Management Accounting Report: Importance and Classifications

This report delves into the core principles of management accounting, emphasizing its significance in organizational success. It begins by defining management accounting and differentiating it from financial accounting, highlighting its role in decision-making, planning, and control. The report then classifies various costs based on their nature, behavior, and function, providing examples for each category. A crucial section examines the impact of fixed and variable costs on the break-even point, illustrating how these costs influence profitability analysis. Furthermore, the report underscores the importance of operational budgets in guiding business activities and resource allocation. The content covers essential topics such as cost classification, break-even analysis, and budgeting, offering a comprehensive overview of key concepts in management accounting and their practical applications.

MANAGEMENT
ACCOUNTING
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Table of Contents
MANAGEMENT ACCOUNTING............................................................................................1
INTRODUCTION......................................................................................................................1
TASK 1......................................................................................................................................1
1.1 Importance of management accounting...........................................................................1
TASK 2......................................................................................................................................2
2.1 Classification of various costs..........................................................................................2
TASK 3......................................................................................................................................4
3.1 Importance of fixed and variable cost while calculating break even point.....................4
TASK 4......................................................................................................................................6
4.1 Importance of operational budget for success of the business.........................................6
Conclusions ...............................................................................................................................8
References..................................................................................................................................9
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INTRODUCTION
Management accounting is the process of identifying, analysing, measuring and
interpreting the organisational information in order to achieve desired goals. In other words,
it can be said that management accounting is a combination of all accounting, finance and
management techniques needed to achieve the set goals. It is also known as “cost
accounting”. It assists manager in taking necessary decisions regarding organisational
performance. The present report depicts about the importance of management accounting and
how management accounting differs from the financial accounting. In this report, importance
of fixed and variable costs is also discussed. It also shows how both fixed and variable cost
affect the break even point of a business. Further, various costs are also classified in this
report. At last, importance of operational budget is also discussed.
TASK 1
1.1 Importance of management accounting
Management accounting helps organization not only in achieving the set goals but
also in controlling the various business activities. Therefore, importance of management
accounting is as follows:-
Assists business control: - Management accounting provides enough information to
the organisation in order to detect positive and negative trend which are followed in various
activities. Some activities are related to estimate sales volume, cost, operating margin and
profit (Scapens, 2006). More importantly this information is available with the company
throughout the financial year.
Detect area of fraud:- Continuous review of all financial activities of business
increases the possibility of detecting the chances of any fraud or malpractices available
within organisation. Alternatively, if regular review of financial activities is not done for a
longer period of time than it creates confusion.
Help in planning taxes: - Management accounting provides up-to-date information to
every business. Up-to-date information assists the owners/directors to plan its transactions
with great confidence (Chapman, 2005). Future planning of various transactions aids the
company to legitimately reduce the tax liability. It also assists the company to maximise its
potential benefits by making payment of dividends opposed to the salary.
Reduce company's accounting cost:- Company will be able to resolve and identify
the various faults and queries through using the application of management accounting
principles. Identification of queries and faults in advance helps to reduce the chances of
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errors in company’s auditing and accounting costs. If advance accounting is not done than
document content will take longer time to prepare and company's cost will also be increased.
Difference between management and financial accounting are as follows:
S.n
o
Basis Management accounting Financial accounting
1 Meaning It is a combination of all
accounting, management and
financial techniques.
Financial accounting is a
process of collecting and
summarizing the financial
information in order to prepare
financial statements.
2 Users It is prepared for the company use
only.
It is prepared for both the
company and outsiders.
3 Objective To aid the management in
planning and decision making
process.
To provide financial
information to outsiders.
4 Format Not specified Specified
5 Time prepared This is prepared according to the
company's requirement.
This is prepared at the end of
every financial year.
6 Type of report Complete and detailed report. Summarized report.
7 Compulsory Conducting management
accounting is not necessary.
Conducting financial
accounting is necessary.
