Management accounting provides the managers of an organization with relevant and important information which helps them in decision making process. The study has evaluated different types of management accounting systems has provided an explanation of its usage and application to achieve sustainable success. Preparation of income statements using marginal costing and absorption costing has been done in the study. In this study the management accounting system adopted by Morrisons have been discussed. The problem statement of the study is to analyse the importance and application of management accounting techniques.
LO1: Management accounting systems
Brief description of organization
Morrisons is one of the leading companies of the food retail sector and has its headquarters in Bradford, UK. It is one the biggest and the fourth largest supermarket established and made a revenue of 1631.7 crores GBP in the financial year of 2017 (morrisons.com, 2018). The Morrison Company belongs to the retail industry and is headquartered at Bradford within province of England. It is taken as a public limited company. The company has in present around 498 stores spread globally (morrisons.com, 2018). The company has products differentiations in form of clothing, magazines, books, DVDs and CDs and food and beverages. The company is with favourable employee strength of 132,000 employees. Apart from that, there company has a revenue generation in around GBP 16317 million (morrisons.com, 2018). The company on other hand is having an operational income in GBP 468 millions.
Explanation of Management accounting and types of management accounting system (P1)
The origin of management accounting can be traced back to 300 years ago. It first emerged during the industrial revolution period. It was used in the European merchant trading ventures and it was looked at from two perspectives (businessperspectives.org, 2018). One was economic perspective and the other was non-economic perspective. From the economic viewpoint it was assumed that management accounting originated from the private sector. Whereas the non-economic approach suggests that it originated from the public sector. Management accounting is the system of identifying, measuring and analysing the financial as well as non financial information. It utilises different techniques like cost accounting, break even analysis, standard costing and many others to analyse expenses and revenues. As per the opinion of Kaplan & Atkinson (2015:23-29), it plays a significant role in the decision making process since managers are able to identify variances by comparing actual with expected costs. Moreover it also helps in setting budgets and choosing the most profitable orders.
Different types of management accounting system are discussed as follows;
Cost accounting deals with recording and managing costs. It refers to the system of recording costs and comparison of inputs and outputs from the production process. As suggested by Kihn & Ihantola (2015:230-255), it helps in comparing results against standards set with the application of standard costing and also helps in choosing between different projects. Marginal costing and activity based costing are one of its subtypes. In case of Morrisons, marginal costing and standard costing is used to control different types of cost. The efficiency of this system lies in the fact that cost allocation is done appropriately, moreover it also helps in indentifying the drivers and cost pools.
Difference between management accounting and financial accounting:
Financial accounting is made to show the appropriate and fair picture of financial affairs. On the other hand, management accounting is helpful to develop meaningful steps and strategies. Scope is much broader in management accounting than financial accounting. Measurement grid for management accounting is qualitative and quantitative both. Financial accounting is mainly for the potential investors and stake holders whereas; purpose of management accounting is limited to accounting.
It comes to use in the preparation of budgets. It helps in assessing the departmental needs and budgets and then prepares an overall budget for the organization. Expenses are allocated on the basis of units to be produced and also department or function wise. Preparation of budgets in Morrisons is done on quarterly basis so that cost control is done effectively. It’s essential requirement is that it helps in controlling costs related to an organisation and keeps helps in removing unnecessary expenses.
According to the definition given by Mittendorf (2015:121-122), it helps in setting prices for the goods or raw material transferred within an organisation. It also helps in comparing the costs of accepting orders from outside and producing it internally. Morrison practices this method in order to determine minimum transfer prices. The essential requirement of this system is that it helps in choosing between selling goods outside and transferring between different departments within a company.
Inventory management system
It is the system which is useful in managing large amount of inventory in an entity. The efficiency of this system is defined by the way it helps in evaluating the amount of inventory required to meet the production or sales process. It also creates a balance between demands and supplies. Morrisons uses this type of management accounting in order to manage its large and varied range of inventories (morrisons.com, 2018). LIFO method assumes that last stock which has entered is sold out first. Whereas, FIFO method assumes that first stock which has entered is sold out first. AVCO on the other hand, measures cost of closing stock at weighted average cost of purchases.
