Management Accounting and Budgeting Techniques

This assignment delves into the realm of management accounting, focusing on essential techniques such as budgeting, capital budgeting, and ratio analysis. It highlights the significance of planning tools in making effective plans for the entity and managing financial problems. The document also references various studies and research papers that emphasize the importance of management accounting systems in intellectual capital development and supply chain optimization. By examining these concepts, students can gain a deeper understanding of how management accounting contributes to better decision-making within organizations.

MANAGEMENT
ACCOUNTING

Table of Contents
INTRODUCTION...........................................................................................................................1
SECTION 1......................................................................................................................................1
1. Importance of management accounting in decision making...................................................1
2. Types of management accounting system used for reporting.................................................2
3. Benefits of management accounting systems and their application in organizational context
.....................................................................................................................................................4
4. (a) Absorption and marginal costing techniques.....................................................................5
4. (b) Supporting calculation regarding difference in the profits from each methods................7
4. (c) Reconciled Profit and Loss statement................................................................................8
SECTION B...................................................................................................................................10
Part A : Planning tools of management accounting..................................................................10
Part B: Management accounting used in dealing with the financial problems ........................11
CONCLUSION..............................................................................................................................11
REFERENCES..............................................................................................................................13

Index of Tables
Table 1: Statement of Profit and loss using absorption costing in Quarter 1..................................5
Table 2: Statement of Profit and Loss using Marginal Costing Method for Quarter 1...................6
Table 3: Statement of Profit and Loss using Absorption Costing for Quarter 2..............................6
Table 4: Statement of Profit and Loss using Marginal Costing Method for Quarter 2...................7
Table 5: Calculation for under absorption in Quarter 1...................................................................8
Table 6: Calculation for under absorption for Quarter 2.................................................................8
Table 7: Reconciled profit and Loss Statement for Quarter 1.........................................................8
Table 8: Reconciled Profit and Loss statement for Quarter 2..........................................................9

INTRODUCTION
Management accounting is a practice where financial statements are analysed and
interpreted in order to take better long term and short decision for the company. The report
discusses about the role of management accounting in decision making process of the entity
which further helps in making future forecasts of profits as well. Further, the report focuses on
calculation of profits by using absorption and marginal costing techniques. The reasons for of
difference in the profits from the two methods will also be focussed on. Several types of
management accounting systems will also be discussed in the report. Moreover, three main
planning tools such as budgeting, capital budgeting and ratio analysis are compared and
contrasted based on their benefits. In the end, the report ponders on the effectiveness of
management accounting ion order to deal with the financial problems that arise in Nero Ltd. Will
also be discussed.
SECTION 1
1. Importance of management accounting in decision making
Management accounting is a practice where accounting information is used for better
decision making. It is an important tool to manage the performance of control functions. It is a
process of preparation of management reports which helps in providing financial data to the
managers so that short term and long-term decisions can be taken accurately and within specific
period. It helps in identifying, measuring, analysing, interpreting and communicating information
to the internal and external sources. Analysing and evaluating the reports, managers can make
better quantitative and qualitative decisions for the organization.
There is a vast difference between management accounting and financial accounting. It is
focussed on providing information mostly to the outsiders. However, management accounting
major used for internal decision making (Bodie, 2013).
Major role is played by management accounting for better decision making in the
organization. Some of its roles are discussed below:
 Helps in forecasting for future: According to the current and past trends of profits and
sales that has been experienced in the entity, management accounting helps in forecasting
for the upcoming years as well. It evaluates the risk that may come up in the enterprise
and helps in taking corrective action to mitigate the risk beforehand.
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 Identification of key performance metrics: It assesses the potential of each department
based on the contribution made by them to maximize organizational goals. According to
it, estimation for further year is made.
 Collecting and comparing available data: It collects and compare present data and take
future decisions for upcoming financial year based on it. Further, the estimated data is
also compared with the actual ones and find the variations in the expected figures. If the
variance is above 10%, manager have to take serious actions so that the variation can be
reduced to zero (Tran-Thanh, Chapman and et. al, 2012).
 Assessing the performance: Accounting manager uses various advanced accounting
techniques in order to assess the performance of the organization. The tools include,
balanced scorecard, key performance indicators, scenario planning, Management
Information System (MIS) etc.
