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# PACC6001 Management Accounting

Published : 04-Oct,2021  |  Views : 10

## Question:

ABC Co. Ltd. specialises in manufacturing electronic products. The range comprises of 2 products, Personal Computers (‘PC’) and Video Players (‘VP’). The company’s products have the data shown below.

Products                              PC VP

Maximum  monthly demand         Unit                10,000         20,000

Direct labour hours per unit      hr                  2             4

Selling Price                      \$             1,200        1,600

Unit variable costs

Direct Material                 \$                600          800

Direct Labour                   \$                 200          400

Other variable O/H          \$                200          200

The company has adopted the OAR in term of direct labour hour. The total estimated fixed cost and direct hours during the year is \$2.4m and 30,000 hours respectively.The company is planned to manufacture a new product, I-Phone (‘IP’) with estimated contribution of \$600 per unit.

The manager wants to prepare the budgets for the coming January to March, assuming that the company will manufacture only IP to fulfill a confirmed special order for 3,000, 3,000 and 4,000 units for Jan, Feb and March respectively at \$200 each. The only variable cost is direct raw material. To produce one unit of IP, the standard usage of raw material is 2 units at standard price of \$70 per unit of IP.  The actual sale and material purchase for last December is 2,500 units and 50,000 units respectively.

You need to advise the manager the following issues:

• Explain the meaning of management accounting, the different types of management accounting and role of management accountants (1.1, 1.2)
• Explain the classification of costs that would help the managementdecision-making (2.1)
• Calculate the unit costs of PC and VP based on absorption costing and marginal costing methods (2.2)
• There is a special order for 10,000 units of PC at \$1050 per unit:

-   which costing method should be used for the accept or reject decision (2.2);

-   calculate the costs using the costing method recommended above (2.2);

• given that direct labour available is limited to 60,000 hours per month, advise the optimum production mix of PC and VP to maximise profit (2.3)
• calculate the break-even units of IP and if the manager is confident that a target profit of \$1,200,000 is achievable, what would be the corresponding target units sold (2.1, 2.3)
• evaluate the proposal to spend an additional \$600,000 to promote the IP so that selling price can be increased by \$60 per unit to sell 6,300 units per month and discuss the corresponding pricing decisions (2.3)

Prepare a proposal to advise the manager who has no management accountingknowledge and background.

Analyse and evaluating ABC’s financial performances by using the various management accounting technique, and make the possible recommendations in dealing with the financial problems and the price strategies in revising its price.

1. Management accounting may be defined as a part of accounting which deals with identifying, analysing, classification, interpretation and communication of the relevant financial information to the managers within the organisation to help in decision making and help the organization to achieve its goals. This is different from financial accouting which focuses mainly on preparation of the annual financial reports for the external stakeholders and is prepared less often. Management accounting is done on weekly or fortnightly basis to keep the managers informed about the raw material, the stock, the collection from debtors, the overdues to creditors, the sales report, inventory, etc. by the use of variance analysis, the trend analysis, graphs and dashboards (Gai, K., Qiu, M. and Hassan, H., 2017).

There are different types of management accounting reports that can be presented like the budget both fixed and flexible buget, accounts receivable ageing, inventory ageing report, job cost report which helps to analyse the cost being incurred per unit and thus bringo=ing about efficiency, activity based costing, throughput accounting, transfer pricing , capital budgeting, constraint analysis based on the availability of the resources and product costing showing valuation of the product.

The role of the management accountants is make awre the management of the needs and the risks they foresee in the financials and the business of the company. They are responsible for driving the overall management and strategy of the company (Gomez, J., Insua, D.R. and Alfaro, C., 2016). They manage the assets, taxes and budgets of the company.

There are various types and classification of the cost based on which management decision making is done:

Based on variability in relation to output, costs can be fixed cost, variable cost and semi-variable costs. Fixed costs do not have any impact on decision making but variable costs needs to be managed well as per the requirement of company so as to earn adequate profits.

Based on the type of expense, it can be material, labour and overhead costs. All need to be properly apportioned such that it does not exceeds the sales price.

On the basis of control, it can controllable and uncontrollable costs. Managers take their decision using and minimising the controllable costs and economising it (Yi, X., Liu, F., Li, Z. and Jin, H., 2016).

On the basis of P&L, costs can be classified into direct and indirect costs whre direct costs are mainly attributable to the product manufactured whereas indirect costs are generally administration, general, selling and distribution costs. All this helps in analysing the gross profit and the net profit margin for the company.

The other types of costs in which managers make decision are sunk cost, opportunity costs, replacemnent cost, imputed cost, real cost, social cost, conversion costs, differential and incremental costs. All this helps to analyse whether the decision taken is right or wrong.The units cost of both the products using marginal and absorption costing.

To complete the special order of 10000 units of IP at USD 1050 per unit, the company should use the marginal costing method as the fixed costs would remain constant and would not affect the decision whether or not to produce (Cooper, D.J., Ezzamel, M. and Qu, S.Q., 2017). Moreover, here there i s only direct material cost which is required to make it and the estimated contribution is given to be \$600 per unit. If the contribution on the special order is more than that or equal to \$600, the same can be accepted or else it should be rejected.

