Management Accounting: Cost Analysis, Budgeting and Financial Ratios

This report provides a detailed analysis of various management accounting aspects through different scenarios. It evaluates a make-or-buy decision for Thunder Company, concluding that manufacturing the product internally results in savings. Financial ratios are applied to J.P. Robard Manufacturing Company, revealing a favorable position in the industry. The report highlights how budgeting improves productivity by eliminating non-value-added activities and discusses variance analysis as a tool for identifying deviations from the budget for corrective action. The analysis includes calculations and interpretations of financial metrics like current ratio, inventory turnover, asset turnover, and debt ratio, offering recommendations based on the findings.

Running head: MANAGEMENT ACCOUNTING
Management Accounting
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

MANAGEMENT ACCOUNTING
Executive Summary:
The current report intends to evaluate the various aspects of management accounting
based on different provided scenarios. The first segment has focused on deciding whether to
make or buy a product, in which it has been found that the make decision would help in making
additional savings for Thunder Company. Moreover, after applying the various financial ratios in
the context of J.P. Robard Manufacturing Company, it has been found that the organisation is
placed in a favourable position in the industry. Furthermore, it has been evaluated that budgeting
helps in removing those activities not adding value to the organisation in order to improve the
overall productivity. Finally, variance analysis is an important tool to identify the variations from
budget in order to undertake corrective actions.
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Table of Contents
Question 2(b):..................................................................................................................................3
Requirement 1:.............................................................................................................................3
Requirement 2:.............................................................................................................................3
Question 3:.......................................................................................................................................5
Requirement A:............................................................................................................................5
Requirement B:............................................................................................................................7
Requirement C:............................................................................................................................7
Question 4:.......................................................................................................................................8
Requirement A:............................................................................................................................8
Requirement B:............................................................................................................................8
Question 5:.....................................................................................................................................10
Requirement 1:...........................................................................................................................10
Part a:.....................................................................................................................................10
Part b:.....................................................................................................................................11
Part c:.....................................................................................................................................11
Requirement 2:...........................................................................................................................12
Conclusion:....................................................................................................................................12
References:....................................................................................................................................13
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Question 2(b):
Requirement 1:
As per the provided information, it could be observed that Sparks Limited manufactures
three products A, B and C. However, as Product A is suffering loss of $7,000, the managing
director of the organisation makes arguments in favour of discontinuing the product. However,
sometimes it is necessary to retain the unprofitable product due to the following reasons:
Remaining raw materials:
There might be some raw materials on hand, which are associated only with the Product
A and thus, management would like to draw down such quantities through additional product
sales (Armitage, Webb and Glynn 2016).
Hole in product line:
It might be significant to depict complete product line-up to the customers for refraining
them from using the competitors’ products; in case, hole in the product line is inherent.
Market blocking:
If Sparks Limited decides to retain Product A at a low price point, the rivals would be
kept from making market entry with their own products.
Dependent products:
There might be a chance that the dependent products providing outsized profits could
cover up the losses incurred by one product (Ax and Greve 2017). If the situation is similar for
Sparks Limited, the other two products B and C could cover up the losses generated by Product
A.
Requirement 2:
Make or buy decision is the act of selecting between producing a product internally or
buying the same from an external supplier (Bromwich and Scapens 2016). In this decision, the
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factors that need special consideration include related production costs and whether the
organisation has the ability of manufacturing at needed levels. The following calculations are
made to arrive at make or buy decision in the context of Thunder Company:
From the above table, it is inherent that Thunder Company would have to incur $39 per
unit to manufacture the product and the overall cost would stand $585,000. On the other hand, if
the organisation decides to purchase the product from the supplier, it needs to incur $34 per unit
including fixed cost amounting to 75% of the fixed manufacturing overhead. The total cost
needed to make the buy decision is obtained as $622,500. However, the buy decision would help
in making another product, which would provide a contribution margin of $15,000. It has been
analysed that Thunder Company could save $37,500 by undertaking make decision and when
contribution margin by choosing buy decision is subtracted from savings, the final savings stand
at $22,500. Hence, Thunder Company is recommended to manufacture the product internally.
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Question 3:
Requirement A:
The following financial ratios are computed in the context of J.P. Robard Manufacturing
Company:
From
the
above
table, it
is
inherent that the current ratio of the organisation has been 1.75, which is more than the industrial
average of 1.50. With the help of current ratio, it is possible to determine the liquidity position of
an organisation by gauging its ability to repay short-term obligations (Cooper, Ezzamel and Qu
2017). A higher ratio is always favourable and in case of J.P. Robard Manufacturing Company,
the ratio is above the industry norm. Hence, in terms of liquidity, it is maintaining competitive
position in the industry by converting working capital into cash within shorter timeframe.
