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Importance of Management Accounting In Companies

680 Downloads 12 Pages 3101 Words

INTRODUCTION

Grubnic and Birchall, 2014). Therefore, management accounting is based on the costing principles. Management accounting reports are for the internal assessment of an organization. These reports usually consist of details about the cash, sales revenues as well as organization's accounts payable and receivables (Bebbington, Unerman, and O'Dwyer, 2014). The present report is going to discuss various useful aspects of management accounting along with their applications. Along with that different types of costing methods specifically absorption and marginal costing will be discussed in detail. The present report effectively addresses the importance of management accounting in the companies. The various uses and applications of the management accounting has been analyzed. Also necessary examples have been cited for the purpose of establishing the relevance of the different aspects used in management accounting. Moreover the explanation of how management accounting can be used to improve the cash flows and financial returns of the business.

SECTION-1

1. Importance of Management Accounting

Management Accounting makes an efficient partnering with the other financial aspects of an organisation. It also has a great significance in the decision making, devising planning and performance management systems and thus providing expertise in the financial reporting and control to assist the management in the formulation and implementation of an organisation strategy (Bebbington, Unerman, and O'Dwyer, 2014). Following are some of the reasons highlighting importance of use of management accounting concept in various organizations .

Measuring Performance- Two types of performances can be measured with the help of management accounting. Firstly, analysis is made at the individual employee’s level that is the performance of employees. Secondly, efficiency of performing various tasks is measured with that of their respective standards maintained by the organization. In this process, actual performance is compared with the standard performance and the deviations are analysed as well. These deviations will be finally reported to the management and hence individual accountability for different tasks will be established (Sandalgaard and Nikolaj Bukh, 2014). This will help in the performance assessment of each employee and the respective departments. Also, the policies regarding incentives can be framed with reference to their performance (Bebbington, Unerman and O'Dwyer, 2014).

Risk Assessment- This is also one of the major objectives ofmanagement accounting. It is used for the assessment of risks andfor managing them effectively in order to prevent any uninterrupted business operations.
Systematic Allocation of Resources-udgeting is an important area in management accounting which includes the allocation of resources for different business operations. This will prevent the wastage and production of damaged unitsincompany. Proper resource allocation is also important for the purpose efficiently managing all the scarce resources available in the organisation. The management accountant has been appointed to utilise the current resources as their primary aim is to minimise the costs. The cost reduction is the basic factor which is followed by devising of strategies to ensure its achievement of several goals and the objectives. The resources that is financial resources are optimally utilised in the best possible manner to fa ciliate various users. The budgeting will determine the current requirements of the resources in a business to meet the needs and the expectations of the existing business.

Presenting Financial Statements to the Management- Management accounting reports are of great significance for the purpose of preparing financial statements of organisation. The financial statements incorporate information which is available from the reports presented by management accountant of company. The good presentation of the financial statements will help an entity in order to attract wide number of investors to invest in the current business. The accoutring standards will also guide an entity to follow various frameworks in order to present the financial statements in a better way.

2. Types of Management Accounting Systems

Responsibility Accounting- This system is based on the concept that managers of respective departments are only accountable to the items to which they exercise control. For instance: purchase manager will only be heldresponsible for the purchase of inventory and no other unrelated matter (Management accounting techniques, 2016). This accountability system emphasises on the importance of settingvarious financial goals, measuring them and then reporting the performance. This accounting systems refers to the identification ofthree types ofresponsibility standards which are cost investment and profit centres. This aspect covers the management reporting system and the way it is useful formanagement and organisation as a whole to makeeffective and efficient decision-making. The current approach will emphasises on increasing decisdion makinga bility of a person by making strong decisions in the business.

Budgetary Accounting- Budgets are prepared for different departments in an organisation. The different budgets reports presents the allocation of the resources to a particular department. This ensures an effective planning that will help in decision-making. The budgets are framed for respective departments and for the different costs to be incurred. For instance: cash budgets, sales budgets, etc. are presented for the respective periods. These budgets show the prediction of figures hat can be used in decision making.

Variance Analysis Accounting- After the preparation of budgets, actual performance will be measured with that of the budgeted andrespective variance will be analysed. Variance analysis will further help in controlling the wastage ofresources in respective activities. Variance analysis report will assist the management in efficiently establishing the accountability to respective managers .Variances involves differences ofstandard and actual figure which assists the management in efficient decision-making (Management accounting techniques. 2016).

3. Application and benefits of the Management Accounting Systems in an Organisation

Responsibility accounting is applied in all the spheres of organisation for primary objective of establishing the accountability for various operations carried out in an organisation. However, following are some of the specific areas where concept of responsibility accounting can be applied:

Decentralisation- In the process of applying responsibility accounting organisation is divided into smaller subunits. This division makes an organisation all the more manageable and structured.

