Business Studies Essays on Managerial Accounting

Managerial accounting is defined as the process of classifying, measuring, evaluating, interpreting as well as communicating information in reference to leading an organization towards its obligations.  The income statement is used as a tool that aids managers attain the aforementioned processes in accessing the efficiency of available resources as revenue transforms into either profits or losses (Noreen, Brewer, & Garrison, 2017). It should be noted that income statements are prepared in two formats namely absorption costing income statements and variable costing income statements.  The reason to take note of this was the fact is that the two formats generally produce dissimilar net operating income results. According to Lal and Srivastava (2009), the net incomes will always be different under the two formats majorly because of the closing inventory cost.  Below is table representing financial data of an organization

Number of units produced each year 6,000
Variable cost per unit:
Direct materials $2
Direct labor $4
Variable Manufacturing Overhead $1
Variable selling and Administrative expenses $3
Fixed costs per year:
Fixed manufacturing overhead $30,000
Fixed selling and administrative expenses $10,000
Units in beginning inventory 0
Units produced 6,000
Units Sold 5,000
Units in ending inventory 1,000
Selling price per unit $20
Selling and administrative expenses:
Variable per unit $3
Fixed per year $10,000

Source; Accounting explanation. http://www.accountingexplanation.com/income_comparison_of_variable_and_absorption_costing.htm

 

Absorption Costing Income Statement
Sales (5,000 units×$20 per unit) $100,000
Less cost of goods sold:
Beginning inventory $0
Add Cost of goods manufactured (6,000 units×$12per unit) $72,000
Goods available for sale $72,000
Less ending inventory $12,000
Cost of goods sold $60,000
Gross Margin ($100,000 – $60,000) $40,000
Less selling and administrative expenses
Variable selling and administrative expenses (5,000 × 3) $15,000
Fixed selling and administrative expenses $10,000
$25,000
Net operating income ($40,000 – $25,000) $15,000
Variable Costing Income Statement
Sales ($5,000units×$20 per unit) $100,000
Less variable expenses:
Variable cost of goods sold:
Beginning inventory $0
Add variable manufacturing costs (6,000 units×$7 per unit) $42,000
Goods available for sale $42,000
Less ending inventory (1,000 units×$7 per unit) $7,000
Variable cost of goods sold $35,000
variable selling and administrative expenses
(5,000 units × $3 per unit)
$15,000
50,000
Contribution margin ($100,000 − $50,000) 50,000
Less fixed expenses:
Fixed manufacturing overhead $30,000
Fixed selling and administrative expenses $10,000
$40,000
Net operating Income ($50,000 − $40,000) $10,000

Source; Accounting explanation. http://www.accountingexplanation.com/income_comparison_of_variable_and_absorption_costing.htm

From the tables the Net operating income as indicated by the Absorption Costing Income Statement is $15,000 while that presented by Variable Costing Income Statement is $10,000 yet the figures are from table 1. As stated by Lal and Srivastava (2009) some of the fixed manufacturing costs in the current trading period will not be presented in the instance if inventories increase when dealing with absorption costing income statements. The fixed manufacturing costs differ to the next financial period as overhead inventory costs.  From the example offered the balance, which would end up being inventory carried flowered, is 1000 units (6000 manufactured units- 5000 sold units). In reference to the fixed overhead cost, it determined that each unit costs $5 (30,000/6000) therefore the fixed overhead costs for the unsold units adds up to $5,000 (1,000 units * $5). The costs are later deducted from the total fixed overhead costs (30,000-5000) making up $25,000 which is subtracted from the gross margin of $40,000 giving a Net Operating Income figure of $15,000.  On the other hand, using Variable Costing Income Statement method the fixed manufacturing overhead costs $30,000  has been highlighted as an entirety and presented as an expense of the current period thus the $5,000 difference on the Net operating Income figure. According to Warren, Reeve, and Duchac (2009), the differences can be broken down into five points

  1. a) The Net operating income when preparing an absorption costing system is always higher than of the figure presented on a variable cost system when inventory increases
  2. b) The net operating income when using variable costing system is always higher than higher than of the figure presented on the absorption costing system when inventory decreases.
  3. c) When inventory goes up, the fixed overhead costs are carried forwards to inventory.
  4. d) When inventory decreases, the fixed manufacturing overhead costs are brought forward from inventory.

The main purpose managers or organizations prepare the two forms of income statements is to highlight real operational income and evaluate the efficiency of resources. According to Cafferky and Wentworth (2010), real income is a derivative off sales and an organization acquires a higher efficiency ratio when sales are higher than production as cost such as inventory costs are avoided. Additionally, real operation income highlights the true financial position of an entity thus allowing managers to make the proper decisions on leading the organization towards the right direction.

As earlier highlighted managers by identifying the transformation of resources into either profits or losses using the income statement. In most instances, managers require the knowledge to know the specific sales that lead to the full coverage of all costs in order to avoid losses. This position is what is identified as a break-even point.

Break-even Analysis

According to Cafferky and Wentworth (2010), a break-even analysis involves the control and analysis of the lowest revenue margins in reference to associated costs. In other words, a break-even analysis entails the control of prices in reference to market demands for the purpose of making significant sales to cover fixed costs. Lal and Srivastava (2009), states that a break even analysis can be used as a decision making to influence production either by lowering or increasing unit manufacturing in order to avoid losses or maximize profits in reference to prevailing market conditions.  For example, if a company has a total fixed cost of $50,000 and a contribution margin of $35, the break-even point would be 1,429 units. This means the sale of the 1,429 units the company covers its variable costs and any sale above is a profit. This consequently offers managers with a chance to come up with strategies that may allow increased revenue.

In summary, Managerial accounting is defined as the process of classifying, measuring, evaluating, interpreting as well as communicating information in reference to leading an organization towards its obligations. In doing so managers use income statements to meet their obligations. This paper highlights two different income statements namely Absorption Costing Income Statement and Variable Costing Income Statement. The paper highlight the dissimilarities between these two documents and how they can be used in a break-even analysis to help a manager make informed strategic decisions.

 

 

References

Warren, C. S., Reeve, J. M., & Duchac, J. (2009). Financial and managerial accounting. Mason, Ohio: South-Western Cengage Learning.

Noreen, E. W., Brewer, P. C., & Garrison, R. H. (2017). Managerial accounting for managers. New York, NY : McGraw-Hill Education.

Lal, J., & Srivastava, S. (2009). Cost accounting. New Delhi: Tata McGraw-Hill.

Needles, B. E., Powers, M., & Crosson, S. V. (2010). Financial and managerial accounting. Mason, OH: South-Western Cengage Learning.

Cafferky, M. E., & Wentworth, J. (2010). Breakeven analysis: The definitive guide to cost-volume-profit analysis. New York: Business Expert Press.