Accounting Discussion
Discussion 1: Importance of Managerial Accounting
As a decision tool, management accounting provides internal analysis for guiding the overall business strategy. To support decision making, this tool provides appropriate cost analysis, budget definition, planning, controlling, and evaluation of make or buy options. Management accounting simplifies the complex financial data turning them into actionable insights. The relevant financial data is recognized, broken down and translated for better understanding by the managers. Ideally, this tool helps in preparation of financial records, reports, and accounts to support managers make strategic business decisions. Accounting management tool provides directors with measurable data to managers to aid them in making present and long term decisions (Zimon, 2018). The tool is broadly used and is beneficial to managers in the decision making process in different ways:
Planning: Management accounting presents managers with a combination of financial and non-financial data regularly, say monthly or weekly. The presented data include in-depth analysis and budgetary forecasts to facilitate business planning.
Strategic management: Based on simplified, measurable, understandable management accounting information, managers can make appropriate strategic management decisions for an organization. These include a decision about product continuity, modification of sales, buy or make decisions, and so forth.
Identification of problem areas: The tool is essential in pinpointing business problems based on provide data. Problem identification is possible when the management is diligent and has access to regular reports and data on different accounts.
Decision making: Overall, the aim of management accounting is designed to support management decision. It presents simplified, measurable, and summarized data in the form of charts and forecasts. It thus becomes easier for managers to use this information in the decision-making process (Zimon, 2018). Based on regular information, the management can detect problems early and make a timely correction. For example, weekly charts on sales accounts make it easier for managers to identify non-performing product and declining sales early in time.
Discussion 2: Planning and Managerial Application
- Article Review on Cost Volume Profit Relationship
The cost volume profit (CVP) analysis a cost accounting method used to evaluate the effects of varying cost and volume level on the operating cost. As noted by Schofield (2018), CVP analysis is used to determine breakeven volume and sales at various cost structures. The information is used to support managers in making short term economical decision. The main assumption underlying cost volume analysis include a constant fixed cost, sales price and per unit variable costs. However, the concept becomes irrelevant if these assumptions are violated. Several equations for cost, price and other variables are used to rum CVP analysis and plotted on an economic graph. The CVP formula is stated as:
Break-even units = Fixed cost/ contribution margin
The CVP concept has three components; cost, volume, and profit components. However, the above formula does not have these concepts, as plainly stated. The components in the CVP analysis as per the formula include contribution margin and fixed cost. In this case, the profit and components are contained in the contribution margin, which is a profit generated by a unit product sold. The contribution is calculated as sales revenue less the variable cost (Lulaj, & Iseni, 2018). The remaining component is the volume. However, sales revenue is the product of unit price and the volume of items sold over a specified period. Mathematically, it is possible to obtain the volume sold by merely dividing the sales revenue by the unit price. A firm can thus use the CVP formula to determine the sales unit required to breakeven. As noted by Navaneetha et al. (2017), a firm can use the formula to identify the target sales volume by adding a targeted amount of profit per unit to the fixed cost component. The calculation arrives at the target sales units as per the model assumptions.
- Importance of Profit Cost Volume in planning
Generally, formal profit planning is facilitated by budgets and detailed forecasts. However, Lulaj & Iseni (2018) argued only used to give an overview of the process of profit planning. CVP analysis evaluates the purpose and justifies those budgets and forecasts. Ideally, fixed cost and contribution margin are used to determine breakeven points of sales. Managers can thus determine the volume needed to breakeven and even determine its profits based on CVP concept. For instance, a firm with a fixed cost of $10, 000 and 40% contribution margin will breakeven at $25,000 sales revenue.
For planning purpose, the management can used CVP analysis to arrive at the desired outcome. For instance, managers can add desired profit to the fixed cost. In previous example, if the management desires to generate a profit of $5,000, the required sales revenue will be $37,500 calculated as: (10,000+5,000)/40% = 37,500. The managers can plan to produce the required volume by dividing sales revenue by unit price. Managers also use the CVP analysis to plan for marketing in terms of promotions, placement and even pricing for the products.
