You never can tell - you may be given theory in an exam, so I posted this below for your edification.
QUESTION:
What is
Margin of Safety (MOS)?
ANSWER:
Margin of safety is used
in break-even analysis to indicate the amount of sales that are above the
break-even point. In other words, the margin of safety
indicates the amount by which a company's sales could decrease before the
company will become unprofitable.
QUESTION:
What is
Break –Even Point?
SOLUTION:
The break-even
point (BEP) in economics, business, and specifically cost accounting, is
the point at which total cost and total revenue are equal: there is no
net loss or gain, and one has "broken even."
QUESTION:
What is the DIFFERENCES between Financial and Management Account?
SOLUTION:
Management
accounting is presented internally, whereas financial accounting is meant for
external stakeholders. Although financial management is of great importance to
current and potential investors, management accounting is necessary for
managers to make current and future financial decisions. Financial accounting
is precise and must adhere to Generally Accepted Accounting Principles (GAAP),
but management accounting is often more of a guess or estimate, since most
managers do not have time for exact numbers when a decision needs to be made.
MANAGEMENT
ACCOUNTING (Theory)
NATURE
AND PURPOSE OF MANAGEMENT ACCOUNT
Management
Accounting is the application of professional knowledge and skill in the
preparation and presentation of accounting information in such a way as to
assist management in the formulation of policies in planning and control of the
undertaking.
Management
accounting is concerned with identifying, presenting and interpreting
information used for planning and control of an enterprise operation.
Management
accounting involves data gathering, analyzing, processing, interpreting and communicating
the reporting information for effective planning decision marking and
operations.
Management
accounting uses data from the financial and cost accounting systems and
Statistics. Management accounting also
uses statistics and operations research for analysis.
Management
accounting produces information: which is relevant for the intended
purpose. Management accounting is
concerned with helping management to run a business efficiently.
Purpose of
Management Accounting
The
main Purpose of management accounting is the provision of information used for:
a. Formulating
strategy
b. Planning and
controlling activities
c. Decision
making
d. Optimization
use of resources
e. Disclosure to
shareholders and employees
f. Safeguarding
the assets
Management
accounting compared with financial accounting and cost account. Financial accounting is concerned with
stewardship function. The emphasis is on
financial record-keeping and preparation of financial accounts whereas
management accounting provides information that is useful to the manager of an
organization in taking decisions within the scope of their managerial
responsibility. Therefore, the main
difference between management accounting and financial accounting lies in their
purpose; financial accounting is for stewardship purpose while management
accounting is essentially for internal purpose.
Management accounting and cost accounting are closely related.
There
is no realistic guideline between cost accounting, management accounting with
regard to the provisions of information for planning and control. Cost accounting is concerned with the
provision of information about costs while management accounting uses this
information to plan, control or provide problem-solving analyzes. Therefore cost accounting is the essential
foundation for the development of management accounting system.
In
general, management accounting is wider in scope and uses more advanced
techniques than cost accounting. A
fundamental requirement for management accounting is the existence of a sound
costing system to provide basic data.
Management
accounting is activity base and is concerned mainly with the present, the
future and sometimes the past. Cost and
management accounting provide an internal information system to assist the
planning and control decisions by managers.
Financial,
cost and management accounting from past of the financial information system of
an organization and in many enterprises, the various facets are totally
integrated with no artificial divisions between them.
MANAGEMENT ACCOUNTING AS A TOOL OF
MANAGEMENT
Managers
must be properly informed in order to carry out their responsibility for
planning and controlling the resources of a business. Thus management accounting as a tool of
management is management information system which analyzes past, present and
future data to fit the variety of different problems confronting managers.
Management
accounting ensures that there is effective:
a. Formulation of
plans to meet objectives
b. Formulation of
short term operational plans
c. Acquisition
and the finance
d. Communication
of financial and operating information
e. Corrective
action to bring plans and results into line
f. Reviewing and
reporting on systems and operations.
Evolution of
Management Accounting
Management
accounting evolved out of industrial revolution and the challenges of modern
business to meet the dynamic nature of environmental and industrial
conditions. Management accounting starts
from where cost accounting stopped.
