MANAGEMENT ACCOUNTING REPORT
Introduction
This report covers budgeting, break-even analysis, and the analysis of make-or-buy decision. The budgeting details the purpose of a budget and the importance of involving staff in developing a budget. The report contains a direct material purchase budget (in units and in dollars), a direct labor budget (in hours and in dollars), and a manufacturing overhead budget. The break-even analysis compares the hammer division break-even point locally and in Myanmar. The break-even analysis indicates that the business will have a lower break-even point if they shift the hammer division to Myanmar because of lower fixed costs and reduced variable costs. The analysis of make-or-buy decision indicates that it is cheaper to make SP-65 rather than outsource it to AMC.
2.0 The Purpose of a Budget
A budget is an organization plan for a forthcoming period expressed in monetary terms. A budget identifies the costs, revenues, and resources of an organization for a forthcoming period. A budget aims at fulfilling the following objectives:
Planning, a budget forces a manager to set goals and identify resources and strategies to meet those goals. For instance, a cash budget forecasts the future cash position of the business by forecasting the amount of cash the business will generate and how much cash the business will spend.
Coordinating the various departments, budgets sets the targets for various departments and ensures that there is proper coordination between the various departments. For instance, the production department should coordinate with the sales department in order to produce enough output to meet customer demand. The production department should also coordinate with the purchasing department in order to ensure that there are sufficient materials to meet production demands.
Communication, budgets communicate the plans of the organization to the various departments. For instance, the growth in the annual sales may be broken down into sales per region. The budget can be sued to communicate to each regional sales manager their sales target for the year.
Motivation, when staff participates in the budget process, they are more likely to own up the objectives set in the budgets and are therefore motivated to achieve those targets.
2.1 Staff Participation in the Budget Process
An organization should involve employees in the budget process because of two main reasons. One, lower level employees execute critical activities of the business such as sales and production. The budget process requires information regarding these activities. Two, every employee play a critical role in achieving the budget targets. Employees will be more motivated to achieve targets they participated in setting. When staff does not participate in the budget process, they tend to view the budget targets as unrealistic and thus may not be motivated in attaining them.
2.2 Direct Material Purchases Budget
A direct material purchases budget is detailed plan showing the amounts of purchases required to meet the budgeted production and the desired inventory levels and the related cost . Table 1 and Table 2 shows the direct materials purchases budget in units and in dollars respectively. For detailed calculations, see Exhibit 1.
The direct labor budget forecast the number of direct labor hours that are required in order to meet the budgeted production and the related cost. Table 3 and Table 4 show the direct labor budget in hours and in dollars respectively.
A manufacturing overhead budget is a detailed plan of manufacturing costs other than direct labor and direct materials. Table 5 shows the manufacturing overhead.
Hammer Division
The hammer division is currently making a profit of $288,000 as shown in Table 6.
The Hammer Division has a contribution/sale ratio of 75% (3,024,000/4,032,000 x100%) and a break-even point of $3,648,000 (2,736,000/75%). In order to double profits, i.e. increase profits from $288,000 to $576,000 the sales would have to increase to $4,416,000.
3.1 Shifting Hammer Division to Myanmar
Shifting the hammer division would increase profits from $288,000 to $744,800 representing a 159% increase in profits. The increase in profits is driven by a reduction in variable cost to 22.5% of the selling price, and $356,000 decrease in fixed costs. The reduction in the fixed costs and decrease in the variable costs make Myanmar to have a lower break-even point of $3,070, 967.74 as compared to the local break-even point of $3,648,000. To achieve the same break-even point locally as that of Myanmar without changing the variable costs would require the business to either increase the selling price and thus improve the contribution margin or reduce the fixed cost.
Ceteris paribus, an increase in direct material costs will reduce the contribution per unit and thus raise the break-even point. Conversely, ceteris paribus a decrease in material costs will increase the contribution per unit and reduce the break-even point. Similarly, ceteris paribus an increase in selling price will increase the contribution per unit and lower the break-even point, while a reduction in the selling price will reduce the contribution per unit and raise the break-even point.
AMC offer
AMC offer to supply SP-65 presents the business with a make-or-buy decision. In making a decision of whether to produce the component in-house or outsource it to AMC, it is important to consider the relevant costs associated with each alternative. The relevant costs are the future incremental costs of each decision alternative.
The relevant costs analysis shows that outsourcing the manufacture of SP-65 to AMC would increase the relevant cost of the component from $461,040 to $553,600. Therefore, the business should not accept AMC’s offer.
4.1 Non-financial factors to consider in make or buy decisions
Other than the cost consideration of make-or-buy decisions, a business should also consider other non-financial factors that include:
The reliability of the external supplier
Alternative use of the spare capacity that will arise from outsourcing
Confidentiality, outsourcing may mean sharing of technical know-how with the supplier
Customer response to outsourcing, customers may perceive the company as a profit driven company that cares more about reducing costs while contributing to unemployment locally
Conclusion
A budget expresses the plans of an organization for a forthcoming period in monetary terms. It is important to involve employees in developing a budget in order to motivate employees to attain the budget targets. The break-even point is the point at which the costs are equal to the revenues. An increase in the selling price or a reduction in costs (fixed costs and variable costs) lowers the break-even point. A decrease in selling price or an increase in costs raises the break-even point. Make-or-buy decisions are evaluated based on the relevant costs associated with each alternative. In addition to considering, the costs associated with the make-or-buy decision, a business should also consider the non-financial factors that include reliability of supplier, spare capacity, confidentiality, and customer response.
References
Cafferky, Michael E and Jon Wentworth. Breakeven Analysis. New York: Business Expert Press,
2010.
Collis, Jill, Andrew Holt, and Roger Hussey. Business Accounting. Houndmills, Basingstoke,
Hampshire: Palgrave Macmillan, 2012.
Crosson, Susan V and Belverd E Needles. Managerial Accounting. Mason, OH: South-Western
Cengage Learning, 2011.
Drury, Colin and Colin Drury. Management And Cost Accounting, Eighth Edition. Andover:
Cengage Learning, 2012.
Hansen, Don R, Maryanne M Mowen, and Liming Guan. Cost Management. Mason, Ohio:
South-Western, 2009.
Appendix
Exhibit 1
