Comparison of Absorption and Variable Costing Methods

This assignment provides an in-depth analysis of the two cost accounting methods - absorption costing and variable costing. It explores their similarities and differences, along with their applications in management accounting. The document also delves into planning tools of budgetary control, highlighting their benefits and limitations. The study aims to understand how these methods contribute to effective management decision-making.

UNIT 5 Management
Accounting

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
TASK 1............................................................................................................................................1
P1. Management Accounting and types of management accounting systems that could be used
by Nisa....................................................................................................................................1
P 2. Different methods used by Nisa for management accounting reporting.........................3
TASK 2............................................................................................................................................5
P3. Production of income statements showing absorption costing and marginal costing
techniques...............................................................................................................................5
TASK 3............................................................................................................................................7
P4. Advantages and disadvantages of different types of planning tools................................7
TASK 4..........................................................................................................................................10
P5. Adapting management accounting systems to respond to financial problems...............10
CONCLUSION..............................................................................................................................12
REFERENCES..............................................................................................................................13

INTRODUCTION
The performance of a business is reflected through accounting. There are two branches of
accountancy, fiscal and management. Financial division deals with fiscal data and transactions.
Management Accounting (MA) have wider scope, as it considers both monetary and
administrative information of business and aids the governance in significant decision making. In
presented report a detailed analysis is done of management accounting systems, its relevance and
applications in the organisation and it is carried out on the basis of Nisa is a leading retail chain
in economy of UK. With these various reporting methods which can be used in enterprise is
presented, income statements are prepared on marginal and absorption accounting technique.
Different planning tools considerable in governance of firm, their advantages and disadvantages
are reported as well.
TASK 1
P1. Management Accounting and types of management accounting systems that could be used by
Nisa
Management Accounting:
Management Accounting is also known as cost accounting or managerial accounting, it is
the process of analysing operations and business costs to prepare internal financial reports to aid
manager's decision making process in achieving business goals. This enables managers to look at
the events that happen in and around a business while considering the needs of the business.
Main aim of cost accounting is to translate estimates and data into knowledge that will ultimately
be used to guide decision making (Mårtensson and et.al., 2016). Outcome of the same are shown
in form of periodic reports. These reports are usually confidential and are for internal use only. In
management accounting, it is required to utilize qualified information and skills for preparing
accounting statements.
The main difference between financial and management accounting is that, FA provides
information which is required by stakeholders in order to assist decision and MA put emphasis
on providing data and information for aiding managers in decision making process.
Functions of management accounting system:
 Analysis and interpretation of data: For effective planning and decision making data is
analysed in meaningful manner.
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 Facilitates control: It helps in translating given objectives into strategies and plans for
its effective achievement of goals.
 Provides data: Management accounting provides relevant data for past progress and for
making future forecast. Means of communication: Forwarding plans upward, downwards and outwards through
organization.
Difference between management and financial accounting:
Basis Financial accounting Management accounting
Data evaluation period After a definite time period. On daily basis.
Aim Information is supplied in the
form of P&L account, income
statements etc. for
stakeholders (Otley, 2016).
It is designed to provide
accounting information for
internal use of management
Precision Higher Lower
Legal compulsion It is compulsory for every
business.
No compulsion for every
business to install this system.
Types of management accounting systems that could be applied in Nisa:
Management Accounting System is a framework in which various objectives, functions
are incorporated and are evaluated crucially for decision making. These are also termed as
standardised system which aims at analysing, identifying and communication information.
 Cost accounting system: This type of system is defined as cost ascertainment, which
is directly related to a specific product or activity. Cost are allocated in this either
through activity based or traditional form of system. This could be defined as the
identification of all expenses and allocating it to relevant product or activity. In case
of activity based cost system, expenses related to specific operations are allocated to
it directly (Cost accounting, 2018). Expenses which are related to overall operations
of organization are allocated on the basis of proportionate to all departments or
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activities. Cost is measured and recorded individually in order to assist management
in decisions which are related to inventory and control of expenses for any specific
area of business.
 Job Costing System: In this system, main emphasis is given to allocation of
manufacturing cost of individual component produced in Nisa. This system is applied
in the cases where processes related with production of various goods, differ from
each other. Also, the determination of data and financial information related with cost
of particular product or job is done. This system would help Nisa in providing it with
information related to particular job performed for consumer under contract in which
costs are refundable (Renz, 2016). Organization is also assisted in executing cost per
unit of a product accurately and aids management in deciding the sales price that
could be quoted for specific products.