 Analysing rate of return: Before making any heavy investment in any project or fixed
asset, manager analyse the profits using various methods such as payback period, Net
Present Value (NPV), Expected Rate of Return (EROR). It analyses different aspects in
order to choose most profitable project from all the available choices (Caglio and Ditillo,
2012).
2. Types of management accounting system used for reporting
Management accounting system helps to collect data related to finance from business
operations for instance, data of sales, inventory shift, change in the cost of raw material cost.
Further, it converts the data into reports so that analysis can be made easily. There are various
types of management accounting system that are made
Job costing system:
Job costing system is a system of management costing in which information about the
cost to be incurred on a specific production or service related task is collected. This information
may be collected to submit to a customer related for reimbursement of cost under a particular
contract. The information is also used of quotation of price for a particular job to generate an
adequate profit. This information may also be used to assign inventories for production. The
information is gathered regarding direct material, direct labour, and overheads associated with
the job. Job costing is different form the contract and target costing the aspects that under this
system of management costing firstly the predictions are made about the cost of the job on the
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basis of direct material, direct labour and overheads to be incurred and quotations are formed
based on that predictions and later reimbursements are made by the customer for the cost
incurred in process of job.
Target costing system:
Target costing system is a costing technique in which the company makes a plan for the
price points, product cost and margins from the sale that it needs to make from the new product.
If the planned level of cost is not achieved by the company then the entire project is cancelled.
Target costing system is the most efficient system of achieving consistent profitability in the
production sector. The management of the company has the power to continuously track the
manufacturing from the design phase to the production's end part. This system takes certain steps
to make the plan for the product, steps include conducting research, calculation of maximum
cost, engineering the product, ongoing activities in the production. The target costing system
differs from contract and job costing systems on the part that under both the other system no plan
is made against the price point, product cost and margin of the product and also no quotations are
filled for the cost cover for the new product under the other two systems (Christ and Burritt,
2013).
Contract costing:
Under Contract costing system cost is tracked which is associated with a particular
contract of a client. These commitments are made between two parties to complete a task within
a specific period. If the two parties agree to provide fees to the company, then this
reimbursement is done on the cost, in parts, incurred by the company in order to complete the
terms within the contract. The process for expenses of cost includes, fixed cost, cost plus, time
and material. The contract costing may also work on considerable amount of overhead allocation
for the task to complete. This system of management costing is different from job and target
costing on the base that this costing system follows the contract basis instead of job or target
setting, under this system reimbursement is done on the basis of cost incurred by the company in
the process of completion of the terms of the contracts. No pre-planning or prediction of the cost
is done under this contract.
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3. Benefits of management accounting systems and their application in organizational context
The main management accounting system that have been discussed are, Job costing,
target costing and contract costing.
Job Costing: The major advantage of job costing is that the managers are able to calculate
profits that have been incurred from each job. It further helps in ascertaining the desired results
that is expected out of the job in near future. It is the best activity that can be adopted by a
manufacturing concern. Also, companies providing customized thing can also find out the cost
involved in it by using this method. It is the best suited technique for those who have continuous
manufacturing setting such as factories, manufacturing concern and utilities companies (Figge
and Hahn, 2013).
Job costing is an effective method that helps in assessing the performance of individuals
and well as the team in terms of cost control, efficiency of the team members and productivity as
well. It is an adequate method to determine the average cost of each unit that has been produced.
The cost can be assessed at every stage of completion of the job which helps in controlling the
cost at every step of manufacturing. Moreover, corrective actions can be taken by the entity in
order to control the cost and maximize profits.
Target Costing: The focus of this type of costing is to identify the cost of the product so that it
can generate desired profit margin. It helps in reducing the cost of production so that the set
target of profits can be achieved. Further, it plays a key role in acquiring the products which are
best suited do that cost can be reduced to the minimum. It creates a financial flexibility in the
organization. Moreover, reduced cost attracts the maximum number of customers towards the
organization. It elevates the customer base of the enterprise. It is a formal and systematic way to
focus on optimization of cost. Since, formal set up of cost optimization is more appropriate for
small organizations. It is medium sized organization and targeting costing method is the best
approach to achieve organizational goals.