DIFFERENCES BETWEEN MANAGEMENT
ACCOUNTING AND FINANCIAL ACCOUNTING
a. Financial
Accounting is regulated by law while management accounting is not e.g. CAMA
1990
b. Financial
Accounting is for external and internal use while management Accounting is for
management internal use.
c. Management
Accounting is future oriented while financial accounting is past oriented
d. Management
accounting reports are generated when the need arises while financial
accounting reports is prepared periodically e.g. yearly.
e. Financial accounting
report follow a prescribed format while that of management accounting do not
SHORT TERM
ACCOUNTING DECISION
Introduction:
Decision
making is the process of choosing among alternative courses of action. Decisions are usually taken through all
process of managerial functions.
Decision
making is an all round activity taken place at every level in the organization.
The
decision process consists of:
i.
Definition
of objective
ii.
Consideration
of alternatives
iii.
Evaluation
of alternatives in the light of the objectives
iv.
Selection
of the course of action. Decision making
is based on both quantitative and qualitative factors. Management accounting supplies information
for decision making purposes both for long and short terms.
Short term accounting decision
criteria are usually based on marginal costing, cost-volume-profit analysis,
differential cost and opportunity costs.
Information
for Decision – Making
Management
makes decision about the future. When
they make decision for economic or financial reasons, the objective is usually
to increase profitability or value of the business, or to reduce cost and
improve productivity.
When
managers make a decision, they make a choice between different possible courses
of action (option), and they need relevant and reliable information about the
probable financial consequences of different options available. A function of management accounting is to
provide information to help managers to make decision, by providing estimates
of the consequences of selecting any option.
Traditionally,
cost and management accounting information was derived from historical cost (a
measurement). For example, historical
costs are used to assess the profitability of products, and control reporting
typically involves a comparison of actual historical costs with a budget or
standard cost and revenues.
-
Decisions
affect the future, but cannot change what has already happened
-
Decision-making
should therefore look at the future consequences of a decision, and should not
be influenced by historical even and historical costs.
-
Decisions
should consider what can be changed in the future. They should not be influenced by what will happen
in the future that is unavoidable, possibly due to the commitments that have
been made in the past.
-
Economic or financial decisions should be
based on future cash flows, not future accounting measurements of cost or
profit. Accounting conventions, such as
the accruals concepts of accounting and their depreciation of non-current
assets, do not reflect economic reality. Cash flow, on the other hand, do reflect the
economic reality of decisions. Managers
should therefore consider the effect that their decisions will have on future
cash flows, not reported accounting profits.
Marginal
Costing and Decision –making
Marginal
costing might be used for decision-making.
For example, marginal costing is used for limiting factor analysis and
linear programming.
It
is appropriate to use marginal costing for decision-making when it can be
assumed that future fixed costs will be the same, no matter what decision is
taken, and that all variable costs represent future cash flows that will be
incurred as a consequence of any decision that is taken.
These
assumptions about fixed variable costs are not always valid. When they are not valid, relevant costs
should be used to evaluate the economic/financial consequences of a decision.
RELEVANT COSTS
AND DECISION-MAKING
Relevant
costs should be used for assessing the economic or financial consequences of a
decision.
The
key concepts in this definition of relevant costs are as follows:
Relevant
costs are cost that will occur in the future.
They cannot include any cost that has already occurred in the past.
Relevant
costs of a decision are costs that will occur as a direct consequence of making
the decision. Costs that will occur anyway, no matter what decision is taken,
cannot be relevant to the decision
Relevant
costs are cash flows. Notional costs,
such as depreciation charges, notional interest costs and absorbed fixed costs,
cannot be relevant to a decision.
Terms used in
relevant costing
Several
terms are used in relevant costing, to indicate how certain costs might be
relevant or not relevant to a decision.
Incremental
Cost
An
incremental cost is an additional cost that will occur if a particular decision
is taken. Provided that this additional
cost is a cash flow, an incremental cost is a relevant cost.
Differential
Cost
A
differential cost is the amount by which future costs will be different,
depending on which course of action is taken.
A differential cost is therefore an amount by which future costs will be
higher or lower, if a particular course of action is chose. Provided that this additional cost is a cash
flow, a differential cost is a relevant cost.
Avoidable and
unavoidable costs
An
avoidable cost is a cost that could be saved (avoided), depending whether or
not a particular decision is taken. An unavoidable cost is a cost that will be
incurred anyway.
-
Avoidable
costs are relevant costs
-
Unavoidable
costs are not relevant to a decision.
Committed Cost
Committed
costs are a category of unavoidable costs.