Inventory turnover for the organisation is computed as 3.30 times, which is higher than
the industrial norm of 3 times. This ratio helps in gauging the efficiency of an organisation in
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controlling its merchandise and thus, a higher figure is desirable for the organisation (Fullerton,
Kennedy and Widener 2014). The ratio is desirable for J.P. Hobard Manufacturing Company due
to increased market demand, which has helped in releasing its merchandise at a faster rate than
its competitors. Asset turnover ratio, on the other hand, gauges the efficacy of an organisation in
utilising its assets for generation of sales revenue (Kokubu and Kitada 2015). A higher turnover
is desirable and in case of J.P. Hobard Manufacturing Company, the ratio is the same as the
industrial yardstick, as it has employed its assets effectively to cope up with the industrial trend.
Operating profit margin of the organisation is obtained as 21.25% in contrast to the
industry norm of 18% and this margin is a key indicator for creditors and investors to analyse the
way an organisation is supporting its operations (Langfield-Smith et al. 2017). In this case, it is
more than the industrial average, as it has lower operating costs in contrast to its competitors.
The similar is the case with return on investment, which denotes that investments are made after
suitable evaluation of projects to maximise the overall returns.
Debt ratio is a measure of solvency that gauges the total liabilities of an organisation as a
percentage of total assets (Lavia López and Hiebl 2014). In case of J.P. Hobard Manufacturing
Company, the ratio is computed as 50%, while the industrial norm is provided as 60%. A lower
ratio is always favourable, since it implies better business stability having the potential of
longevity, as an organisation with lower ratio has lower total debt. In this case, the organisation
has focused on raising funds partly through debt and partly through equity, which has helped in
maintaining optimality in its capital structure. Average collection period denotes the time taken
in order to recover the amounts to be obtained from the credit sales made to the customers by an
organisation. For J.P. Hobard Manufacturing Company, the amounts are recovered within 91
days in opposition to the industrial norm of 100 days. A lower period is desirable, as recovering
money within shorter time helps in increasing the availability of working capital and the case is
similar for the concerned entity as well.
In terms of fixed asset turnover ratio, it is 1.78 for the organisation, while the industry
norm is given as 1.50. A higher turnover is favourable, as it implies that more revenue is
generated through effective utilisation of fixed assets. For J.P. Hobard Manufacturing Company,
the situation is similar, since it might have leased a portion of its unutilised fixed assets for
generating additional revenues in contrast to its rivals. Finally, in terms of return of equity, J.P.
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Hobard Manufacturing Company has a better ratio of 20% in comparison to the industry norm of
15%, as more equity shares are issued and accordingly, adequate returns have been provided to
the investors and shareholders. Therefore, by taking into consideration all the aspects, J.P.
Hobard Manufacturing Company is placed in a favourable position in comparison to all other
competitors in the industry.
Requirement B:
Based on the above financial evaluation, it is evident that the capital structure of the
organisation is perfectly balanced, as equal weights are assigned to both debt and equity. Since
debt ratio is obtained as 50%, it is obvious that the equity ratio would be 50% as well. Moreover,
J.P. Hobard Manufacturing Company is making adequate profits in contrast to its competitors in
the industry, which implies that the profit earned could be used for investing in business
operations. The liquidity position of the organisation is deemed to be favourable, as the owed
amounts from the debtors have been collected within shorter period. Moreover, the market
demand for the products of the organisation is expected to increase in future, which would help
in generation of additional income (Malmi 2016). Hence, Gulf Bank Plc could sanction bank
loan to J.P. Hobard Manufacturing Company, as it has the ability of repaying its loan amount by
increasing its existing asset base, cash availability and income generated.
Requirement C:
In this section, the ratio that could be taken into consideration is the return on total
capital. This ratio gauges the profit earned from the end of an organisation by utilising both debt
capital and equity capital (Nielsen, Mitchell and Nørreklit 2015). For J.P. Hobard Manufacturing
Company, the ratio is computed as follows:
It has been provided that the competitors provide 12% return. In case of J.P. Hobard
Manufacturing Company, the ratio is obtained as 21.25%, which is much higher than the return
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provided by the competitors. The reasons identified behind such higher return are the increased
revenue and optimality in capital structure due to which the investors would be provided with
sufficient return on their investment. Hence, it is recommended to the investors to invest in the
organisation, as it would help in maximising their overall return on investment.
Question 4:
Requirement A:
Requirement B:
Budgeting provides a range of benefits, which are discussed briefly as follows:
 With the help of budgets, the managers are compelled to think and estimate the
challenges to be encountered in future along with developing strategies for meeting the
desired goals of the organisation.
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 Incentives are dependent on the accomplishments in contrast to the budgeted figures.
Therefore, if budgets are formulated realistically, they would help to motivate the
managers and employees in a positive manner (Otley 2016).
 In the stages of budgeting, there have been elimination of those activities that do not add
value; instead, new or improved processes are developed for enhancing productivity.
 Budgeting is the effective tool for coordinating with all the managerial levels in order to
make future plan, promoting teamwork, goal congruency and process enhancement
between the staffs and the organisation.