TASK 2
2.1 Classification of various costs.
Costs can be classified in different ways depending upon its nature, behaviour and
purpose. These costs are classified into various groups. Different types of available costs are
as follows:
Cost according to type
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 Material cost: Material cost represents the cost of raw materials used in the process of
production. This cost can be identified directly with the manufacturing of the product.
For example- cost of printing a newspaper or magazine.
 Labour cost: Labour cost is the cost that spends on the labour at the time of
manufacturing of the product (Garrison, 2010). It is a type of direct cost which
company bears. For example- cost of time spend by an engineer at oil rig.
Cost according to behaviour Fixed cost: Fixed cost is the cost that remains constant within the certain level of
sales. It mainly relates to time and period consumed (Abdel-Kader and Luther, 2008).
In case of fixed cost, cost per unit changes according to the production. For example-
depreciation of fixed assets. Variable cost:- Variable cost is the cost that constantly changes with the different
level of activity (Ward, 2012). This cost increases or decreases according to the level
of production. For example- direct materials, direct labour.
 Semi variable cost: - In case of semi-variable cost, some specific portion of the cost
remains fixed while other changes according to the level of activities. For example- if
the minimum telephone bill is Rs350 per month for 150 minutes and excess
consumption will be charged @1.2 per minute. In this case Rs. 350 is fixed cost
whereas remaining cost left out is variable cost.
Cost according to function Production cost:-In production cost, all the costs related to the production are
recorded. Both direct and indirect cost of product are included. Production cost is also
known as manufacturing cost. For example- Direct manufacturing cost includes the
expenditure of direct raw material anddirect labour. Similarly, indirect cost includes
the salaries of supervisors, quality control cost and so on. Selling cost:- Selling cost includes all types of expenses/cost incurred during the sales
of products and services (Cost And Management Accounting, 2012). It includes all
indirect expenses related to sales. It is also known as selling overheads. For example-
Salary of staff, commission, royalty etc. Administrative cost:- It includes all kind of indirect costs that is incurred by the
general management of the business. It is also known as administrative overheads. For
example- office rent, taxes, audit charges, charges applied by bank and so on.
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 Distribution cost:- It includes all kind of expenses which incurred by the company
during its distribution process. It includes costs of product right from its
manufacturing point till it reaches to its customers. For example- warehouse cost,
transportation costs and many more.
Cost according to relevance Relevant cost: - Relevant cost includes the costs which are changed by the managerial
decisions. These type of costs can be avoided by the finance department of company.
This cost is applicable to particular decisions (Mongiello, 2015). Concept of this cost
is to eliminate the unnecessary expenses and data that can complicate the managerial
decision making power. This is also known as future cost which differs among
alternatives. There are various types of relevant cost. Some of them are: future cash
flow, opportunity cost, incremental cost, avoidable cost and so on. For example-
competitive pricing decision cost of manufacturing and selling a rubber etc.
 Irrelevant cost:-Irrelevant cost consists the costs which do not change as a result of
managerial decision. In other words, it can be said that this cost is not affected by the
managerial decisions of organization. This cost has both negative and positive impact
on the managerial decision. This cost can’t be cut in order to reduce expenses.
Sometimes this cost can be covered into relevant cost depending upon the situation.
There are various types of irrelevant costs (Zimmerman and Yahya-Zadeh, 2011).
Some of them are: Sunk costs, non-cash expenses, general overheads, committed
costs and many more. For example- Suppose, company purchase a software program
but it does not work and it cannot be returned. Then, this cost becomes irrelevant cost
(i.e. Sunk cost).
TASK 3
3.1 Importance of fixed and variable cost while calculating break even point
Cost of doing any business in several situations includes both fixed and variable cost.
For conducting activities like budgeting, production planning and profit forecasting in an
effcetive manner, it is crucial for organization to understand relationship between the fixed
and variable cost. Therefore, break even point is the central point for understanding the
relationship between the fixed and variable cost.
Fixed cost:- Fixed cost consist the costs that constantly remain the same regardless of
sales and distribution volume. It is one of the important costs that assists company to know
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the point at which company will face the condition of no profit no loss i.e. break even point.