 Inventory Management System: This system controls and oversees inventory
orders. In other words, it justifies that how and when order is to be placed for raw
materials to ensure smooth production activity. In this, components are stored and
used so that production and sales of goods could be kept in proper order. This system
enables keeping record of inventories that are sold in stores of Nisa. It also
determines units of various products that are required to maintain in stock so that
goods are readily available for sales in its stores (Cooper, Ezzamel and Qu, 2017).
The function that is performed in this system is; creation of purchase orders,
allocating, receiving, storing, disposing and adjusting the inventory which are
accompanied by functions related to sales orders, shipping and packaging from Nisa
outlet is performed.
 Price optimisation system: This system makes use of mathematical analysis in Nisa,
which helps in determining how consumers will react to different prices for their
products and services distributed through various channels. Main objective of this
system in Nisa is to maximise operating profits and to determine prices.
P 2. Different methods used by Nisa for management accounting reporting
Accounting reports are methods of ensuring complete picture of business performance. A
comprehensive report is produced every quarter to give holistic view of business finances of
Nisa. This is especially crucial for Nisa to derive important strategic insights from these crucial
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documents, as it is a small business. There exist a number of accounting reports which are
valuable for protecting a business. These type of reports could be so important for small business
leaders and helps in analysing business performance.
Accounting reports can help any business, irrespective of it shape, size and number in
achieving goals more effectively. It can also provide business owners with insights that can help
them in capturing future opportunities in the market place. Some important tools and techniques
used in management accounting of Nisa are as follows:
 Accounts Receivable Ageing: It is a periodic report in which company's accounts
receivables are separated according to their time length in an invoice that has been
outstanding. This report can assist Nisa in indicating certain number of customers that
are becoming credit risk takers (Nitzl, 2018). This is a type of management tool which
directs company in right direction and reveals whether company should continue
business or not with consumers who are late payers.
 Job Cost Reports: Job cost reports represents specific type of projects that are financed
by Nisa with their expenses. With the help of this periodic accounting report, company is
able to evaluate profitability of job because they generally match with an estimation of
revenue. It can enable Nisa to put more emphasis on jobs with high profit margins,
instead of wasting time and money on jobs with low profit margins. This has also helped
in identifying high earning areas of the business.
 Cash flow analysis: This analysis is done to navigate movements of cash from one
period to another in Nisa. Further, it is also used to find out reasons for cash balance and
changes between two periods. This analysis is an examination of inflow and outflow of
cash. This analysis explains that how much cash comes in organization and how much
goes out in any year or quarter.
 Inventory and Manufacturing: Nisa can use this type of reporting for efficient
utilization of manufacturing processes in a case, if a physical inventory is maintained or
produced products by it.
 Budgetary Control: By using this method, Nisa estimates and arrange future financial
needs according to an order. This method also assist in controlling financial
performances of concerned businesses (Kihn and Ihantola, 2015). By applying this
accounting report, company is assisted in directing business operations in desired
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manner.This is method where in budgets are created for achieving financial needs of
organization.
 Statistical and Graphical Techniques: Many graphical and statistical techniques are
used by accountant of Nisa to make information more valuable and meaningful.
Company uses methods of; least square, quality control, regression, etc.
 Historical Cost Accounting: This technique is used by Nisa to examine predetermined
costs to evaluate performance. It simply means that cost are recorded after being
incurred.
 Revaluation Accounting: Revaluation of fixed assets as per accounting methods with
asset value in Nisa is done to represent capital properly. Also, helps in finding out fair
return on capital employed. With the help of revaluation of assets the organisation knows
fair value of there assets.
 Management Reporting: This report is prepared to disclose strengths and weaknesses
of operational and financial activities in Nisa, as it is prepared on the basis of balance
sheet and profit & loss account (Mirgorodskaya and et.al., 2017). These identifications
are useful in controlling and decision making.
Above mentioned tools and techniques are used by Nisa to manage accounting functions.
All this management accounting reports put emphasis on different segments of account and helps
in maintaining and controlling them. There is a good number of management accounting
techniques available but are not used by Nisa.
TASK 2
P3. Production of income statements showing absorption costing and marginal costing
techniques
Marginal Costing
It is a technique in which variable costing is charged to units of cost, while fixed cost is
completely written off against the contribution. It is an increase and decrease in total cost cost of
production for making and additional unit of any item. The marginal costing are computed when
any organisation achieves there break even point which means that fixed cost had already been
absorped.
