Differences between management accounting and financial accounting

Analytically discuss how management accounting varies from financial accounting.

Answer 1.

Accounting is a wider concept as it involves two branches which is management accounting and financial accounting (Alex, 2012). These are two completely different terminologies with many similarities and dissimilarities. Both of these play a very significant role and hence is carried out by all the entities.

Financial accounting is the process that involves identifying, analysing and recording all the transactions that happen in an entity(Ball, 1984). This information is used for the preparation of financial statements which helps to provide the user true and fair view of the financial position of a company. These are used by the stakeholders to form an opinion and make their decisions.

Management accounting is done to provide the management with important information so that they can take short term decisions prudently. This accounting can be carried out with the help of financial accounting as well as cost accounting. This enables the management to work with effectiveness so that it can achieve all the desired organisational goals within the specified time.

There are many differences between financial accounting and management accounting based on different basis. They are-

1. Focus- Financial accounting reflects the past trend of performance of the company whereas management accounting is the estimations made for the future.
2. Frequency- Financial accounting helps in the preparation of financial statements which is for a specified period of time whereas in case of management accounting management may prepare reports if required for any time during the year when they feel it is necessary (Berman, Knight, & Case, 2013).
3. Rules- Financial accounting is demanded by the law and certain regulations whereas management accounting is totally optional for the company.
4. Requirement Of Reviewing- The financial statement has to be reviewed every year by a professional whereas there is no such requirement in case of management accounting.
5. Rules- While doing financial accounting certain rules and principles has to be followed but there is nothing as such in management accounting.
6. Users- Financial statements prepared are used by both internal and external parties but if the management prepares any report then it is used only by the management of the company (Berman, Knight, Case, & Berman, 2008).
7. Format- In the preparation of financial statement a specific format has to be followed but there is no any fixed format for the preparation of management report.
8. Information– Financial statements provide monetary information whereas management reports provide all the information it may be monetary or non-monetary.

Analytically discuss the importance of break-even analysis with the help of break-even chart.

Answer  2.

A company survives to earn profits but firstly the company has to recover the cost it has incurred in production. After recovering the cost the company starts earning profit. If the company cannot recover cost it will have to bear losses and there will be no chance of earning profits rather the company has to pay from its own pocket. There are basically two types of cost that are incurred during production. They are-

• Fixed Cost – These are the cost that remains unchanged throughout and do not show any variation with respect to change in volume in production. These cost are of two types discretionary cost and committed costs (Bragg, n.d.). These costs cannot be avoided for a short period and has to be incurred till the business is running. For example – Rent, electricity, advertisement etc.
• Variable cost – The costs that increase with the increase in the production volume and decreases with the decrease in production volume are called variable costs. For example- cost of raw material. The consumption of raw material depend on the volume of production.

The equation will help us to understand the concept of total cost better,

Total Cost = Fixed Cost + Variable Cost.

The situation when the company’s revenue is equal to the cost of production is called breakeven point. There is no profit or losses at this point. But when the company sells anything beyond this point then it starts earning profits.

Total Revenue= Total Cost Of Production

There are two methods of calculating the breakeven point-

1. Breakeven point (in units) – In this method certain number of units is calculated which the sales target of the company sets in order to incur no losses. Say, if the breakeven point is calculated as 4500 units then the company must sell 4500 units in order to recover all the cost incurred (Cafferky, & Wentworth, 2010).

The formula used for the calculation of breakeven (in units) is-

Breakeven Point (In Units) = Fixed Cost/ Contribution P.U.

1. Breakeven points (in sales) – This is another method of calculating breakeven point. In this method the revenues are made the sales target and not the number of units. The formula used is-

Breakeven Point (In Sales) = Fixed Cost/ Pv Ratio

PV RATIO = CONTRIBUTION / SALES *100. (Expressed in percentage)

Following is a table which will help us to understand this more clearly-

Level of units	Total Variable Cost ($)	Fixed Cost ($)	Total Cost ($)	Total Revenue($)
–	–	2,000	2,000	–
50	500	2,000	2,500	1,000
100	1,000	2,000	3,000	2,000
200	2,000	2,000	4,000	4,000
300	3,000	2,000	5,000	6,000
350	3,500	2,000	5,500	7,000
400	4,000	2,000	6,000	8,000
450	4,500	2,000	6,500	9,000
500	5,000	2,000	7,000	10,000

In the above table, we can see that the breakeven point in terms of unit is 200 and in terms of revenue is $4000. Only in these two cases the company will be able to recover the cost. Beyond this point, the company will start earning profit.

Evaluate the performance of any six operational budgets for a limited company.

Answer 3.

The financial plan that is used to keep an estimate of the expenditure and income that may arise in the future. Budgets have a great significance in every company (Financial management, n.d.). They are prepared to manage the expenses according to the available resources in the company.

Importance of break-even analysis

There are usually three types of budgets that a company forecasts- Surplus budget, balanced budget and deficit budget (Fischer, Cheng, & Taylor, 2002). In surplus budget the management of the company estimates that the revenues earned will be more than the expenses in that period of time. The balanced budget means that the revenues and expenses will be equal to each other. The deficit budget is just the opposite of surplus budget as in this case it is estimated that the expenses will be more than the revenues for a specified period of time.