For example- rent and salaries that do not change with business sales volume. In simple
words, it can be said that fixed cost remains constant, regardless of business volume.
Variable cost: - Variable cost includes the costs that can be modified according to the
change in proportion of business volume. This is required by the company in order to
calculate the break even point (Bromwich and Bhimani, 2005). For calculation of break even
point, company needs to know about the both variable and fixed cost. For example- direct
hourly wages, direct labour.
Break even point:- Break even is the point at which fixed and variable cost of the
business becomes equal to its total revenue. Break even point is also known as zero profit
point. It is a point where company faces no profit and no loss condition. It is a point at which
company’s total cost is equal to its revenue and its contribution margin is equal to its fixed
cost (Malmi and Granlund, 2009). Calculation of break even point is very necessary for every
organisation. Calculation of this point assists managers and owners of the company to know
how much sales need to be generated in order to cover both fixed and variable expenses. This
in turn helps company to generate profit. In simple words, it can be said that break even is the
unit volume that differentiates the total cost of company to that of total gain in order to
calculate net cash flow. It is calculated by observing three variables (i.e. fixed costs, variable
costs and revenue per unit).
Formula for calculation of breakeven point is:
Break even point in sales unit
PX =VX+FC
Where P= price per unit
X= number of units
V= variable cost per unit
FC= total fixed cost
or, X=FC/ P-V
Break even point in sales dollars
BEP sales dollars = P* break even sales units
Example
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Price per unit = $20
Variable cost per unit = $10
Total fixed cost = $10000
Solution
Given, P=$20
V=$10
FC=$10000
Substituting the value into formula we get:
Breakeven point in sales units(X)
=10,000 / (20-10)
=10,000 / 10
=1,000 units
Breakeven point in sales dollars
= $20 * 1000 = $20,000
It is seen that fixed cost and variable cost are important factors in estimating the break
even point. Clear identification of variable and fixed cost helps in calculating the break even
point in an efficient manner. Moreover, business unit is able to make effective pricing
decisions through clear distinction between the fixed and variable cost. Therefore, it can be
said that fixed and variable cost are the important factors in supporting business decisions for
a long run.
TASK 4
4.1 Importance of operational budget for success of the business
Business unit needs to prepare budget on the continuous basis. Operational budget
provides guidance to organization in order to conduct its operations. It is through the
preparation of budget that organization is able to allocate resources in an appropriate
manner. Operational budget indicates a planned framework to make expenditure within
business unit. Now days, preparation of budget is considered to be necessary for the
businesses. Organization is responsible to allocate resources in an efficient manner for the
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different set of activities. Moreover, it is through appropriate allocation of resources that
business unit is able to achieve its objectives. Therefore, it can be said that preparation of
budget is highly important in nature for success of the organization. The manner in which
operational budget plays an important role in success of the business unit is discussed
underneath.
Consider all relevant and monetary facts: Budget is prepared through consideration
of all monetary and relevant facts. Henceforth, it can be said that budget provides all relevant
information to management (Rikhardsson, Bennett and Bouma, 2005). Therefore, budgeting
technique is considered to support operational growth of the organization. By considering all
the relevant facts and figures, budgeting technique helps in the formulation of effective
growth strategies for the organization.
Efficient allocation of resources: Organization is able to efficiently allocate resources
to different departments and activities through preparation of budget. With the help of
allocating resources in an appropriate manner, business unit is able to achieve success in a
long run. Budget is prepared to identify the resource's requirement for the different
department and activities. Proper identification of resource requirement assits business unit
to allocate resources in an efficient manner. This in turn results in the optimum utilization of
resources within the organization. The best possible utilization of resources supports long
term growth for the business into consideration. Therefore, operation budget is considered as
a key factor for the success of organization.
Controlling expenditure: It is essential for organization to make expenditure within
specified limit. Cost controlling is considered as an important aspect for generating profit.
Operational budget provides guidance for making expenditure within the organization.