Marginal Cost = Direct Material + Direct Labour + Direct Expenses + Variable Overheads
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Advantages of Marginal Costing:
 Cost Control: Marginal costing had made it easy to determine and control costs of
production. Management could be able to concentrate on achieving and maintaining a
consistent marginal cost by avoiding the arbitrary allocation of fixed overhead costs.
 Simplicity: This type of costing is easy to understand and operate and have capability to
combine with other forms of costing without having much difficulty.
Maximum return to the business: The effects of alternative sales or production policies are
easily accepted, appreciated and assessed with help of marginal costing to ensure that decisions
taken will yield the maximum return to business.
Profit and Loss statement with context of marginal costing
Particulars Figures Figures
Total Sales 33000 33000
Direct expenses
Raw material 5600
Labour Cost 4800
Variable overhead
Production 1600
Sales 800 12800
Less : Ending inventory
Direct Expense
Raw material 1400
Labour cost 1200
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Variable Overhead
Production 400
Sales 200 3200
Production expense of per unit 9600
23400
Less: Fixed expense
Production O/H 3200
Fixed cost
Administrative expense 1200
Selling cost 1500
5900
Net Profit margin 17500
Absorption Costing
This is an accepted technique of determining cost and is also known as full cost
accounting. In this method, value is made up of direct plus overhead costs absorbed on some
suitable basis. In this method, cost per unit remains unchanged and change only when each unit
fluctuates and also change with change in level of output because of fixed cost which remains
constant. This is very useful in case of one product and no inventory. In UK, this principle is
used in implementing GAAP principles of accounting. In Nisa, all manufacturing costs are
treated as product as while considering absorption cost. COGS would include direct materials,
overhead and direct labour. It helps in Cost Control and easy to determine and control costs of
production. Through absorption costing the resources are utilised in better manner with
maximum benefits.
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Management could be able to concentrate on achieving and maintaining a consistent
marginal cost by avoiding the arbitrary allocation of fixed overhead costs. This type of costing is
easy to understand and operate and have capability to combine with other forms of costing
without having much difficulty.
Maximum return to the business: The effects of alternative sales or production policies are
easily accepted, appreciated and assessed with help of marginal costing to ensure that decisions
taken will yield the maximum return to business. They help in maximising return of any
organisation through effective utilization of resources.
Profit and Loss statement on context of Absorption costing
Particulars Figures Figures
Total sales 33000 33000
Direct cost
Raw material 5600
cost of labour 4800
Variable overhead
(production) 1600
Variable overhead (sales) 800 12800
(-) Ending stock
Direct Raw material 1400
Direct cost of labour 1200
Variable overhead (sales) 200
(-)Variable overhead (sales) 600 3400
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(-) (Fixed) Overheads
Absorption
Production cost 9400
Contribution (per unit) 23600
(-) fixed cost
Overheads (production) 3200
Fixed Cost
1. Administrative
expense 1200
1. Selling cost 1500 5900
Net Profit 17700
Interpretation: The above table are signifying profit and loss statement on basis of
absorption and marginal costing. In the present scenario, everybody is rational as with context of
absorption costing it is capable for generating huge return. In this scenario, variable overheads of
sales are classified in marginal and absorption as well. The ascertained net profit of organisation
is 17700.
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B. Calculation of breakeven point and Margin of safety
The above table are signifying break even and margin of safety of specified units.
TASK 3
P4. Advantages and disadvantages of different types of planning tools
Nisa uses following types of planning tools in order to control budget:
Zero Based Budgeting (ZBB): This method includes justification of all the expenses for
each new period. Every function in an organisation are analysed according to its cost and needs,
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as this process starts with zero base. It also enables top level strategic goals to implement into the
budgeting process.
Advantages:
2. To evaluate operations and programmes of the organization, it provides a systematic way.
3. By enabling management, it ensures allocation of resources according to the priority of
programme.
4. Departmental budgets are proven on the basis of cost benefit comparison in it.
Disadvantages:
2. Implementation if problems: Its successful implementation requires whole hearted
assistance from top level of management which may not be available all the time.
3. Ranking problems: In a multi product manufacturing company it may be difficult to
rank because of large number of decision packages (Saeidi and Othman, 2017). It is also
possible that, many problems may arise in ranking decision packages.
4. Formulation problems: While formulating decision packages, there are high chances of
arising severe problems.
Activity Based Budgeting (ABB): It is a process of analysing, recording and researching
activities that leads to creation of costs for a business. This type of budgets are more than just
adjusting previous ones that accounts for inflation or development of business (Jermias, 2017).
Searching is done for efficiencies in business operations and develops plans according to these
activities in this type of budgeting.