Another emphases of target costing is on reducing the time involved in product cycle. It
means that unnecessary steps from manufacturing cycle have been eliminated which ultimately
saves the time involved in production as well. It adds value to the end consumer as they get the
products offered by the entity at reduced prices than before. A shorter time cycle helps the
manufacturer to be a first mover in the market and maximize profits. It also helps in attracting
maximum customers in the first go before any other competitors come to the market.
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Contracting costing: It is mostly conducted by builders, civil contractors, ship builders and
mechanical engineer firms. The manufacturing is basically conducted based on the demands of
the customers and can be customized according to their taste and preferences. It helps in
ascertaining the cost that have been incurred of each contract separately. It helps in analysing the
profits that have been generated from each contract and assess the cost incurred in it. The larger
jobs continues for more than a year. Contracting cost make it easy to analyse the cost year by
year. Since, each contract is different and unique, one can be distinguished with the other with
the help of it based on the cost incurred and profits generated (Hall and West, 2013).
The contractor can assess the cost incurred upto a particular period and can make
estimated about the profits as well. It can further distribute the expenses so that optimum
utilization of the available resources is made. It can analyse the profits it generated from different
contract and estimate the prices of further contracts based on it.
4. (a) Absorption and marginal costing techniques
Absorption costing technique is a managerial accounting cost method of recording the
cost that is directly associated to production of a product. Generally Accepted Accounting
Principles (GAAP) are followed in order report the profits to external users. The cost that is
directly related to manufacturing includes, wages to the workers, cost of raw material all utility
cost etc. It is more accurate in order to assess the net profitability of the firm.
Marginal costing only includes variable cost which is directly related to the production.
GAAP principles are used in order to report the profits generated using this methodology to the
external users and stakeholders. It is difficult to analyse the prices of the product since only
variable cost is considered. However, it helps to evaluate the profitability of the company of
manufacturing a particular product.
Table 1: Statement of Profit and loss using absorption costing in Quarter 1
Statement of Profit and Loss using Absorption Costing Method (Quarter 1)
Particulars No. of units Per unit cost / price Amount
Sales 66000 1 66000
Cost of sales
Opening inventory 0 0.85 0
Add: Production 78000 0.85 66300
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66300
Less: Closing inventory -12000 0.85 -10200 56100
Gross profit 9900
Less: Expenses
Selling and administration cost -5200
Profit 4700
Table 2: Statement of Profit and Loss using Marginal Costing Method for Quarter 1
Statement of Profit and Loss using Marginal Costing Method (Quarter 1)
Particulars No. of units Per unit cost / price Amount
Sales 66000 1 66000
Less: Cost of sales
Opening inventory 0 0.65 0
Add: Production 78000 0.65 50700
50700
Less: Closing inventory 12000 0.65 7800 42900
Contribution 23100
Less: Fixed cost -16000
Less: Selling and admin cost -5200
Profits 1900
Based on the profit and loss account prepared as per absorption costing method and
marginal costing method, the profits ascertained are different. The reason is in absorption costing
production overheads are not considered while determining the profits. According to profit and
loss account using absorption costing for quarter 1, it is 4700. However, in the case of marginal
costing, it is 1900.
Table 3: Statement of Profit and Loss using Absorption Costing for Quarter 2
Statement of Profit and Loss using Absorption Costing Method (Quarter 2)
Particulars No. of units Per unit cost / price Amount
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Sales 74000 1 74000
Cost of sales
Opening inventory 12000 0.85 10200
Add: Production 66000 0.85 56100
66300
Less: Closing inventory -4000 0.85 -3400 62900
Gross profit 11100
Less: Expenses
Selling and administration cost 5200
Profit 5900
Table 4: Statement of Profit and Loss using Marginal Costing Method for Quarter 2
Statement of profit and loss using Marginal Costing Method (Quarter 2)
Particulars No. of units Per unit cost / price Amount
Sales 74000 1 74000
Less: Cost of sales
Opening inventory 0 0.65 0
Add: Production 66000 0.65 42900
42900
Less: Closing inventory 4000 0.65 2600 48100
Contribution 25900
Less: Fixed cost -16000
Less: Selling and admin cost -5200
Profits 4700
Based on the results of quarter 2, it can be ascertained that the profits through absorption
costing is 5900. However, profits through marginal costing is 4700. It is due to non consideration
of production overhead while calculating profits through absorption costing. It is better for the
entity to opt for variable costing based on prudence concept of accounting which says that the
entity should record all the possible liabilities as they occur and keep the expectations of the
profits to the minimum.