Performance Evaluation- The concept of responsibility accounting establishes a fair and sound system of performance evaluation of every manager and other personnel. Hence, the performance of each responsibility centre is measured and presented in the periodically presented performance reports by an organisation (Management accounting techniques, 2016).
Motivation Responsibility accounting specifically emphasises on the performance evaluation of every individual working in organisation. It makes the job more challenging for employees and keeps them motivated to continuously enhance their performance. The motivated employees are valuable assets for company and contribute effectively to increase the value of business.

Transfer Pricing- Responsibility accounting involves the division of an enterprise into different autonomous responsibility centres. In such situations, any product of one division can be transferred to another department of the same organisation by charging a transfer price. This will lead to the creation of inter competitive environment that will make all divisions of an organisation more efficient and profitable.
Budgetary accounting is used for the purpose of planning and controlling expenditures of organisations. Some of the important applications of budgetary accounting are discussed hereunder-

Forecasting of Income & Expenditures- Budgeting is a critical part of business planning process. The owners and management require an estimation or prediction of profitability of business. This prediction can be made by applying budgetary accounting . Presentation of future incomes and expenditures in the form of structured budgets clarifies picture of future incomes and expenditures application of various strategies, plans and events.

Exercising Control over the resources- Budgets are prepared with a primary motive of allocation of resources to different departments in organisation so as to ensure an effective use. Also, the excess utilisation by any department can be traced very easily and the reasons can be evaluated (Bebbington, Unerman and O'Dwyer, 2014). Hence, the concept of economies of scale can be easily established which will lead to the optimised use of resources and increase of profitability for an organisation as a whole.

Monitoring Performance- Primary purpose of budgeting is to enable the actual performance ofvarious operations with that of business performance to ensure that whether business activities are conducted as per the expectations or not. The variances are evaluated and necessary corrective measures are taken (Sandalgaard and Nikolaj Bukh, 2014).

Maintaining Records of the past years- The cost reports of previous years are maintained and kept for record keeping. These statements are than retained by organisations to compare the results of company from that of previous years. This will help in comparison of results and thus, effective assessment of performance can be done (Management accounting techniques, 2016). 

Variance analysis helps the management of an organisation in monitoring excess use of essential resources and take necessary steps to control this excessive use. An effective variance analysis helps an organisation in spotting the issues, trends and opportunities in the path of long term and short term success. Some of the benefits derived by organisations fromconcept of variance analysis are discussed as below-

Establishing Materiality- Materiality is a threshold level of respective statistical variances that are to be worth noting). For the variances that are identified, the materiality levels are required to be ascertained.

Effective Evaluation- Variances help in the timely evaluation of the present situation which will further help in taking the necessary timely rectification actions. Thus, the performance can be enhanced with the timely analysis of all variances and their reasons.

Accountability- By the evaluation,individual accountability is being established for various departments operating in an organisation (Management accounting techniques, 2016). This will further be useful for the purpose of evaluating performance and thereby, framing policies for them.

4. Income Statements

A) Income Statement using Absorption and Marginal Costing Techniques

Analysis of profit per unit-
Number of Units Manufactured = 60000

Table 1: Absorption Costs Statement

 Income Statements Using Absoption & Marginal Costing Techniques

Table above computes the profits oftwo quarters for company by using absorption costing method (Laugen and et.al 2014). The profits in quarter 1 £18400 while in the quarter 2, it is £8600. There is a substantial difference in the profits for given period. In this method of costing, all fixed costs are computed as product costs and charged as the per the product basis.

Table 2: Marginal Costs Statements

 Absorption Costs Statements

The table above shows computation ofprofits ofgiven data for two quarters.It can be seen from the computation that there is loss in quarter 1 while there are high profits reported in quarter 2 (Kristensen, 2015). This is due to the fact that fixed costs in the marginal system of costing is considered to be the period costs which is charged wholly for the period irrespective of the output.
Reconciled Statement

Table 3: Reconciliation Statement

 Marginal Costs Statement

Above table shows the reconciliation of profits computed by using two methods.

B) Reasons of difference in profits by using two methods

Net operating income in quarter 1 in absorption costing system is more than that of the marginal costing system (mail and King, 2014). Difference arises due to fixed manufacturing overheads which further forms the part of closing inventory in case of absorption costing system. This closing inventory includes the portion of fixed expenses which are related to the next period and that further reduces the burden on current period; thus, the profits are inflated (Laugen and et.al 2014). In this way,portion related to fixed costs are transferred to the next period. However, in case of marginal costing, entire fixed costs are treated as period costs and are deducted from the income statement and thus, no segregation of fixed costs are made. Therefore, no portion of fixed overheads are included in the closing inventory. Hence, it reports the losses in quarter 1 but there are high profits in quarter 2.The differences are adjusted and reconciliation is presented as shown above (Management accounting techniques, 2016).