Advantages:
1. More accurate costing of customers, distribution channels, products, etc.
2. Better understanding of overhead.
3. Easy for everyone to understand.
Disadvantages:1. It is very costly to maintain activity based budgeting system.2. ABB produces numbers such as margins that are odds with the help of traditional costing
system.3. It is very easy to misinterpret such data when are used in decision making, so it must be
handle with care.
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Net Present Value (NPV): It is the major difference between the present value of cash
outflows and present value of cash inflows over a period. In Nisa, to analyse profitability of a
projected investment or a project capital budgeting is used. This method is used as a capital
budgeting technique through which viability of project can be ascertained.
Advantages:
1. Importance is given to time value of money in this method.
2. Profitability and risk is given high priority.
3. Value of firm is maximised with the help of NPV.
Disadvantages:
1. NPV method is difficult to use.
2. If amount are not equal of mutually exclusive project, it cannot give accurate decisions.
3. Calculating appropriate discount rate is not an easy task.
Internal Rate of Return (IRR):It is referred as metric with application of capital budgeting
for estimating margin of potential investments. It is specific discount rate which creates NPV of
each cash flow on basis of project as 0. It is an expected growth rate of specific project which
generates estimated return. It provides comparison of its margin for creating innovative
expression for expansing its existing one. To estimate the profitability of potential investments
in capital budgeting, this metric is used. It is a discount rate that makes the net present value of
all cash flows from a particular project equal to zero (Nuhu, Baird and Bala Appuhamilage,
2017).
Advantages:
1. It considers time value of money, in-spite of even and uneven annual inflow of cash.
2. Project profitability is considered over the entire economic life of that project.
3. No need to predetermine cost of capital or cut-off rate.
Disadvantages:
1. Tedious calculations are involved.
2. This method assumes that earnings are reinvested at the IRR for the remaining life of
project.
3. Gives importance to the profitability only and do not consider earliest recouping of
capital expenditure.
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Standard Costing:
Advantages Disadvantage
 Assists in setting yardsticks against
actual costs which are then compared to
ascertain efficiency of actual
performance and is helpful in cost
reduction.
 This locates persons who are
responsible for unfavourable variances
and assists an individual out of
inefficiency (Mårtensson and et.al.,
2016).
 As it is predetermined, it is useful in
planning and budgeting.
 It is difficult to attain cooperation of all
concerned.
 In industries which deals with non
standardised products, this technique
may not be very effective and with jobs
which change according to the
requirements of customers.
Cost, Volume and profit analysis:
Advantages Disadvantage
 By showing the relationship between
cost, volume and profit it helps
management in taking sound decision
regarding distribution channel.
 With the help of this optimum price of
the products are fixed of the products
and services.
 It is difficult in this type of budgeting
tool to segregate total costs into fixed
and variable components.
 It is unlikely to stay constant in case of
fixed costs, as output increases beyond
a certain range of activity (Otley,
2016).
TASK 4
P5. Adapting management accounting systems to respond to financial problems
 Bench-Marking: It is a process of measuring company's products and services against
the set standard of other competitive businesses which are considered to be the best in the
industry. Main aim of implementing bench marking is to identify internal opportunities
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for improvement. Continuous and Dramatic are the two types of improving opportunities
(Mirgorodskaya and et.al., 2017). Continuous improvement is incremental and involves
only small adjustments to collect sizeable advances, etc. Whereas, Dramatic
improvement can only come out through re-engineering the whole internal work
processes. Nisa uses this management system in order to measure performance of
company's products and services and are effective too in responding to financial problems
that are faced by company.
 Financial Governance: It is a method or a way in which company manages, collects,
monitors and controls financial information. It includes navigation of financial
transactions, controls data and manage performances. In other words these are policies
and procedures that are used by companies to manage business data and ensure its
correctness. Significance of it could be given as; it gives assurance of right financial data,
it is a key to produce compliant regulatory reports and disclosures. More accuracy could
be achieved by drafting a sound financial governance budget. By using centralised,
unified corporate disclosure management software it could be improved. Nisa uses this
system, as it helps firm in managing, controlling, organizing and collecting financial
information that are very much helpful in responding financial problems efficiently as
compare to Vectair Holdings, a small business which deals in retail and hygiene products.
 Key Performance Indicators KPIs: It is a value which is measured to know how
effectively the company is working to achieve its main objectives. It is used at multiple
levels of a company in order to evaluate success in reaching targets. It also includes
function of setting objectives and tracking progress against it. To represent how
successful an organization is at achieving results in the past lagging pointers are shown.