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4. (b) Supporting calculation regarding difference in the profits from each methods
Table 5: Calculation for under absorption in Quarter 1
Quarter 1
Particulars No. of units Per unit cost / price Amount
Absorbed 66000 0.2 13200
Total fixed cost 16000
Under absorption -2800
The difference in the profits through marginal costing and absorption costing have arisen
up due to not considering fixed production overhead while calculating profits through absorption
costing method. Under absorption amount have been calculated by considering fixed production
cost of sales amounting to 16000. Per unit cost have been estimated as 0.2 by diving 16000 with
total sales that is 80000. Absorbed amount is worth 13200 which have been deducted from total
fixed cost amounting to 16000 leading to unabsorbed cost of 2800.
Table 6: Calculation for under absorption for Quarter 2
Quarter 2
Particulars No. of units Per unit cost / price Amount
Absorbed 74000 0.2 14800
Total fixed cost 16000
Under absorption -1200
Under absorption cost for quarter 2 have been calculated by deducting the absorbed
amounting to 14800 from fixed cost worth 1600. It has led to total under absorption 1200 in
negative.
4. (c) Reconciled Profit and Loss statement
Table 7: Reconciled profit and Loss Statement for Quarter 1
Statement of profit and loss using reconciled method (Quarter 1)
Particulars No. of units Per unit cost / price Amount
Sales 66000 1 66000
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Cost of sales
Opening inventory 0 0.85 0
Add: Production 78000 0.85 66300
66300
Less: Closing inventory -12000 0.85 -10200 56100
Gross profit 9900
Less: Expenses
Selling and administration cost -5200
Profit 4700
Less: Under absorption -2800
Reconciled profits 1900
Reconciled profit and loss account shows that the profits of the company will be 1900
after adjusting the amount of under absorption for quarter 1.
Table 8: Reconciled Profit and Loss statement for Quarter 2
Statement of profit and loss using reconciled method (Quarter 2)
Particulars No. of units Per unit cost / price Amount
Sales 74000 1 74000
Cost of sales
Opening inventory 12000 0.85 10200
Add: Production 66000 0.85 56100
66300
Less: Closing inventory -4000 0.85 -3400 62900
Gross profit 11100
Less: Expenses
Selling and administration cost 5200
Profit 5900
Less: Under absorption -1200
Reconciled profits 4700
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After adjusting the amount of under absorption, the profits incurred by the organization is
4700 for quarter 2. It shows that the company was able to earn higher profits in quarter 2 in
comparison to that of quarter 1.
SECTION B
Part A : Planning tools of management accounting
Planning is an effective tool that is used by the entities for better decision making
(Longinidis and Georgiades, 2011). These tools have a great impact on maximization of profits
and organization is able to perform optimum utilization of available resources through a
blueprint of a plan. There are various techniques tat are used by the entity in order to have
effective planning for its functions. Some of the methods that can be used by Nero Ltd are
discussed below:
 Budgeting: Budget is a forecast which helps in assessing that what will happen next in
near future. It also evaluates the estimated profits based on past track records and
prevailing economic conditions of the country. A budget is prepared by every department
and it is compared with the actual outcomes in order to assess that if any variance is
present between actual and estimated figures (Mendes and Saito, 2014). However, any
change in the economic condition of the sector of the entity. The budget then holds no
use and company have to get involved in the process of budgeting all over again. Various
budgets are prepared by the enterprises such as, cash budget, sales budget, purchase
budget, operating budget etc. Effective implementation of these budgets help in achieving
organizational goals in a better way. The subordinates will be aware of what they have to
do and how much finance is available to them in order to meet out their needs.
 Capital budgeting: It is another method of planning which helps in assessing that
whether the project In which company is planning to invest will prove to be profitable or
not. It is basically designed to evaluate the profitability a project or fixed asset in which
entity ids investing carries. Long term investment consists of machinery, new plants,
products, research development project etc. It also determines the time period in which
the company will be able to get its investment back (Merchant, 2012). The main methods
of capital budgeting techniques are Net present value method, Internal rate of return and
Accounting rate of return. ARR do not considered time value and money factor and
hence, considered to be the weakest among the three. The mostly used technique of
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capital budgeting is Net present Value. It is reliable to make better plans for the entity. It
assesses the cash inflow and outflow which the company can experience in the upcoming
years. Organization can rely on this technique of planning in order to make long term
investment decisions. However, any decrease in the value of the currency have a wide
impact on estimations made through this method (Novas, Alves and Sousa, 2016).
