Week 6 Final Paper Diana Leigh BUS630: Managerial Accounting Wendy Achilles April 15th, 2013 Introduction Managerial accounting is an internal business function that deals with the day? to? day operation of a business. A managerial accountant gathers and reports information that helps managers in decision making and unlike financial accounting it does not have to follow established standards and principles. It is concerned with such matters as profitability in relation to both cost and volume of sales, budgeting, making decisions about pricing, and the general productivity of the business (Schneider, 2012).
This information is of value to managers and helps them to make decisions about projects, new products or services, reorganization of departments, and other internal matters. How important are the new approaches such as just in time, activity based costing and flexible forecasting, to managerial accounting? Definition of managerial accounting The definition of managerial accounting, also called cost accounting, is that, it is the process of identifying, measuring, analyzing, interpreting, and communicating information within an organization to achieve the organizations goals.
Managerial accounting is not subject to the same rules and principles as is financial accounting (Schneider, 2012). Financial accounting is mandatory and its statements must comply with the generally accepted accounting principles (GAAP). These statements are used to report the company’s status to external users such as; investors and creditors. With managerial accounting operational reports, are only used inside a company to help managers make decisions. Managerial accounting emphasizes the future while the past is the emphasis with financial accounting.
Role of managerial accounting and the management accountant in a business or organization Managerial accountants add value to an organization by maintaining accounting records, preparing financial statements, generating managerial reports and analyses, and coordinating the company’s budgeting (Schneider, 2012). With this information managers can direct and control operational activities, measure performance, allocate business costs to goods or services, prepare operational budgets and forecast production output or sales.
Numerical information consists of operational statistics; units produced raw materials and labor hours used. Non-numerical or qualitative information are associated with customer satisfaction, employees moral, access to markets and image of the company. Management should also evaluate the cost of value-added versus non-value added activities. In many businesses today managerial accountants are overseen or supervised by a controller who is responsible for performing managerial accounting activities, such as planning and controlling activities necessary for decision making.
Ethical issues/concerns for the management accountant The Institute Management of Accountants (IMA) developed “Standards of Ethical Conduct for Management Accountants”. These standards require the compliance with four basic principles: competence, confidentiality, integrity, and objectivity (IMA, 2011). Management accountants are not expected to police a business however they are expected to report any unethical behavior they find regardless of any impact on the business (Schneider, 2012). The company’s financial operations internally and externally must be accurate and valid.
A company must establish and communicate written policies regarding ethical behavior based upon the specific company values. Ethical issues can result from managerial accounting activities such as overproduction, cost allocation, asset replacement and conflicts of interest. As with all financial reports, production reports can easily be manipulated. One way this can be done is by changing the estimated the stage of completion of the work in process. Managers might want to overestimate the stage of completion because of pressure to meet production quotas of units or equivalent units produced or to minimize unit costs.
A higher estimate for the completion of the work in process inventory, gives you a greater number of equivalent units of output for the period, which generates lower cost per equivalent unit. However, any overestimate in one period results in an opposite impact in the following period. General description of at least three managerial accounting techniques available and their application within a business or organization Managerial decisions can be categorized according to three interrelated business processes: planning, directing, and controlling (Walther, 2012).
Manager’s reports are tailored to specific decision-making tasks and focus on products, departments, and activities; these are internal specifications for data accumulation and presentation. Planning involves selecting a course of action and specifying how the action will be implemented. Identify the alternatives is the first step of planning and then choosing which of the alternatives best suits the company’s objectives. When making decisions management balance the opportunity against the demands made on resources.
Management plans are usually attached to budgetary requirements that represent management’s plans in specific, quantitative terms. Effective strategic planning helps to reduce costs, allows entering new markets and creates customer services (Chai-Amonphaisal, & Ussahawanitchakit, 2010). In planning profit, management considers sales volume, selling prices, variable costs, fixed costs, and the sales mix (Schneider, 2012). An interesting point is when the contribution margin is equal to fixed costs, the company breaks even. To achieve a cost objective, activities occur and resources are used and resources cost money.
Profitability techniques allow an examination of the relationship between accounting information and decision-making. Directing is a day-to-day function that managers must do to keep the company running smoothly. They have to motivate and direct people, assign tasks to employees, deal with disputes, answer questions, solve on-the-spot problems, and make decisions that affect customers and employees (Chai-Amonphaisal, & Ussahawanitchakit, 2010). Managerial accounting data, like daily sales reports are often used in this type of day-to-day decision making.