However, this tool is only relevant if fixed and variable costs remain constant over a given level of production. Further to that, it is assumed that all units produced and changes in the cost occur as a result of changes in the level of activities. It is also advisable to split semi-variable costs using methods of expense classification such as statistical regression, scatter plot or high low approaches. In conclusion, the CVP tool is used to determine how changes in fixed and variable costs impact the profitability of a firm. For planning, managers can use the CVP formula to determine the breakeven volume and arrive at the minimum profit margin.
- Article Review on Variable Costing
Variable cost is a business expense that changes proportionately with production output. As the volume of production increase or decline, so does the variable cost, rising as the volume increase or falling as output decline (Suver, & Cooper, 1988). The contrasting is the fixed cost which remains constant of the units produced. Fixed cost is paid regardless of the firm sales or not because the cost is independent of the output. Common examples of fixed cost include rent, insurance, salaries and wages. Regardless of whether there were sales or not, a firm must pay rent for its business space. The fixed cost can also change, but such changes are not connected to production output.
On the contrary, the variable cost depends on the produced output and remains constant per unit output. To produce a high output, the company will source for more materials and labour for increased production. It will also incur additional packaging cost for the extra units produced. Conversely, these costs reduce with fewer units (Zimon, 2018). Typical variables costs include direct labour, packaging, raw materials, sales commission, and cost of utility.
An important point to note is that variable cost varies from one industry to another. Hence, it is not recommended to compare variable costs across different industries or sectors. Instead, a comparison is relevant in firms operating in the same sector or industry (Geiszler, Baker, & Lippitt, 2017). Total variable cost is the product of output quantity and per-unit cost output. For example, assume that firm x has produced 1000 glasses at a cost $5 per glass. Total variable cost is $5000. However, if firm x fails to produce a single glass in a month, then the variable cost is zero. Supposing that firm x increased output to 2500 glasses in the next month, the variable cost will be $7500 for that month. This example illustrates that variable cost increase with the production output, assuming that per unit cost remains constant.
- Application of Variable Costing in Managerial decision Support
Variable cost is used to support the managerial decision by analyzing data based on actual production cost. Managers use variable costing is an accounting decision-making tool for purposes of internal reporting. Unlike absorption costing, variable costing excludes other fixed costs incurred in the production of goods and services (Suver & Cooper, 1988). Therefore, variable costing can support managers in making strategic decisions in multiple ways.
First, managers use variable costing method to determine product and service offerings. Accordingly, variable costing is utilized by managers to determine which products to continue or discontinue. Instead of terminating the product due to negligible profits, variable cost is used in determining the overall cost of maintaining the product. For a company offering four products and decides to discontinue two, it means that the remaining products absorb higher overhead costs. Variable cost is applied to demonstrate the overall effects of stopping a product on all production cost. Thus, managers can consider using variable cost to logically envision that maintaining a unit can retain the overall profitability by absorbing part of the fixed cost.
Secondly, variable cost helps management in cost control decisions. The system simplifies the estimation of customer and product profitability. Cost analysis is based on the actual production cost of each unit, thereby allowing managers to minimize variances between budgeted and exact amounts. Consequently, the variable cost will enable managers to control cost and gain higher sales revenue for the firm. Thirdly, variable cost system aids managers with irregular sales patterns to accurately determine production cost over a given period. Typically, units sold by a company fluctuates let’s say between winter and summer months. As observed by Zimon (2018), since sales patterns are comparable every year, variable cost data can be applied to estimate future production costs.
References
Zimon, G. (2018). Tools of managerial accounting in production management. Research in Logistics & Production, 8.
Geiszler, M., Baker, K., & Lippitt, J. (2017). Variable Activity‐Based Costing and Decision Making. Journal of Corporate Accounting & Finance, 28(5), 45-52.
Suver, J. D., & Cooper, J. C. (1988). Principles and methods of managerial cost-accounting systems. American journal of hospital pharmacy, 45(1), 146-152.
Navaneetha, B., Punitha, K., Rashmi, M. J., & Aishwariyaa, T. S. (2017). An analysis of cost volume profit of Nestlé limited. International Journal of Commerce and Management Research, 3, 66-68.
Lulaj, E., & Iseni, E. (2018). Role of Analysis CVP (Cost-Volume-Profit) as Important Indicator for Planning and Making Decisions in the Business Environment. European Journal of Economics and Business Studies, 4(2), 99-114.
Schofield, J. A. (2018). Cost-benefit analysis in urban & regional planning (Vol. 20). Routledge.