Costs using the cost method recommended above is: Since the contribution here is \$910 which is more than \$600, it should be accepted.

In the given question, one of the factors of production i.e., labour hours has been constrained to 60000 hours per month and we have to find the optimum mix of production of PC and VP based on this to maximise profit.Therefore, 10000 units of PC and 10000 units of VP should be produced to maximise the profit under the given condition.
If the manager thinks that the target profit of \$1200000 is achieveable, then the number of units that has to be sold is given below. Further more, the break even no. Of units is also mentioned below (Feger, C., Feger, C., Mermet, L. and Mermet, L., 2017) In the given proposal the company wants to spend additional \$600000 on IP so that the selling price can be increased by another \$ 60 which in turn will also help in selling 6300 units per month. The additional profit based on the above impact The company should go ahead with the proposal of investing \$ 600000 as it is resulting in the increamental profits of \$1068000 within 3 months.

On the basis of the above analysis, the manager should go ahead with his decision to allocate the production between PC and VP based on the contribution per constraint factor. Overall the profitability is positive. Further, in case the company wants to go ahead with the production of IP in place of the earlier products, it can do so as this again is profitable and further if the investment of \$600000 is made, it will be even more profitable for the company implying higher growth. Therefore, based on the above proposal criteria and expected outcomes, the manager can go ahead with these products (Soderstrom, K.M., Soderstrom, N.S. and Stewart, C.R., 2017). The roles and responsibilities as a manager and the types of costs he needs to take into consideration have also been discussed in brief.

The financial performance of ABC company can be analysed using the various management accounting techniques like in case the full capacity of the company is utilised and sold, then the total variable costs will be \$38 Mn whereas the fixed cost is only to the tune of \$ 2.4 Mn. This shows that the company might not have right mix of the fixed and variable costs and this is putting too much pressure on the fixed component like depreciation, rent, etc (Bennett, M. and James, P. eds., 2017). In case the company wants to increase efficiency, it needs to increase investment in the fixed costs like plant and machinery and other fixed assets.

Furthermore, we say the concept of controllable and uncontrollable costs and therefore to increase the profits either the sale needs to be increased or costs needs to be cut down. Since the fixed costs are unavoidable and uncontrollable costs therefore the variable costs or controllable costs needs to be avoided by increasing the efficiency. We also saw that the labour hours constraint is there due to which the company cannot operate at the optimum capacity, the same can therefore be increased by increasing teh number of labours to increase the sales. Lastly, we see that last year only 2500 units were sold whereas material purchased by company was 50000 units which is enough to produce 25000 units. Hence, only 10% of the sale could be achieved. This over ordering of the material causes the storage costs and wastage to increase. The same can be avoided by using the just in time approach where the raw materials will be ordered only when the need arises. The company can also increase its profits by reducing the sales price marginally and increasing the number of units sold. This will increase both the topline and the bottomline of the company.

Budget is one of the most critical and significant statement showing company’s future operating and financial plan based on estimates and discussion. This is a comprehensive statement outlining all the estimates costs, sales, risks, opportunities, no.  Of units., etc (Elmendorf, D.W. and Sheiner, L.M., 2017). It gives a fair view to the management on the scarcity of the resources if any so that the same can be utilised efficiently and effectively. It is generally prepared on a yearly basis. Besides this, the other major functions of the budgeting process are:

1. It helps the management to take various oprating and financial decisions.
2. It helps to foresee the risks in the business if any and outlines as to what should be the strategy and target for each one to be achieved.
3. It shows where from the funds will be arranged for doing the business and how the same will be utilised (Mattson, A.J. and Taylor, S.R., Spider Data Services, Llc, 2017).
4. It helps in financial planning and forecasting the economic and financial variables.
5. It helps to plan in dealing with the government regulations, market issues well in advance.
6. It acts as target and later on individual performance can be tracked through it.

Further, the advantages of operating a budgetary control system are it helps in control and coordination amongst the various teams operating within an organization, definite planning, enhanced efficiency, proper communication of the goals and objectives, delegation of authority so that the responsibility can be fixed, budgets acting at motivation, maximisation of profits, forecasting the credit needs, etc.

Whereas, it has got some disadvantages too like risk of inefficient and inaccurate estimates, risk of rigidity of data, the human factor which is very important, lots of effort, time and expenditure is required. It may also hide inefficiencies and there may be issues of over budgeting or lack of cost benefit analysis.

Based on the data given in the question, the company should go ahead with preparing the flexible budget based on the following reasons:

1. The company is not sure whether to sell PC and VP, which are already there in the market or to introduce and complete a new order for the new product IP.
2. The company is still to take a decision on the quantity to be produced and what exactly is the amount of sales that can be achieved.
3. The company is to take  decision on whether to invest additional \$600000 in the company or not.

All these factors may make a significant change in the planned numbers and so that the company in order to avoid the rigidity should go ahead with the flexible budget instead of the fixed budget (Chohan, U.W., 2017).

