Purposes and Processes of Managerial Accounting

3576 words (14 pages) Business Assignment

12th Jun 2020 Business Assignment Reference this

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Business owners and management are faced with making decisions every day regarding operations performance, profit, and labor force amongst many others. Managerial accounting helps with making those decisions through various techniques. Specifically used to produce information for managers in an organization, managerial accounting helps with planning, controlling, decision-making, problem-solving, and goal setting.

According to Kenton (2019), managerial accounting, also known as cost accounting, is the process of identifying, measuring, analyzing, interpreting, and communicating information to managers for the pursuit of an organization’s goals. The major difference between managerial and financial accounting is that managerial accounting information is aimed at helping managers within the organization make decisions, while financial accounting is aimed at providing information to parties outside the organization. Managerial accounting as defined simply by Warren, et.al. (2018), as the type of accounting that deals with information designed to meet the specific needs of a company’s management.

The key purpose of managerial accounting is to assist decision-makers. A managerial accountant, or management accountant, is one who records and analyses the financial information that is provided to those decision-makers. Through collecting, interpreting, and preparing data, the managerial accountant is responsible for major business activities. From analyzing the data in the financial statements to making budget forecasts, managing risk, arranging financing, enforcing compliance, measuring performance, and presenting information to executives.

Managers must often make decisions in business, including product decisions based on profitability. A major factor in determining whether a product is profitable is the cost related to manufacturing that product. Cost analysis is performed by managerial accountants for certain products and divisions, which include variable and fixed costs. The production decisions made by managers are a direct result of information received from managerial accountants. Data provided to management from managerial accounting is used in budgeting and planning, forecasting, and developing goals and strategies for the future. The managerial accountant and managerial accounting play an important role in organizations, keeping management updated with the financial data they need to make decisions. According to Goretzki, et al. (2013), management accountants have evolved into members of the management team. In this sense, the traditional ‘bean-counter’ stereotype, characterised by routine work such as recording, data inputting, and reporting seems to have been replaced by the ‘business partner’, that has been depicted as willing and capable to provide more added value to the decision-making and control

Like all professionals, management accountants need to remain ethical when producing data for managers to base their decisions on. Common issues/concerns for management accounts are overproduction, cost allocation, conflicting interests, and asset replacements. Overproduction refers to recording more expenditures as production costs, therefore lowering period expenses and increasing finished goods inventory. According to Thomason (2017), absorption costing is the common method abused during overproduction. Higher profits reported using absorption costing to record fixed costs in final inventory accounts is utilized by operating managers and management accountants.  Cost-plus contracts are a common area that management can shift overhead costs from the income statement to contracts. This can distort the accounting statements and damage client relationships due to inappropriate contract billing. Conflicting interest arises in any form of accounting when one helps management “come up” with the numbers they are looking for. While this could place them in better graces with that particular management, it is not in the company’s best interest. Management accountants are often the ones making recommendations to replace assets in manufacturing facilities. Identifying the inefficiencies in costs, helps determine changes that need to be made, sometimes in the replacement of an asset not performing to standards. However, if a management accountant does not take the ROI into account in the recommendation, they are not considering the bottom line of the company and can be considered making the recommendation unethically.

As mentioned, managerial accountants need to analyze various operational processes and metrics in order to translate data into useful information that can be utilized by the company’s management in their decision-making process. According to CFI (2015), managerial accountants aim to provide detailed and disseminated information regarding the company’s operations by analyzing each individual line of products, operating activity, facility, etc. In order to achieve these goals, managerial accounting relies on a variety of different techniques, including, but not limited to: Margin analysis which is primarily concerned with the incremental benefits of increased production. Margin analysis is one of the most important techniques as it includes the calculation of the breakeven point that determines the optimal sales mix to determine the unit volume at which the business’s gross sales equal total expenditures;

Inventory valuation and product costing involves the identification and analysis of actual costs associated with production and inventory. Managerial accountants calculate and allocate overhead costs as well as the assessment of the direct costs related to the cost of goods sold (COGS). The overhead expenses may be allocated based on the quantity of goods produced or other factors related to production, such as the square feet of the facility; and trend analysis and forecasting which identify the patterns and trends of product costs as well as identifying variances between the budgeted or forecasted values and actual values.

As mentioned, managerial accountants have a multitude of techniques available to them to perform their functions in the organization. Among them are various cost accounting techniques, of which we are going to discuss the process cost system. In process cost accounting, the costs are allocated to the product based on the department or process. When you think of most mass marketed products, their costs are based on process costing, meaning every item has the same costs because there is no differentiation in the product itself. A processing cost system is one in which nearly identical units are mass produced.