Controlling can be defined as the systematic process of regulating organizational activities making sure it is consistent with the expectations established in plans, targets, and standards of performance (Chai-Amonphaisal, & Ussahawanitchakit, 2010). An important part of any control system includes performance assessments (Chai-Amonphaisal, & Ussahawanitchakit, 2010). Feedback is essential to any control system performance reports and scorecards can inform management if they are on track or not. When using a scorecard it is important that the process is carefully balanced.
The goal is to identify and focus on performance that can be measured and improved, as well as financial outcomes, these components can be categorized as relating to business processes, customer development, and organizational betterment. Cost Management Techniques Most of managerial accounting deals with cost information so understanding cost behavior is crucial in making business decisions. Cost data can be used in many different ways but it is always related to planning, decision making, cost control and income measurement which is used to position the company to achieve its goals.
Cost accounting classifies and accumulates cost data of products and processes and analyses it for decision making purposes. The approach to measurement depends on what is measured and what benchmark the performance will be measured against. A benchmark could be a goal, or a standard that is expected to achieve. A cost accounting systems includes: 1) input measurement 2) inventory valuation method, 3) cost accumulation method, 4) cost flow assumption, and 5) recording inventory cost flows at certain intervals.
Allocating business costs to goods and services is an important part of managerial accounting because it shows how a business can stay profitable. Once a cost savings measure has been put into place, it should be closely monitored to make sure it is meeting the company’s goals or objectives. An accounting system measures costs that can be used for profit determination, performance evaluation, inventory valuation and cost control. Cost can be classified in terms of the functions it performs such as manufacturing costs, selling & administration costs and financial costs (Schneider, 2012).
Some costs can be directly identified to a particular product such as direct material and direct labor while others are indirect costs. Traditionally costs are divided into three group’s direct material costs, direct labor costs and factory overhead costs. Direct material costs usually mean the raw materials to make the product (Noci, 1995). Direct labor costs are the labor associated directly with the making of the product. Factory overhead costs include all manufacturing costs that are not materials or direct labor.
A standard cost is what is used as a measurement of total costs to output levels. Standard costs are estimates of unit costs at targeted output levels, including direct materials costs, direct labor costs, and indirect costs. Standard costs are used for planned production in a budget and to assess production. Some costs increase or decrease in line with the volume of production, while some are fixed, some are physical goods and others are a service (Noci, 1995). Three cost concepts are cost behavior, traceability, and controllability.
Cost behavior includes fixed cost which is a cost that is not related to production. This cost remains unchanged even with variations in output. A variable cost is a cost which varies exactly in proportion to the change in activity whether in production or sale however a variance, may provide warning signs of situations requiring corrective action by managers (Schneider, 2012). Four methods for identifying variable and fixed cost behavior are account analysis, the engineering approach, the scatter graph and visual fit, and the high-low method (Schneider, 2012).
Mixed costs or semi-variable costs are a combination of fixed and variable costs. Account analysis determines the cost behavior of a specific cost by reviewing and interpreting managerial policies with respect to the cost and by inspecting the historical activity of the cost. Three managerial accounting techniques available are job costing, process costing, activity-based costing. Job costing is used where jobs or products are different from one another whereas, process costing is used when products are mass produced.
Some costs can be traced directly and to a particular product. Costs that cannot be traced back to a product are indirect costs. Allocations of indirect costs are formulated by machine hours, direct labor hours or raw material quantity. Other costs such as selling & administration costs are not added in the cost of the product but are termed as period costs. Determining a product’s cost means finding the cause-and-effect connection between inputs and outputs. A cost driver links the activity that create outputs and resources that are used.
Management accountants usually create a system to allocate a portion of costs to each item produced by the company this usually covers the cost of the product and with a profit. Failing to accurately allocate production costs and to generate enough profits may lead the company into a negative cash flow. For a manufacturing company inventory may consist of raw materials, work in process, and finished goods. Raw materials are what will eventually be processed into a final product. Work in process is goods that are under production.