Essential elements related to Management accounting system
Government and risk management are associated with management accounting system. Additionally, it is necessary to develop a strategic planning and execution with the help of balanced scorecard, operational dashboard. Measuring performance management is another necessary aspect that has to be based on the performance of the management accounting system. Planning, forecasting, service delivery and value recognition are among the other essential elements in management accounting system.
Different Methods of management accounting reporting
As opined by Cooper et al. (2017:991-1025), it is a form of an internal report which is prepared in order to show the different types of budgets prepared. It provides with information which help managers compare between the estimated costs and the actual costs incurred. The management of Morrisons prepare reports on a quarterly basis. Its importance lies in the fact that it helps in controlling costs and highlighting cost items which are required to be managed.
Capital appraisal methods
This method helps in evaluating the best investment opportunity that could be undertaken by the company and involves measures like IRR, ARR, and NPV. It provides the managers with range of times period within which initial investment done could return. The project which takes the least amount of time is selected by the managers.
Inventory valuation method
Inventory valuation is done on the basis of two or three methods such as LIFO and FIFO. It provides the managers with information related to closing inventory and opening inventory as well as the amount of raw materials required to meet the demands of customers. A FIFO method assumes that the first stock that has entered would be used first and under LIFO method last time which enters is used first. Morrisons has adopted LIFO method and values stock on the assumption that last items entered is used first. The importance of this system is that it leads to reporting of fewer profits which allows them to pay less tax.
Benefits of management accounting system and its application
- It helps in setting standards and also provides a benchmark to compare against. This in turn helps in analysing the variances and costs are controlled (Hague, 2018:6-9).
- It is significant in calculation of contributions made by different machines or project. Therefore it helps in making decisions related to buying or manufacturing and accepting or rejecting orders.
Morrisons uses standard costing and marginal costing in order to manage costs effectively.
- It also helps in cost control process.
- It helps in allocating different costs as per their importance and functions.
Morrisons prepares budgets quarterly and uses it as an effective tool to control expenses.
- Transfer pricing helps in comparing situations of transferring raw material internally and selling it outside the organisations.
- Minimum transfer prices can also be calculated with the application of transfer pricing and it makes the internal process smooth (Van der Stede, 2016:100-102).
Inventory management system
- It provides with different measures to determine the level and direction of using stocks in an organization.
Inventory management system is used by Morrisons to analyse the level of inventory so that the organization does not suffer from lack resources.
Integration of management accounting system and reporting
Since the management of Morrison uses budgeting, cost accounting and inventory management system hence the managers are required to prepare reports related to these. Budgeting reports preparation is integrated well with the budgeting system of management accounting. Budgeting reports are prepared as part of budgeting system and it is prepared on a quarterly basis by Morrisons. Managers report on facts outlining the estimated expenses and revenues to be received. On the other hand, expenses and revenues are compared with the actual performance of the company on a quarterly term. As a part of cost accounting system cost reports are prepared which helps in outlining cost related to specific activities. Standard costing is used by Morrisons, which helps in evaluating the performances of the company based on costs saved or incurred. This is reported with the help of standard cost income statements. Moreover inventory control system has been applied within the organization and it uses LIFO method. In order to report about the quantities used through inventory valuation summary reports.
LO2 Range of Management accounting techniques
Preparation of income statements using
a) Marginal costing [Refer to appendix 1]
Marginal costing is one of the most effective cost accounting methods which can be used under different situations. Income statements prepared under this shows the amount of sales deducted by variable cost to give contribution amount. Machines or projects are compared in terms of contribution (Armitage et al. 2016:31-69). Project or order is ranked on the basis of contribution and the least one is rejected. In this case fixed expenses are deducted at last from the contribution amount in order to calculate net profit. The method is usually applied in situations where decisions related to make or buy are required to be taken. It is also applied in situations of accepting or rejecting export order. According to the view of Otley (2016:45-62), marginal costing is more accurate than absorption costing as it does not allocate fixed expenses in terms of units produced.
b) Absorption costing [Refer to appendix 2]
This method takes into account all directs costs such direct material costs, direct labour cost and variable overheads. It does not take fixed expenses and it assumes full costing method. Sales are deducted with all forms of direct costs and fixed cost is also divided in terms of number of units produced. After this the over or under absorbed costs is deducted with all forms of administrative expenses or selling expenses to determine net profit. It is of more realistic approach as it assumes that all inventories are not sold out and that some are left as closing stock in the organisation (Hall, 2016:63-74).
