MANAGEMENT ACCOUNTING
Standard Costs Used for Variance Analysis and Favourable/Unfavourable Terminologies with Suitable Examples 8
References 11
Management Accounting
Differences between Management Accounting and Financial Accounting and the need for Investing in the latest Accounting Software
Audience Served
The basic difference between these two accounting fields is that the management accounting is concerned with providing information to internal stakeholders of an organisation such as the senior management, supervisors and employees. In contrast, financial accounting provides information about the financial health of the business to external stakeholders such as potential investors, shareholders (in case of a publicly traded company), tax authorities, lending institutions and suppliers/vendors etc .
Report Generation
As management accounting is concerned with making short-term decisions about daily operations of the business, management reports could be generated at any time during the year with frequency like daily, weekly or monthly . In contrast, financial accounting deals with information disclosure at end of the period, reports could only be generated at a certain period, probably on the last day of the financial accounting period.
Coverage
Management accounting deals with specific cost centres, production facilities, departments or products whereas financial accounting covers the financial aspect of the entire organization
Importance of an Accounting Software
Regardless of whether an organisation aims to implement management or financial accounting software, all that is needed is the implementation of accounting software into business operations that offers certain promising benefits. An organisation must invest in the acquisition and implementation of accounting software because doing so will increase accuracy with which records are entered, reports are published and possibility of human errors is eliminated.
Information could be processed with greater accuracy and speed when an organisation invests in accounting software. When an organisation invests in acquiring as well as implementing financial and management accounting software programs, employers and managers can get more work done in a less time.
Importance of Classifying Costs on Different Bases
It is one of the functions of cost accounting on the basis of which managers could classify costs for maximising profits and putting similar costs in alignment to facilitate decision-making process. Classifying costs is important for managers because it helps managers determine fixed and variable costs of the business as well as direct and indirect costs in producing an item.
Another reason for which managers must classify costs on the basis of functions, variability, behaviours and others is because it facilitates managers to design strict cost control program. As an example, cost classification helps not only in keeping business expenses to an optimal or controlled level but highlight those areas where business finance is utilised unproductively .
Cost Classified by Variability or Behaviour
The first cost classified on the basis of variability is fixed that remains unchanged regardless of units produced and continuity of business operations. Examples include rent expense and telephone line expense. Variable cost classification by variability represents cost that changes with the level of production such as labour wages and cost of materials used. Cost classification on the basis of semi-variable category contains the mixture of both the fixed and variable cost such as electricity bill.
Cost Classified by Function or Activity
Production, administrative, finance, Research and Development (R&D), selling, distribution as well as direct and indirect costs are classified into this category.
Objectives of Preparing Budgets and Examples for Operational Budgets
The Need or Objective behind Preparing a Business Budget
The very first objective for which an organisation should prepare a detailed budget is that managers need to gain an insight bout the manner in which revenue is generated and how the cash is utilised to pay operating expenses as well as for covering different business costs. Managers prepare budgeted information so as to determine how the financial performance of the business could be improved by making forecasts and planning. For this, managers prepare budgeted models about sales revenue, operating expenses, business costs as well as cash inflows and outflows.
Managers prepare budgeted income statement so that they could gain an insight about the manner in which profitability of the business could be improved in the next financial accounting period. They also prepare budgets to control costs and expenses so that the stakeholder wealth could be created. Resource allocation and financial planning are the other reasons for which managers should prepare budget. To highlight the manner in which a business expects to utilise its funds and generate revenue is the need which managers address by preparing a business budget .
Overall, the primary reason for which a business budget is prepared concerns the ease of performing variance analysis so that expected and actual financial performance could be compared. Managers prepare budgeted information through forecast about the future and compare these standard figures to the actually realised figures for comparison. If there is a much difference between budgeted and actual results, managers perform variance analysis to make adjustments, wherever and whenever needed.
Different Forms of Operational Budgets
Every business prepares five different types of operational budgets which are elaborated in sufficient detail in the following manner:
Master Budget
It is a form of operational budget that presents the overall financial picture of an organisation. It is formulated after compiling the individual operational budget of every department and subsidiary to design an organisation wide budget. Master budget displays overall temporary and permanent financial accounts of the company on the basis of which consolidated financial statements and notes to these records are prepared.