Section-2

Part-A

Assessing the Planning Tools and their effectiveness in Management Accounting

Management accounting is an effective tool for assisting the management in achieving better planning and exercising control over company.Various cost accounting tools that can be used by Nero Ltd are-

Budgeting & Variance Analysis-Company should prepare periodical budgets for the assessment of performance. Purpose of preparing budgets are for short and long term planning of company's objectives. After that variance is analysed which is the difference between actual and budgeted results (Management accounting techniques, 2016). This process is of great significance for the calculation of the deviations. However, these deviations are either favourable or adverse. Therefore, rectification steps are taken immediately for the adverse variances. But, it is difficult to apply in the service industry as the major portion of costs is related to the overhead expenses. Moreover, proper responsibilities cannot be assigned by using variance analysis as variances can be due to many reasons such as using unrealistic standards.

Cost Volume Profit Analysis- This analysis assists managers of Nero Ltd in determining the level of outputs at which all costs become equal to the revenues (Kristensen, 2015). This is also called as breakeven point that is the situation of no profit and no loss. It also used to analyse the change in costs and volume which affects the operating income of Nero Ltd. (Khanna and Gogia, 2014). However, this approach can be applied to the limited information and products. Therefore, it is computed by the management on single product. This analysis cannot be applied to all products manufactured within organization (Management accounting techniques, 2016).

Activity Based Costing- This method can be used by Nero Ltd. to effectively allocate its overheads on those departments which actually use them in their respective activities. Thus, the cost ofmanufactured products can be assessed accurately. This assessment will further help company in setting an appropriate profit margin and competitive selling price.Use of this method of overhead allocation also helpcompany in identifying true costs which support the pricing policy of company and reveal unnecessary costs incurred that should be eliminated. However, the implementation of ABC is expensive and not suitable for small sector companies (Cole, Upstate and Claiborne, 2015). At times, it is not suitable and easy to identifydrivers associated with the costs. Also, it is difficult for companies to evaluate costs on the basis of activities.

Part-B

Management accounting system of any organization has a direct impact on its financial statements. Management and financial accounting concepts are interrelated with each other. However the information of management accounting is for internal use of the company but it forms an important base for the preparation of the financial statements. It can be said that the management accounting provides data to be presented in financial statements. Following are the areas in financial accounting where management accounting plays a vital role-

Capital Budgeting Decisions- These decisions are involved in making the decisions regarding investment of capital in order to generate maximum profits for an organization as the whole. For the purpose of maximizing profits of company, information regarding costs and other related data of projects are required (Ward and Peppard, 2016). These data is required to be provided by the management accountant of the company. The more accuracy in this data will lead to make analysis of more beneficial investing decisions and hence, it will increase the profitability.

Costs controlling decisions- Costs related to different projects are required to be evaluated first in order to exercise the controlling function. Correct evaluation of different cost statements are presented by employing an effective management accounting system and hence, various measures can be designed by the management of company to control excessive costs (Bovens, Goodin and Schillemans , 2014). The variance analysis in costing will present an accurate estimation of difference in standard and actual costs that will present a clear picture in the minds of financial decision makers to frame the policies of controlling costs.

Cash Flows Analysis & Efficient management of working capital- Management of working capital is of prime importance for any company. In order to run the business successfully, company needs to effectively manage its liquidity position to pay its outstanding liabilities. Proper assessment of different components of costs like labor, material and overheads will ensure the computation of accurate working capital for a particular period. This will further help in assessment of various options required to finance the requisite working capital to effectively manage the business activities (Ball, Grubnic and Birchall, 2014).
Hence, it can be said that management accounting is of prime importance and generates data on which major financial decisions are based and thus, it majorly affects the profitability of a company.

CONCLUSION

Moreover the use of management accounting in the presenting the financial statements of the company has been explained in detail along with suitable examples. The importance of management accounting has been identified and applied in the management accounting. Thus it can be concluded that the main objective of management accountant in an organisation is to effectively manage costs, and handle other administrative aspects. Budgets also hold an important significance in the management accounting.

REFERENCES

Ball, A., Grubnic, S. and Birchall, J., 2014. 11 Sustainability accounting and accountability in the public sector. Sustainability accounting and accountability. p.176.
Ward, J. and Peppard, J., 2016. The Strategic Management of Information Systems: Building a Digital Strategy. John Wiley & Sons.
Bebbington, J., Unerman, J. and O'Dwyer, B., 2014. Sustainability accounting and accountability. Routledge.
Bovens, M., Goodin, R.E. and Schillemans, T, 2014. The Oxford handbook of public accountability. OUP Oxford.
Bradbury, M. and Scott, T., 2015. The association between accounting performance and constituent response in political markets. Pacific Accounting Review. 27(4). pp.394-410.

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