 By setting up budgets, there are proper segregations of delegation of duties,
responsibilities and authority limit. The top management of the organisation might feel
that they are in complete control of the different business activities with the help of
budgeting.
However, budgeting has a number of limitations, which are enumerated briefly as follows:
 The staffs might not be motivated, as they might feel that the budget figures are way too
high to be accomplished.
 There is high chance of budgetary slack, as the managers might blow up the budget
figures due to the fact that the higher-level management would reprimand them.
 The budgets tend to emphasise on outcomes, rather it ignores the actual reasons.
 Unrealistic budgets could result in certain managerial decisions that might be detrimental
to the organisation. For instance, over ambitious sales would result in drastic impact such
as providing steep discount for raising volume (Quattrone 2016).
 Regardless of procedures followed in preparing budgets, budgeting does not possess the
ability of reflecting the actual scenario or complexities faced by the organisation.
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Question 5:
Requirement 1:
Part a:
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Part b:
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Part c:
Requirement 2:
In the words of Senftlechner and Hiebl (2015), variance analysis could be defined as the
quantitative examination of the variation between planned behaviour and actual behaviour. This
analysis is utilised for maintaining complete business control. In addition, it includes the
examination of the differences so that the result is a statement of the variation from expectations
and explanation of the occurrence of such variation. With the help of variance analysis, efficient
budgeting activity could be ensured for enabling the managers to undertake detailed and forward
looking budgetary decisions. Moreover, it helps in assigning responsibility along with engaging
control mechanism on departments, as needed. For instance, if labour efficiency variance or
material cost variance is favourable, it is possible to increase the control on these departments for
enhancing efficiency. However, variance analysis is subject to certain drawbacks, which are
elucidated briefly as follows:
 As the accounting staffs compiles variances at month end, it is not possible for the
management of an organisation to obtain feedback in less than a month. Therefore, it
needs to rely on other measurements for undertaking decisions (Van Der Stede 2015).
 Variance analysis is necessarily the contrast of actual outcomes to an arbitrary yardstick,
which might have been derived from political bargaining. Therefore, the resulting
variance might not provide valuable information.
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Conclusion:
Based on the above discussion, it could be found that it would be feasible to continue
with a product, even if it is incurring loss, for using the raw materials in other product lines.
Moreover, Thunder Company is needed to manufacture the product internally, as the savings
would be more rather than purchasing from the external supplier. From the ratios computed, it
has been analysed that J.P. Robard Manufacturing Company has been enjoying leading position
in the market due to superior financial performance and position. It has been evaluated that
budgeting helps in removing those activities not adding value to the organisation in order to
improve the overall productivity. Finally, variance analysis is an important tool to identify the
variations from budget in order to undertake corrective actions.
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References:
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by small and medium‐sized enterprises: a field study of Canadian and Australian
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Ax, C. and Greve, J., 2017. Adoption of management accounting innovations: Organizational
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Bromwich, M. and Scapens, R.W., 2016. Management accounting research: 25 years
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Cooper, D.J., Ezzamel, M. and Qu, S.Q., 2017. Popularizing a management accounting idea: The
case of the balanced scorecard. Contemporary Accounting Research, 34(2), pp.991-1025.
Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2014. Lean manufacturing and firm
performance: The incremental contribution of lean management accounting practices. Journal of
Operations Management, 32(7-8), pp.414-428.
Kokubu, K. and Kitada, H., 2015. Material flow cost accounting and existing management
perspectives. Journal of Cleaner Production, 108, pp.1279-1288.
Langfield-Smith, K., Smith, D., Andon, P., Hilton, R. and Thorne, H., 2017. Management
accounting: Information for creating and managing value. McGraw-Hill Education Australia.
Lavia López, O. and Hiebl, M.R., 2014. Management accounting in small and medium-sized
enterprises: current knowledge and avenues for further research. Journal of Management
Accounting Research, 27(1), pp.81-119.
Malmi, T., 2016. Managerialist studies in management accounting: 1990–2014. Management
Accounting Research, 31, pp.31-44.
Nielsen, L.B., Mitchell, F. and Nørreklit, H., 2015, March. Management accounting and decision
making: Two case studies of outsourcing. In Accounting Forum (Vol. 39, No. 1, pp. 64-82).
Elsevier.
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Otley, D., 2016. The contingency theory of management accounting and control: 1980–
2014. Management accounting research, 31, pp.45-62.
Quattrone, P., 2016. Management accounting goes digital: Will the move make it
wiser?. Management Accounting Research, 31, pp.118-122.
Senftlechner, D. and Hiebl, M.R., 2015. Management accounting and management control in
family businesses: Past accomplishments and future opportunities. Journal of Accounting &
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Van Der Stede, W.A., 2015. Management accounting: Where from, where now, where
to?. Journal of Management Accounting Research, 27(1), pp.171-176.
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