A committed cost is a cost that a company has already committed to or an
obligation already made, that it cannot avoid by any means. Committed costs are not relevant costs for
decision making.
Sunk Cost
Sunk
costs are costs that have already been incurred (historical costs) or costs
that have already been committed by an earlier decision. Sunk costs must be
ignored for the purpose of evaluating a decision, and cannot be relevant costs.
Opportunity
Costs
Relevant
costs can also be measured as an opportunity cost. An opportunity cost is a benefit that will be
lost by taking one course of action instead of the next-most profitable course
of action.
IDENTIFYING
RELEVANT COSTS
There
are certain rules or guidelines that might help to identify the relevant costs
for evaluating any management decision.
Relevant Cost
of Materials
The
relevant costs of a decision to do some work or make a product will usually
include costs of materials. Relevant
costs of materials are the additional cash flows that will be incurred (or
benefits that will be lost) by using the materials for the purpose that is
under consideration. If none of the
required materials are currently held as inventory, the relevant cost is the
cash that will have to be paid to acquire and use the materials.
Note
that the historical cost of materials
held in inventory cannot be the relevant cost of the materials, because their
historical cost is a sunk cost. The
relevant costs of materials can be described as their “deprival value”. The deprival value of materials is the
benefit or value that would be lost if the company were deprived of the
materials currently held in inventory.
-
If
the materials are regularly used, their deprival value is the cost of having to
buy more units of the material to replace them (their replacement cost)
-
If
the materials are not in regular use, their deprival value is either the net
benefit that would be lost because they cannot be disposed of (their net
disposal or scrap value) or the benefits obtainable from any alternative
use.
In
an examination question, materials in inventory might not be in regular use,
but could be used as a substitute material in some other work. Their deprival value might therefore be the
purchase cost of another material that could be avoided by using the materials
held in inventory as a substitute.
Relevant Cost
of Labour
The
relevant costs of a decision to do some work or make a product will usually
include costs of labour. The relevant
cost of labour for any decision is the additional cash expenditure (or saving)
that will arise as a direct consequence of the decision.
If
the cost of labour is a variable cost, and labour is not in restricted supply,
the relevant cost of the labour is its variable cost.
If
labour is a fixed cost and there is spare labour time available, the relevant
cost of using labour is zero. The spare
time would otherwise be paid for idle time, and there is no additional cash
cost of using the labour to do extra work.
Relevant Cost
of Overheads
Relevant
costs of expenditure that might be classed as overhead costs should be
identified by applying the normal rules of relevant costing. Relevant costs are
future cash flows that will arise as a direct consequence of making a
particular decision.
Fixed
Overhead Absorption Rates are therefore irrelevant, because fixed overhead
absorption is not overhead expenditure and does not represent cash spending. However, it might be assumed that the
overhead absorption rate for variable overheads is a measure of actual cash
spending on variable overheads. It is therefore often appropriate to treat a
variable overhead hourly rate as a relevant cost, because it is an estimate of
cash spending per hours for each additional hour worked.
The
only overhead fixed costs that are relevant costs for a decision are extra cash
spending that will be incurred, or cash spending that will be saved, as a direct consequence of making
the decision.
Question:
Explain the general rule for
decisions to keep or drop a product, service or segment of a business:
Answer:
The general rule to keep or drop
a product, service or segment of a business is that of contribution. To keep a product or segment of a business,
the product or segment must be showing or have a positive contribution but if
otherwise is the case, i.e. negative contribution, such a product, service or
segment will be dropped.
Question:
Define
Management Accounting
Answer:
Management accounting is the process of measuring
and reporting information about economic activity within organizations, for use
by managers in planning, performance evaluation, and operational control:
TYPES
OF BUDGET
The types of budgets
found in a typical manufacturing business are:
a. Sales
Budget
b. Selling
and distribution costs budget
c. Administration
cost budget
d. Debtors
budget
e. Finished
Goods stock budget
f. Production
budget
g. Material
usage budget
h. Machine
utilization budget
i. Material
purchases budget
j. Direct
Labour budget
k. Creditors
budget
l. Production
overhead budget
m. Cash
budget
n. Capital
expenditure budget
o. Research
and development budget
p. Master
budget i.e. budgeted statement of profit and loss and statement of financial
position sheet. Note that all the budgets from A to P above are known as
functional budgets. Thus functional
budgets are segmented on; functional activities of the organization. The master budget is prepared from summaries
of the functional budgets.
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