 Ratio Analysis: This is another method of planning tool that is used to assess the
financial position of the company and based on it, manager take further important
decisions as well. Ratio analysis is a quantitative assessment of information that is
present in the financial statements of the company. The line items of profit and loss
account, balance sheet and cash flow statement plays an important part in making this
evaluation. Different aspects of the entity can be determined such as, operating, financial
etc. It also helps in evaluating financial efficiency of the company. The trend of the ratios
is studied so that effective decisions for the organization can be made. It helped in
assessing whether the financial performance of the company is improving or degrading.
The key ratios in ratio analysis are current ratio, return on equity ratio, debt equity ratio,
dividend payout ratio etc. By analysing these ratios it will be easy for the managers to
assess that whether the entity need to make any further investment in debt or equity or not
(Parker, 2012). Moreover, it can estimate profits for the next financial year easily and
accurately. However, the main problem of planning through ratio analysis is that
sometimes what ratio depicts is not the actual position of the company. For instance, an
increase in debt equity ratio above 0.5 can be bad for the company but it can be good if
company is earning higher profits year by year and have good financial position as it can
easily pay out interest to the debenture holders.
Part B: Management accounting used in dealing with the financial problems
There are several ways through which management accounting can be applied in Nero ltd. These
are as following: Variance analysis: It is the tool that defines deviation in company's financial
performance from pre decided budget. There are many causes due to which expenses get
increased and create problem for the management. The actual difference between planned
and actual amount is called variance. With the help of this technique Nero ltd will be able
to identify issues and will be able to resolve these problems on time. With the assistance
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of variance analysis management can make effective decision that may support in
increasing profit of the cited firm. Ratio analysis: It is another way of applying management accounting in the Nero ltd.
Finance department of the company can look upon ratios such as profitability, liquidity,
solvency etc. in order to analysis financial performance of the firm. This will support in
addressing loop fall and making effective growth strategies through which organization
can get success and can accomplish its objective soon.
 Budgeting: It is considered as one of the most important aspect to apply management
accounting in the organization. Before preparing budget managers have to look upon
expenses and income source for future. It will support in allocating resources effectively
thus unnecessary expenditures will be minimized. That would support in increasing
revenues of the entity.
All these tools are effective in resolving financial problems of Nero ltd. With the help of
ratio analysis company \will be able to identify issues in business and operations. By this way
management will be able to make effective strategies so that such type of problems can be
minimized. Profitability ratio will assist in knowing strength of the entity through which it can
era high profit. That would support in making good pricing and cost curtailments strategies that
will help in improving business performance. Liquidity ratio will be beneficial in making
effective balance between assets and liabilities. With the help of ratio analysis Nero ltd will be
able to make effective control over liabilities. That would decrease financial burden of the cited
firm.
Furthermore, budgeting is effective management accounting tool that assists in allocating
resources in impressive manner. That may help in resolving cash flow problems. With the
assistance of this technique Nero ltd will be able to run its operations smoothly without any
complications. Variance analysis is the great tool that supports in identifying difference between
actual and expected amount. By this way financial problems related with high cost and wrong
decision will be minimized. That would support in the growth of the organization because with
the help of this Nero ltd will be able to make effective pricing strategies and investment
decisions that may give high return to the entity.
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CONCLUSION
Based on the above report, it can be concluded that, management accounting is an
important tool that is used by the organization for better decision making. It helps in making
future projections for the entity as well (Renz, 2016). Further, it can be inferred that absorption
costing do not consider fixed production overhead while calculating profit or loss for the entity.
Moreover, there are various types of management accounting systems such as job costing, target
costing and contract costing. Panning tools are used to make effective plan for the entity that can
be utilized for better functioning. It includes, capital budgeting techniques which helps in
assessing that whether the fixed asset or project will be profitable enough for the company or
not. Ratio analysis helps in taking better investment decisions for the organization. However,
budgets are prepared so that departments are aware how many expenses they can make in the
upcoming financial year. In the end, it can be concluded that management accounting helps in
better decision making for the company and helps in dealing with financial problems as well.
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