and total fixed cost (building rent) remains the same since its cost is not dependent on the number of units sold therefore all the cost has to be paid for the rent. Part Two Role of Financial Accounting Financial accounting illustrates the performance of a business over specific periods (usually at the end of an accounting year). They are directed towards external users of accounting information such as investors and creditors. These accounts typically present a historic view on the financial performance of the business [1] Role of Managerial Accounting Management accounting is used by the management to record, plan and control the activities of a business and to help in taking decisions. They can be made for any period or accounting year. It provides information for internal users like the employees, managers, and executives of the company. Management accounts largely focus on analyzing historical performance to give budgets and forecasts for the future. [1] Differences between Managerial and Financial Accounting Laws and Regulations GAAP (generally accepted accounting principles) and Accounting Standards are followed in financial accounting while in managerial accounting there are no legal requirements to prepare management accounts. [2] Reporting Format In management accounting confidential financial reports are prepared for the exclusive use of top management within an organization. Specific accounting formulas and equations are used to reach to these reports. Such reports may include: Sales Forecasting reports; Budget analysis and comparative analysis; Feasibility studies; Merger and consolidation reports While on the other hand financial accounting helps prepare financial reports, that include the basic reporting requirements of profitability, liquidity, solvency and stability. Both internal and external users can view these reports. [2] Time Period of Information Managerial Accounting gives the management those reports that are future-oriented, while Financial Accounting give reports based on historical information to use statistical methods to reach at future values. [2] Detail of Information The details from financial accounts provide information on the business as one unit rather than analyzing the different elements of the business. [2] The management accounts focus on specific areas of the activities performed by the business such as information about its products, the different locations of business or the information about the departments. [2] Nature of Information The nature of information provided by financial accounts is mostly monetary. While management accounts usually include non-financial information such as employees' information or the units sold in a period. [2] Part Three 1) Cost of Advertising allocated to Unicycle Business: 5m / 2 = $2.5 million Cost of Warehousing allocated to Unicycle Business: 3m / 2 = $1.5 million Cost of Advertising allocated to Bicycle Business: 5m / 2 = $2.5 million Cost of Warehousing allocated to Bicycle Business: 3m / 2 = $1.5 million Explanation: Since the allocation of these costs is in an equal ratio, the costs are divided by two. 2) The traditional allocation was being done on an equal ratio basis. This type of allocation can lead to various problems for a smaller business and may lead to a better looking outlook for the bigger business. For this reason, the costs should be allocated according to their respective equity. In this scenario, the advertising costs should be allocated on the ratio of the sales generated by the business and the warehouse expense should be allocated on the ratio of the space occupied by the businesses. Ratio for Sales Unicycle : Bicycle = 150 : 20 = 15 : 2 Therefore for Unicycle the ratio is 15/17 and for the Bicycle the ratio is 2/17 Ratio for Warehouse Space Occupied Unicycle : Bicycle = 75000 : 25000 = 3 : 1 Therefore for Unicycle the ratio is 3/4 and for the Bicycle the ratio is 1/4 Cost of Advertising allocated to Unicycle Business: 5m / (15/17) = $4.41 million Cost of Warehousing allocated to Unicycle Business: 3m / (3/4) = $2.25 million Cost of Advertising allocated to Bicycle Business: 5m / (2/17) = $0.59 million Cost of Warehousing allocated to Bicycle Business: 3m / (1/4) = $0.75 million 3) As described above various problems can arise due to improper allocation of costs to the businesses. Firstly the total outlook of the business would have changed. Following the scenario above, the outlook of Unicycle will look much better and the outlook of Bicycle will look very bleak if the traditional allocation had been used. The net profit would have been higher for Unicycle and lower for Bicycle since the costs would have been lower for Unicycle and higher for Bicycle. The investors looking at the profile would think that Unicycle is performing really well and Bicycle is not. This misunderstanding may cause the smaller business to close in the long run due to wrong perception. Also the managers may close the Bicycle business down if too much expense is allocated to it making them feel that this business is going into a loss. Costs that have no relation to a particular business may be allocated thus making its performance seem bad. These problems can have dire consequences on the business unit therefore proper allocation is extremely important. Works Cited 1) Melissa Bushman, May 07, 2007, "The Differences between Financial Accounting and Management Accounting", [Internet], Associated Content, Available From Accessed on June 2, 2007 2) "Comparison of financial and management accounting" [Internet], tutor4u, Available From Accessed on June 2, 2007 Read More