The different monthly budgets based on the inputs given in question are shown below:

 ABC Co. Ltd. Jan Feb Mar Expected sales in units 3,000 3,000 4,000 Total Budgeted Sales \$         600,000 \$         600,000 \$         800,000 Schedule of Expected Cash Collections Current month sales 40% \$         240,000 \$         240,000 \$         320,000 Prior month's sales 60% 300,000 360,000 360,000 Total cash collections \$         540,000 \$         600,000 \$         680,000 Production Budget Budgeted sales in units 3,000 3,000 4,000 Total needs 3,000 3,000 4,000 Required production 3,000 3,000 4,000 Direct Material Purchases Budget Units to be produced 3,000 3,000 4,000 Raw Materials needed per unit 2 2 2 Production needs 6,000 6,000 8,000 Total needs 6,000 6,000 8,000 Raw materials to be purchased 6,000 6,000 8,000 Cash Payment Budget for Raw Material Purchases Units to be purchased 6,000 6,000 8,000 Per unit price 70 70 70 Payment to be made 350,000 420,000 420,000

 Collections from customers 540,000 600,000 680,000 1,820,000 Total cash available 560,000 510,000 770,000 1,840,000 Direct materials 350,000 420,000 420,000 1,190,000 Total disbursements 650,000 420,000 420,000 1,490,000
1. In case the actual purchase and use of raw material amounts to \$435600 in January, the raw material variance would be Budgeted – Actual  =  420000-435600 = \$ 15600 (Adverse)
2. Here, as  per the given question,

Raw Material Price Variance = ( Standard unit price – Actual per unit price ) × Actual Qty

Or, RMPV = (70-66)*6600 = \$ 26400 Favourable

Raw Material Usage Variance = Standard price per unit * (Standard qty for actual output- actual output)

Or, RMUV = 70*(6000-6600) = \$ 42000 (Adverse)

It has been identified that the company has purchased the material from the vendor other than that listed in the company’s approved vendor list. This has led to the increase in cost and due to which the variance can be seen. This is a serious non complainace and should be corrected immediately as this was donewithout notice to the manager (Kolesnik, N., 2017). The department has not correctly worked as per its roles and responsibilities which should have been to put up a quote to the approved vendors and then deciding from whom to order the raw material based on the minimum quote and best quality. The same should also fall within the approved vendor list of the company. Further, in case of any deviation of the set in process, the same should have been informed to the management and an exception approval should have been taken based on which the management could have revised the budget.

The corrective action can be taken going forward with the implementation of the standard operating process with respect to procurement of the raw material in line with the above stated guidelines. Further for the time being, in order to give a more realistic view to the management, the budget should be revised so that the true and fair view can be achieved and proper forecasting for the year can be done (Shevelev, A.E., Sheveleva, E.V. and Gvozdev, M.Y., 2017).

## Bibliography

Bennett, M. and James, P. eds., 2017. The Green bottom line: environmental accounting for management: current practice and future trends. Routledge.

Chohan, U.W., 2017. Legislative Budget Offices and Market Sentiment Impact: The Case of Trumpcare.

Cooper, D.J., Ezzamel, M. and Qu, S.Q., 2017. Popularizing a management accounting idea: The case of the balanced scorecard. Contemporary Accounting Research.

Elmendorf, D.W. and Sheiner, L.M., 2017. Federal Budget Policy with an Aging Population and Persistently Low Interest Rates. Journal of Economic Perspectives, 31(3), pp.175-194.

Feger, C., Feger, C., Mermet, L. and Mermet, L., 2017. A blueprint towards accounting for the management of ecosystems. Accounting, Auditing & Accountability Journal, 30(7), pp.1511-1536

Gai, K., Qiu, M. and Hassan, H., 2017. Secure cyber incident analytics framework using Monte Carlo simulations for financial cybersecurity insurance in cloud computing. Concurrency and Computation: Practice and Experience, 29(7).

Gomez, J., Insua, D.R. and Alfaro, C., 2016. A participatory budget model under uncertainty. European Journal of Operational Research, 249(1), pp.351-358

Kolesnik, N., 2017. Problems And Ways Of Activating The Budget Process In Ukraine.

Mattson, A.J. and Taylor, S.R., Spider Data Services, Llc, 2017. Budget information system with cross-reference feature and related methods. U.S. Patent 9,799,086.

Shevelev, A.E., Sheveleva, E.V. and Gvozdev, M.Y., 2017. Methods of internal control in integrated management accounting system of the enterprise. In SHS Web of Conferences (Vol. 35, p. 01115). EDP Sciences.

Soderstrom, K.M., Soderstrom, N.S. and Stewart, C.R., 2017. Sustainability/CSR research in management accounting: A review of the literature. In Advances in Management Accounting (pp. 59-85). Emerald Publishing Limited.

Yi, X., Liu, F., Li, Z. and Jin, H., 2016, June. Flexible instance: Meeting deadlines of delay tolerant jobs in the cloud with dynamic pricing. In Distributed Computing Systems (ICDCS), 2016 IEEE 36th International Conference on (pp. 415-424). IEEE.

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