Nisa uses this technique, as it assists firm to measure value in order to determine
effectiveness of company effectiveness in achieving business objectives.
Following are some techniques which are used by Vectair Holdings in order to respond financial
problems:
 Balanced Score Card: This is a method which is developed by Robert Kaplan and David
Norton. The objective of balance score card is to translate vision statement into actual
form. It is a type of metric which shows performance and is used in strategic management
to identify and improve various internal functions and their resulting outcomes. The
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information which is gathered is interpreted by managers and executives and is also used
to make better decisions for organization (Balanced Scorecard, 2018). The purpose of it
is to implement good behaviour in the organization by isolating four separate areas which
are needed to be analysed. This technique is used by Vectair Holdings to improve their
internal management function and resulting outcomes.
 Budgetary Target: The basic motive is to derive cost targets in a goal oriented manner.
Relationship of target budgeting and target costing is obvious and complement each other
but it also differs in their significance. By using this technique Vectair Holdings derive
cost targets in a goal oriented manner which can help company effectively according to
their business environment as compared to Nisa.
Above mentioned tools and methods are used by Vectair holding and Nisa in order to
respond to their financial problems. Techniques used by both of them differs a lot and has
diversified impacts on companies. Nisa uses; KPIs, benchmarking and financial governance
whereas, Vectair Holdings; Budgetary control and balanced score card. It was also concluded
that Nisa is using better techniques to respond financial problems.
Summary table related to comparison
Basis of difference Nisa Vectair Holdings
Management accounting tools
which are used by company in
order to respond financial
issues or problems.
1. Bench Marking.
2. Financial Governance.
3. KPIs.
1. Balanced Score Card.
2. Budgetary Target.
Usage of selected tool 1. Bench Marking: Used
to measure
performance of
business with that of
other businesses.
2. Financial
Governance: It is used
to manage and collects
1. Balanced Score Card:
This is used to identify and
improve various internal
functions of a business.
2. Budgetary Target:
To derive cost targets in a goal
oriented manner (Saeidi and
Othman, 2017).
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financial information.
3. KPIs: It is a
measurable value
which measures how
effectively company is
achieving key business
objectives.
CONCLUSION
From the above study it had been concluded report about brief study of management
accounting in context of Tesco, a leading retail store in the markets of UK in retail industry. This
file contains research on management accountancy and their requirement with types of
management accounting systems. Moreover, different methods of management accountancy
reporting are also highlighted briefly accompanied by management accounting system to respond
to financial problems in order to maintain financial accounting process. Tesco is recommended
and suggested to use mentioned different types of planning tools of budgetary control in order to
implement budget effectively and effectively. Practical aspect of report is covered by calculation
of income statement on the basis of marginal costing and absorption costing accompanied by
budgeted trading and P&L account of both costing methods. Further, planning tools of budgetary
control are explained with their advantages and disadvantages.
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REFERENCES
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studies of management accounting. Qualitative Research in Accounting & Management.
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Mårtensson, M. and et.al., 2016. Management accounting of control practices: a matter of and for
strategy. In the 9TH INTERNATIONAL EIASM PUBLIC SECTOR CONFERENCE, held
in LISBON, PORTUGAL, SEPTEMBER 6-8, 2016..
Mirgorodskaya, E. O. and et.al., 2017. Balanced Budget System: Organizational and Financial
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Nitzl, C., 2018. Management Accounting and Partial Least Squares-Structural Equation
Modelling (PLS-SEM): Some Illustrative Examples. In Partial Least Squares Structural
Equation Modeling (pp. 211-229). Springer, Cham.
Nitzl, C., 2018. Management Accounting and Partial Least Squares-Structural Equation
Modelling (PLS-SEM): Some Illustrative Examples. In Partial Least Squares Structural
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Nuhu, N. A., Baird, K. and Bala Appuhamilage, A., 2017. The adoption and success of
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Wiley & Sons.
Saeidi, S. P. and Othman, M. S. H., 2017. The mediating role of process and product innovation
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Online
Absorption costing. 2018. [Online]. Available through: <
https://www.accountingcoach.com/blog/absorption-costing>.
Balanced Scorecard. 2018. [Online]. Available through: <
http://www.balancedscorecard.org/BSC-Basics/About-the-Balanced-Scorecard>.
Cost accounting. 2018. [Online]. Available through: <
http://onlineaccountreading.blogspot.in/2014/12/cost-accounting.html#.WtwyHtTwbIU >.
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