Process costing, like job order costing, assigns material, labor, and overhead costs to products and provide a method for calculating unit product costs. Both costing systems use the same manufacturing accounts such as manufacturing overhead, raw materials, work in process, and finished goods. According to an article shared by Kumar (2015) on Your Article Library, the distinctive feature of process costing is that the unit costs of products are determined for the respective process through which the units pass. All costs relating to a process are charged to a separate account and then averaged out to determine the cost per unit. When a product passes through several processes, the total cost of one process is transferred to the next process. Additional costs such as  materials, labor, and overhead are added and the total cost transferred until production is completed and finished products turned out.

With back-to-school coming, I know I go through pencils by the box full with students. Pencils are an item that utilize process cost accounting to allocate costs. Costs are allocated in materials with wood for the outside casing of the pencil, graphite for the inner core, erasers, and aluminum ferrule that holds the eraser onto the pencil. Labor is allocated in production in various stages: In the first stage, the following processes take place; thin slats of wood are passed through a machine that cuts groove in which the graphite will eventually sit. From there the graphite is then laid into the grooves, which have been filled with glue. Next, another piece of wood with the same slats, is laid on top of the first piece to form a type of sandwich. Another machine compresses the pieces together until the glue dries.

The next machine, or shaper, slices the pieces into the hexagonal shape of the pencil separating them in the process. From here, pencils are moved to another machine through which they will pass through a lacquering tube, which applies the paint to all sides at one time. It takes four passes through this machine until the wood grain is no longer visible. The pencils then get a clear coat finish, which is also applied through a lacquering tube. To finish in the painting department, the pencils are stamped with the companies name and the hardness of the graphite. Once this is complete, they move on to the assembly stage where an aluminum ferrule is pushed onto one and then a rubber eraser is then pushed into the ferrule. From here they are sent to packaging. In total, pencils are sent through four different processes, all of which have workers, floor supervisors, and overhead associated with them. The factor must also be taken into consideration when costing the product.

Process costing in this case, helps management decided how many pencils should be manufactured each month to keep the cost at a profitable level. If the capacity is not met and production is much lower than expected, the cost can increase, therefore impinging on profitability. Or if the price is raised to meet costs, it can harm sales if customers are not willing to pay the higher price. According to Clavero (2017), with the standardization of products, managers track performance, productivity, and costs over time. Process costing allows for greater flexibility when making changes in the production process. Managers can target specific departments’ processes or materials to lower production costs.

Budgeting and forecasting is an important aspect of accounting and management. There are many functions that can be performed in the process of developing a budget and later forecasting that budget. One technique used by managerial accountants is standard costing. A standard cost is the predetermined cost of manufacturing a single unit or a specific quantity of product during a specific period, or the planned cost of a product under current or anticipated operating conditions. A standard cost has 2 components: A physical standard, which is a standard quantity of inputs per unit of output, and a price standard, which is a standard cost or rate per unit of input. Standard costs help aid in the planning and controlling of operations, budgeting, estimating, and simplifying costing procedures and expediting cost reports. Keeping in mind it is necessary to determine the physical and monetary factors needed in the computation of the manufacturing elements, such as materials, labor, and factory overhead: the physical aspect (units of materials, number of hours worked) and the monetary factor (price per unit material and the labor rate per hour).

When I worked in publishing we utilized standard costs for our print jobs. As a direct response marketer, we promoted our products through various print media, one of which were co-ops, or inserts that are placed in outgoing envelopes or packages with a similar demographic. I managed the collectible division with the majority of our sales coming from ornaments. Some examples of co-ops we would place our inserts in were companies like The Bradford Exchange, Danbury Mint, and Hamilton among many other general categories. Our purchasing department, in conjunction with our accounting and finance departments, would provide standard costs before budget time to be used in our calculations. These standard costs consisted of a physical aspect, paper and machine hours and a monetary factor, cost of the paper and rate per machine hour. We printed quarterly for all products and divisions so paper was purchased on contract, therefore limiting the variation in the cost from quarter to quarter. The variations came in form of set-up fees associated with the quantity, various sizes, and the number of variations being printed. In this case, physical labor is measured in machine time or print run.

I am going to use one product as an example for this purpose. One product could have multiple offers: a basic offer, a control offer, and test offers. Each individual insert (where it was being placed) and offer had its own key. This allowed marketing and analysis to track each offer and “list” for response, pay rates, conversion rates, and ultimately profitability. After each quarter ended and jobs had been inserted, forecasting was performed after the first month. This entailed forecasting the response rate based on early responses and finalizing costs. Subsequent month forecasting would build upon the response rate, but add factors such as pay and conversion rates. For the purpose of costs, our purchasing, accounting, and finance departments would calculate actual costs per job and provide new rates for the printing of the inserts.