Finished goods are the completed units ready to be sold. Each category will require special consideration and control. Failure to properly manage inventory can lead to overstocking of raw materials or overproduction of finished goods which increases costs and obsolescence. Out-of-stock situations for raw materials will stop production and not having goods on hand might result in lost sales. Capital Investment Decision Techniques Capital investment decision techniques can make or break a company. Using the correct data information is vital for new business opportunities or expansion.
Managerial accountants prepare financial information and analysis the data to see if an opportunity exists for profit. In order to give an accurate picture of the situation they use formulas such as net present value, return on investment or a basic payback model. These all help managers understand the financial impact of business opportunities and how to make the best business decision based on the information available. A capital investment is when a company acquires assets with an expected life greater than one year so is classed as a long term asset, so the information they gather is vital to the company to make the right decisions.
A company needs to know how far into the future the asset will benefit the company. Capital investment is primarily interested in cash outflow and inflows which are the returns on the investment. Williams Northwest Pipeline, NWP, operates an interstate natural gas pipeline system consisting of approximately 4000 miles of trunk line and 42 compressor stations (Lewis, & Spencer, 2007). Because of a demand for the company to move south they set about to expand using an old unused station.
Their main concern was keeping their stakeholders happy and didn’t consider long term costs and reliability. Their planning process included enterprise business strategy and objectives, requirements, stakeholder input, asset performance assessment, benchmarking information, historical information (Lewis, & Spencer, 2007). NWP wanted to be a safe low cost leader in the business however benchmarks or historical data used were not adequate to assess this station. They were left with two alternatives one being modifying a capital asset and two replace two turbines or do nothing.
Describing requirements includes measurable performance levels; NWP did not document reliability requirements even though reliability was element of the business strategy (Lewis, & Spencer, 2007). The cost to operate and maintain the station must be less than the market impacts sustained by not operating it so they had to fit within internal financial limits one of which is a modified form of NPV analysis. Net Present value (NPV) is a capital investment technique and represents the value added to the business by the project or the investment (Schneider, 2012).
The decision rule is to accept the project only if its NPV is positive or zero a project with a negative NPV should be rejected. While comparing two or more exclusive projects having positive NPVs, accept the one with highest NPV (Schneider, 2012). The NPV represents the value added to the stockholders’ wealth by the project. The NPV approach correctly accounts for the time value of money and adjusts for the project’s risk by using the opportunity cost of capital as the discount rate. The NPV model presented includes an evaluation of risks throughout the life cycle.
The analysis applied risk evaluation at the project level and not at an individual cost component level (Lewis, & Spencer, 2007). The project final costs ended at $5. 79MM or 77 percent over budget, and the project was nine months late. This case study examined several missed opportunities and clearly shows how using the wrong data or being swayed by stakeholders needs can severely damage a project. The case study identified missed steps in the three major areas of strategic asset planning: requirements and analysis, asset planning, and investment decision making.
A formal and structured budgeting process is the foundation for good business management, growth and development. Budgeting needs should be driven by the vision of the company and be a strategic plan. Organizations that stay focused on their strategy and plan know where they want to spend their resources and have a plan to help keep them from spending in areas that do not line up with the vision. Budgeting A budget tells a manager how much to spend, how many units to produce, or how many customers to process. These items will become benchmarks that management will use as measurement tools.
At the end of the period, the actual performance will be compared to the budget amounts to see how well the manager has performed. Budgets have the potential of motivating workers to reach higher levels of efficiency and productivity or creating artificial barriers to progress (Schneider, 2012). Budget slack, or “padding the budget,” for example, can occur when managers intentionally request more resources than needed to guard against budget cuts (Schneider, 2012). A company’s budgeting process must take into account ongoing operations, capital expenditure plans, and corporate financing.
There are many planning details that are need to prepare budget schedules the data is taken from past experience, estimates of beginning balances, and future forecasts which are operating and financing assumptions. Borrowing details, cash policies, taxes, dividends, and beginning balance sheet figures are the independent variables for financing assumptions and are also needed to complete the cash-flow forecast and financial statements (Schneider, 2012). An example page 245 of our text uses a company called Schwartzben Products Company; a small manufacturer of wood-based products is used.
In the Schwartzben Products factory, wood is cut and assembled, a polyurethane finish is applied, and packing and shipping are done. A small sales office and administrative staff completes the organization (Schneider, 2012). The starting point for building a budget is to forecast the likely sales based on historical information which Schwartzben Products Company’s did. With these amounts in place, budgets can then be allocated for costs relating to sales, marketing and administration, and amounts established for the likely costs of storing and distribution of the podiums.