Though preparation of budget, organization is able to limit its expenditure on various
activities. Preparation of budget helps in controlling expenditure for the organization
(Schaltegger and et.al, 2008). This in turn results in increasing profitability for the
organisation. It can be therefore claimed that business unit is able to control its expenditure
through preparation of budget on the regular basis.
Financial road map: Operational budgets are considered as the financial road map of
the business unit. With the help of preparing the operational budget, organization is able to
make appropriate future planning of financial resources (Kaplan and Atkinson, 2015).
Creation of operational budget helps in the development of concrete financial map for
success of the business unit. Budget is prepared on basis of past performance of the
business unit. Moreover, it provides a road map for utilization of financial resources in future.
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It can be said that preparation of operational budget improves business performance by the
creation of financial road map. Planned utilization of financial resources is expected to
support long term growth of the organization into consideration.
Future growth: Creation of operational budget supports long term growth for the
organization into consideration. By preparing operational budget, organization is able to
make optimum utilization of financial resources. Moreover, budgeting helps in adequate
financial planning. This in turn supports the growth and development of organization (Lukka,
2007). Along with this, business unit is able to manage its financial resources in an efficient
manner through preparation of budget. Efficient management of financial resources is
proved as one of the success factors for the organization.
As discussed above, it can be said that operational budget plays an important role in
organization’s growth and development. With the help of budget, organization is able to
manage financial resources in a planned manner. This in turn results in increasing the
efficiency of performance within operations. Therefore, it can be said that operational
budget is highly important for gaining success in the organization.
CONCLUSIONS
This report emphasizes on the various importance of management accounting. This
shows how management accounting differs from the financial accounting. In this report, it
has been seen that how different costs of the company affect its managerial decisions .
Moreover, it is also seen that how important is to calculate break even point for the company
in order to generate profit. It also shows how fixed and variable costs of the company affect
the company’s break even point. At last, importance of various types of operational budget
are also discussed and summarized.
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REFERENCES
Books and journals
Abdel-Kader, M. and Luther, R., 2008. The impact of firm characteristics on management
accounting practices: A UK-based empirical analysis. The British Accounting Review.
40(1). pp.2-27.
Bromwich, M. and Bhimani, A., 2005. Management accounting: pathways to progress. Cima
publishing.
Chapman, C. S., 2005. Controlling Strategy: Management, Accounting, and Performance
Measurement: Management, Accounting, and Performance Measurement. Oxford
University Press.
Garrison, R. H., 2010. Managerial accounting. Issues in Accounting Education. 25(4).
pp.792-793.
Kaplan, R. S. and Atkinson, A. A., 2015. Advanced management accounting. PHI Learning.
Lukka, K., 2007. Management accounting change and stability: loosely coupled rules and
routines in action. Management Accounting Research. 18(1). pp.76-101.
Malmi, T. and Granlund, M., 2009. In search of management accounting theory. European
Accounting Review. 18(3). pp.597-620.
Rikhardsson, P.M., Bennett, M. and Bouma, J. J., 2005. Implementing environmental
management accounting: Status and challenges. Springer Science & Business Media.
Scapens, R. W., 2006. Understanding management accounting practices: A personal journey.
The British Accounting Review. 38(1). pp.1-30.
Schaltegger, S. and et. al., 2008. Environmental management accounting (EMA) as a support
for cleaner production. Springer Netherlands.
Ward, K., 2012. Strategic management accounting. Routledge.
Zimmerman, J. L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control.
Issues in Accounting Education. 26(1). pp.258-259.
Online
Cost and Management Accounting, 2012 [pdf]. Available
through:<http://icmai.in/upload/Students/Syllabus-2008/StudyMaterial/
Cost_Mgmt_Ac.pdf> [Assessed on 14th November 2015].
Mongiello, M., 2015. Management Accounting. [pdf]. Available
through:<http://www.londoninternational.ac.uk/sites/default/files/
programme_resources/lse/lse_pdf/subject_guides/ac3097_ch1-3.pdf> [Assessed on 14th
November 2015].
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