As mentioned previously, the cost of paper rarely changed from the standard. Factors that could alter the standard for paper were when the print production run in a given quarter far exceeded budget. The cost of paper was allocated across all products, therefore if one product exceeded their budget and additional paper had to be purchased for quarter four, all products saw a shift in their paper costs for quarter four – not just the product that exceeded their budget and caused the shortage. The second material item that was calculated were the set-up charges for the printing presses. As explained, each product can have multiple offers and numerous keys. Each insert quantity is typically a minimum of one hundred thousand, with total print runs in the twelve to fifteen million range. Set-up charges to produce and change the plates in the offset printing process. Due to the number of lists used, there could be 50-75 keys per quarter. These set-up charges are distributed among the whole job, therefore a part of the standard material cost.

Standard Material Cost = Standard Physical Factor (paper, set-up charges) X Standard Monetary Factor (price per contract, set-up charge rate)

Standard labor cost for this is based on machine hours. The total machine hours it takes to run the job. Monies collected through this charge covers actual labor, maintenance of offset printers, and overhead.

Standard Labor Cost = Standard Physical Labor (in machine time) X Standard Monetary Factor (rate per machine hour)

In the end, total standard costs averaged $12-$16 per thousand print quantity. The lower costs associated with basic jobs and the higher costs associated with small test panels and special print runs. Actual costs typically varied by less than 5%. During the budgeting process, these standard costs were used to determine the feasibility of testing certain offers and lists. When a budget was first produced, it was a minimum number of lines, typically a basic and any known tests that would be conducted. When planning a campaign the original budget lines were used as a baseline for the list by list recommendation P&L If a line in the recommendation did not fit within the original parameters of the budget, the line was tabled. This could of been because the cost of the campaign was too high, or any number of contributing factors, from projected response to retention rates. The 50-75 keys per quarter mentioned above were all a separate line in the recommendation that needed to be as close to budget as possible.

As with anything, there are advantages and disadvantages and according to WIlkinson (2013), the primary advantages to using a standard costing system are that it can be used for product costing, for controlling costs, and for decision-making purposes. Whereas the disadvantages include that implementing a standard costing system can be time consuming, labor intensive, and expensive. If the cost structure of the production process changes, then update the standards. In the case detailed above, standard costs were an advantage and benefit that help control over testing.

According to our textbook, capital budgeting is the process in which managers plan, evaluate, and control investments in fixed assets. The process involves analyzing a project’s cash inflows and outflows to determine whether the expected return meets a set benchmark. There are various techniques used by managerial accountants when considering capital budgeting. One of these methods companies use to determine which projects to pursue includes average rate of return (ARR). Average rate of return measures the average income as a percent of the average investment. The average rate of return is computed as such:

Average Rate of Return = Average Annual Income

Average Investment

Where Average Investment = Initial Cost + Residual Value

2

Management sets a minimum rate of return which is acceptable for the investment. If the average rate of return is equal to or exceeds the minimum, the project is acceptable. The higher the rate of return, the more likely it is to be accepted. The average rate of return is easy to compute, includes all the income earned over the life of the project, however it does not consider the expected cash flows. Average annual profit can be presented as an even set of cash flows, or as varying cash flows.

This is an example of even cash flows;

ABC Company is looking to invest in some new machinery to replace its current malfunctioning one. The new machine, which costs $360,000, would increase annual revenue by $180,000 and annual expenses by $35,000. The machine is estimated to have a useful life of 12 years and zero salvage value.

●       Calculate the depreciation expense per year: $360,000 / 12 = $30,000

●       Calculate the average annual profit: $180,000 – ($35,000 + $30,000) = $115,000

●       Use the formula: ARR = $115,000 / $360,000 = 31.9%

Therefore, this means that for every dollar invested, the investment will return a profit of about 32 cents.

This is an example of varying cash flows;

XYZ Company is considering investing in a project that requires an initial investment of $120,000 for some machinery. There will be net inflows of $30,000 for the first two years, $20,000 in years three and four, and $40,000 in year five. Finally, the machine has a salvage value of $18,000.

Inflows, Years 1 & 2

($30,000*2)

$60,000
Inflow, Year 3 & 4

($20,000*2)

$40,000
Inflow, Year 5 $40,000
Less: Deprecation

($120,000 – $18,000)

($102,000)
Total Profit of Project $38,000
Average Annual Profit

($38,000/5)

$7,600

Average investment = ($120,000 + $18,000) / 2  = $69,000

ARR = 7,600/69,000 = 11%

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