Operating Budget
This is a budget type that aims to display financial forecasts designed by managers and analyses projected revenue and expenses of an organisation over a certain period of time. Operating budget is created by departmental and subsidiary managers from time to time so that they could compare the financial performance on a weekly, monthly, or an annual basis. On regular intervals, the managerial performance is highlighted by comparing the financial figures in operating budget which displays the daily financial health of an entity.
Cash Flow Budget
Business prepare cash flow budget to determine the manner in which an organisation earns its cash inflows as well as areas that cause cash to be invested. This budget, in true essence, highlights the cash inflows and outflows in the operational activities of the business throughout the financial accounting year.
Cash flow budget is prepared so that managers could determine if the company’s cash based resources are utilised or invested in a wise manner within a specified period of time. As an example, cash flow budget highlights if the business has ample amount of cash in its business vault (liquidity) to pay its stakeholders and continue operational activities as a Going Concern. One can say that cash flow budget highlights liquidity management practices of an organisation.
Financial Budget
Business prepare financial budget in an attempt to design a strategy for managing cash inflows and outflows as well as other financial aspects of operations.
Static Budget
This kind of budget remains fixed and is never altered until and unless there is any dramatic change in any of the financial accounts such as sales revenue and its volume.
Standard Costs Used for Variance Analysis and Favourable/Unfavourable Terminologies with Suitable Examples
Variance analysis, in financial accounting and management, is concerned with comparing the forecasted financial information and actually realised figures to identify any deviation from the standard performance and determining the reasons for any deviation. In this section, the relation between standard costing and variance analysis is established since the use of standard costs is concerned with comparing the budgeted standard costs and incorporating the actual ones in financial records so that deviations could be highlighted through variance analysis.
In reality, managers estimate different business costs associated with numerous products and activities in budgeted or forecasted information. With regular monitoring, actual costs are applied through variance analysis. This is done not only to identify any deviation from the planned cost figures but also to closely align the estimated figures with actual costs. This is so because, practically, estimated costs will always be slightly different than the actual ones.
For instance, an organisation, at start of the financial accounting period, estimates that the labour costs would be $3 per unit. Managers arrive at such an estimated cost figure by either estimation by any management scientist or engineer as well as after performing historical trend analysis. With regular monitoring, after a certain period/interval, it is observed that the standard cost of labour turns out to be $3.15 per unit. Managers can now highlight any deviation through variance analysis which facilitates managers to determine if they are successful in controlling costs or not. This is done with help of determining whether such a deviation is favourable or unfavourable.
In variance analysis, comparison between budgeted information and actually realised figures could either be favourable or unfavourable to an organisation depending upon what kind of financial account is being examined. For instance, if a company expects, forecasts or budgets that it would generate sales revenue of $1 Million by the end of current financial accounting period, managers will compare this information to the actually realised figure at end of the period.
If, let’s say, sales revenue is $1.1 Million, such a figure could be termed as “favourable” the organisation since the business has generated more sales revenue than it forecasted. In contrast, if the actual sales revenue generated is worth $0.9 Million, here, the business is short and has generated less revenue than what it expected at start of the year. Such a comparison in variance analysis would be termed as “unfavourable” .
Compared to the term “favourable”, a budget could also be “unfavourable” for an organisation if its actual costs are more than the expected ones. For example, if managers expect, forecast or budget that the per unit cost of labour would be $3 during the specific financial accounting period, such a cost would prove to be dangerous if the actual labour cost increases to $3.5 per unit.
The variance analysis would term such a deviation as “unfavourable” for the business as the actually realised cost is greater than the expected figure of $3 per unit. In contrast to this, if the actual labour cost is less than the budgeted figure of $3 per unit, such a variance analysis can be termed as “favourable” as the actual labour cost is less than what the managers expected.
References
Arora, M.N., 2012. A Textbook of Cost and Management Accounting. Vikas Publishing House.
Gilbertson, C.B. & Lehman, M.W., 2008. Fundamentals of Accounting: Course 1. Cengage Learning.
Gitman, L.J., Joehnk, M.D. & Billingsley, R., 2013. Personal Financial Planning. Cengage Learning.
Lal, J., 2009. Cost Accounting. Tata McGraw-Hill Educatio.
Maher, M.W., Stickney, C.P. & Weil, R.L., 2012. Managerial Accounting: An Introduction to Concepts, Methods and Uses. Cengage Learning.
Mitra, J.K., 2009. Advanced Cost Accounting. New Age International.