Financial Budget- Financial budget is considered one of the most important budget. A company must have knowledge about the resources it has with it so that it can carry on the business effectively. It is very clear to us that lack of liquidity can stop the operations of the entity which may affect the profitability of an entity (Garrison, & Noreen, 2003). Therefore, the company remains proactive for any kind of sudden changes or cash crunch situations. It is very important to identify and distinguish between important and wasteful expenditures so that the company does not waste its resources (Gitman, 1985).

Production Budget – The two factors that should be kept in mind in the preparation of this budget is the demand of the commodity and the stock of finished goods that will be required.  A proper record of the production should be maintained and production should take place as per the requirement in order to reduce the cost. Inventory should be properly managed because a lot of inventory storage will increase the carrying cost which may lead to rise in the price of product (Goyal, 2012).

Overhead Budget- All the expenses it may be direct and indirect expenses in the process of production and distribution. Indirect expenses which are popularly known as overhead are those cost which cannot be measured in a particular unit and are not directly attributable to the product. The company is well informed about the expenses that have arise during the production. This budget helps in the elimination of the redundant cost included in the finished goods. These overhead expenses are huge in proportion and therefore it is necessary to maintain proper records.

Sales Budget – All the companies survive to earn profits and for earning those profits it has to make several efforts for selling the product. The estimated sales must be equal to the actual sales to earn sufficient profits (Narayanaswamy, 2014). It is important to evaluate the performance and encourages employees to work efficiently by overcoming the drawbacks for better and improved results in future. The budget is considered to have some fault in it if the estimated sales do not match with the actual sales (Pandey, 2015).

Personnel Budget – The personnel budget makes an estimate of the labour force that will be required by the entity in the production of finished goods. As we know that manpower is the one of the most important resource because it is not possible to produce goods. Manpower is required in all the fields such as like manufacturing, administrative and selling distribution. It also lets them arrange form emergency situations. The company with the help of this budget allocates the right work to the right labour so that there can be efficient utilisation of the manpower (Pratt, 2006).

Two methods of calculating breakeven point

Master Budget – This budget is the summary of all the budgets that are prepared in a company and hence its name is master budget. This budget helps in the evaluation and self assessment so that the company can perform more excellently in future. This budget boosts the morales of the employees and helps them retain the confidence.

Every budget has its own significance in an entity. These are very helpful as they enable the proactive behaviour of the management. It provides them confidence to take small decisions prudently which may have a great impact on the organisation.

Discuss analytically the importance of variance analysis as cost controlling and decision making tool.

Answer 4.

 Variance analysis is the gap between the estimated figures and the actual figures. A company has to use several tools that will help it to run smoothly. Variance analysis is one of those most widely used tools in cost accounting which helps to keep a track of the expenses so that it results in cost reduction.

The various types of variances are explained below-

Material Variance – The material variances is the difference between the budgeted consumption of material the actual consumption of the company. This variance helps to control the material usage in an entity. It provides idea to the company about the various areas where there are huge wastages and using unnecessary material.  It controls wastage and leads to improvement in the production by producing maximum output with use of minimal resources. Material being the basis requirement of the production process and it also involves huge costs and so it is very important to do a proper study of material variances as it may improve the profitability in future.

Labour Variance – Apart from material, manpower is also one of the most important requirements of the company which it needs to finish the production process. Manpower is required at all the levels of management. An adequate quantity of manpower in the company should be employed as both excessive and less manpower has negative impacts on the company. If the number of employs is more than required then it is said that there are surplus employees this will lead to increase in the cost of product. But also there should be no shortage of manpower in the company because it may affect the quality of the product or loss of orders.

Overhead Variance – Apart from the direct expenses the company also has to bear several indirect expenses. These indirect expenses are in huge amount so maintaining its proper records is essential. There are two possibilities either there can be over recovery or there can be under recovery. Under recovery is a loss for the company and is charge to the profit and loss account(Ramsey, & Ramsey, 2003). Over recovery of overhead help the company earn profits but this is not always considered as the increased recovery rate influence the sales.

Sales Variance –All the companies has to have a clear objective and to obtain those objective there should be plan. A company always aims at earning sufficient profits so that it is able to carry on its operation for a long period; this is possible only when the company make a sales target. If the actual amount of revenue is greater than the budgeted amount them it is a positive sign for the entity (Tulsian, 2006). This reflects the efficiency of the company to achieve the sales target. Achieving sales target means having sufficient profits.

References:

Alex, K. (2012). Cost accounting (1st ed.). Chennai [India]: Pearson.

Ball, W. (1984). A sense of direction (1st ed.). New York: Drama Book Publishers.

Berman, K., Knight, J., & Case, J. (2013). Financial intelligence (1st ed.). Boston, Mass.: Harvard Business Review Press.

Berman, K., Knight, J., Case, J., & Berman, K. (2008). Financial intelligence for entrepreneurs (1st ed.). Boston, Mass.: Harvard Business Press.

Bragg, S. Corporate cash management (1st ed.).

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Financial management (1st ed.).

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Gitman, L. (1985). Principles of managerial finance (1st ed.). Harper & Row.

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Ramsey, D., & Ramsey, S. (2003). Financial peace revisited (1st ed.). New York: Viking.

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