The net profit as calculated under both the methods is £ 794230. The reason for same profits obtained under both absorption costing and marginal costing is that there have been no changes in the levels of inventory. Furthermore there was no inventory at the beginning of the period as well as at the end of the period.
Application of range of management accounting techniques and production of financial reports
Cost volume analysis
It measures the amount of impact variable cost; sales and fixed expense have on the amount of profits. It helps the organisation to reduce costs effectively since the level of impact is known. On the other hand it also helps in evaluating the level of profits required to cover all variable expenses incurred by an organization.
Morrisons uses the technique of budgeting to control costs and prepares budget reports quarterly to help it analyse the variances. Budgets are prepared for all departments present in the organisation. The expected level of expenses makes the management measure all pros and cons. Effective steps are taken to prevent losses in the future. Budget reports are useful if this technique is applied by an organization.
Capital appraisal techniques
Capital appraising techniques such NPV, IRR and ARR are used by Morrisons. NPV provide the managers with present value of all future returns from the investment. IRR on the other hand, ranks the projects in terms of profitability that can be derived from it. The project which returns higher profits from the investment and takes the least time tin cover initial investment is chosen. ARR id the average rate of return earned and time me value of money is ignored by the method hence it is used less.
Financial reports that are required to be produced in case of inventory valuation and standard costing are discussed as follows;
It is the report which helps in compared planned or estimated outcomes against the actual outcomes. The results are compared so that variances can be found out. The variances are differences or deviations in the expected results (Weygandt et al. 2015:96-101). The reports prepared to show variances help the managers know in which respect or department costs control is required to be applied. It shows all material items and their expected as well as actual costs for a quarter. It will be helpful for Morrison to identify the factors that are affecting on the cost controlling system. Additionally, the managers can access idea about the company expenses and division according to the department.
Inventory valuation reports
Inventory valuation reports as asserted by Malmi (2016:31-44), shoes or depicts the quantity of raw material of stock used or sold for a given accounting period. Iis is essential for the determination of cost of goods sold by the entity and is also used as collateral by any organization. Since it deals with the most important current asset of an organization hence the preparation of it report becomes essential and should be manage it properly. Morrison can use reports for its current planning in the future purposes.
Budgetary reports show the budget of all departments present in an organization. It assists in analysing trends of revenues and projection of expenses. Preparation of budget reports enables the management to know about the expenses which have gone out of control and which are under the control of an organisation. With the help of budgetary reports, Morrison can make its strategy for future expenses. The firm can be focused on the money goals in order to avoid unnecessary spending. It will be beneficial to attain the financial goals of the company.
Recommendation and Conclusion
Based on the above evaluation, comparison and analysis it can be recommended that the Morrisons should use fund flow analysis and transfer pricing techniques. It would help the company to be more effective in identifying financial issue before hand. Sustainable success and profitability would be observed for a long term. Cost reports and variance analysis report should also be prepared by the company since it would help in analysing the amount of deviations incurred. This would further help in preventing similar type of deviations in future and profitability would thus be guaranteed.
The benchmarking system of Morrisons is good however it needs to adopt departmental benchmarking too as this would enhance the internal processes.
The study has provided an in depth understanding of management accounting procedures. The difference between marginal costing and absorption costing has been outlined with the help of income statements. It has discussed about the benefits and application of management accounting system in Morrisons Company. It can be concluded that management accounting is crucial and essential to be undertaken at every step of decision making process. Morrisons uses varied range or type of management accounting technique as well as planning tools effectively.
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