These details provide data for relevant departments such as sales, administration. Amounts can then be added for likely capital expenses. The final stage is to construct a budgeted profit and loss account and balance sheet. Schwartzben Products Company’s sales forecast is an independent variable which is prepared as shown in Schedule 3 on page 247. A production plan, Schedule 4, is prepared using the beginning finished podium inventory, the sales forecast, and the desired ending inventory levels (Schneider, 2012).
Their materials requirements and purchases budget reflect the relationship between the schedules and show what where and when they could improve their processes. There are many supporting schedules that are prepared and are important to various forecasts and calculations. Assumptions about collections, payments, and ending balances were given in Schedule 2. Forecasts for accounts receivable (Schedule 9), inventories (Schedule 10), and accounts payable (Schedule 11). The first summary is the preparation of the cash-flow forecast; nearly every schedule impacts cash (Schneider, 2012).
With cash flow forecasting the company can see if it needs to borrow or invest. If the cash balance falls below the minimum in Schedule 2 it has to borrow from the bank. If cash exceeds the minimum, it should be invested for maximum earnings. Calculations of Schedule 15 forecast suggest that Schwartzben Products will need to borrow cash. A budget should be evaluated for reasonableness reviewing the sales forecast is usually a good place to start. In the evaluation key variables should be looked at to see how they would change cash flows or profitability.
Using the “what if” process is a good process to find a better way to do things to improve inputs. Constant monitoring and evaluation by managers will ensure maximum output and profitability in the long term. Conclusion Because of globalization, competition and automation more accurate, timely, and relevant costs for products and services are needed. New activity measures like just in time, activity basted costing and flexible forecasting are now being used to link resources used with production activities.
The traditional approach of allocating overhead costs using direct labor hours or direct labor cost is no longer relevant in companies that are highly automated. JIT costing does not use a Work in Process account and costing combines direct labor and overhead into one account. JIT costing does not apply overhead to products until the products are completed. (Schneider, 2012). Activity-based costing will increase the number of cost drivers that makes cost centers budgeting easier since costs activity are more closely related (Schneider,2012).
Flexible manufacturing and team production activities change the collection of cost data; it is regrouped for improved planning and control (Schneider, 2012). One of the benefits of activity-based costing is more accurate product cost information as seen in the example below. This can help marketing people to price more competitively, and to expand or withdraw a product offering. Ideally, the implementation of an activity-based costing system involves marketing people, so they in turn better understand the costs they use and the system which generates the costs.
By allocating overhead on the basis of direct labor costs, the company has been understating the cost to manufacture high-grade units and overstating the cost to manufacture standard units. As a result, ABC shows that the standard unit is more profitable than originally thought and the high-grade unit is less profitable: Traditional Costing Method ABC StandardHigh-Grade Standard High-Grade Grade Price$3. 60 $5. 80$3. 60$5. 80 Cost2. 724. 062. 424. 86 Profit$0. 88$1. 74$1. 18$. 94 References Chai-Amonphaisal, K. ;amp; Ussahawanitchakit, P. (2010).
Decision-making/ Strategic Planning. Retrieved from; http://www. freepatentsonline. com/article/International-Journal-Strategic- Management/237305841. html Institute of Management Accountants. (2011) Ethical Behavior for Practitioners of Management Accountants and Financial Management, Retrieved from; http://www. imanet. org/pdfs/statement%20of%20Ethics_web. Pdf Lewis, R. M. , P. E. , ;amp; Spencer, G. R. , P. E. (2007). Total cost management: A case study in missed opportunity. AACE International Transactions, OW31-OW36. Retrieved from http://search. proquest. om/docview/208182419? accountid=32521 Noci, G. (1995). Accounting and non-accounting measures of quality-based performances in small firms. International Journal of Operations ;amp; Production Management, 15(7), 78-78. Retrieved from http://search. proquest. com/docview/232363342? accountid=32521 Schneider, A. (2013). Managerial Accounting: Manufacturing and Service Applications. San Diego, CA: Bridgepoint Education. Walther, L. (2012). Introduction to Managerial Accounting. Principles of Accounting. com. Retrieved from; http://www. principlesofaccounting. com/chapter17/chapter17. html