Question one
Managerial economics’ is concerned with the application of economic principles and methodologies to the decision-making process within the firm or organization under the conditions of uncertainty” (Malesios et l., 2018). Spencer and Siegelman define it as “The integration of economic theory with business practices for the purpose of facilitating decision making and forward planning by management.”
Management accounting system and financial accounting system
Deciding on which products are profitable; If a business is reviewing their current product range, managerial accountancy will provide them with all the financial and business-crucial statistics to help them decide exactly which products are profitable, which aren’t, and how to remedy that. It can also provide them with valuable metrics for understanding how decisions they make affect an individual product’s profitability.
Planning new products for launch; if an organization is planning to launch new products, managerial accounting is even more important. It can support at every stage, from initial validation right through to execution, by giving a detailed breakdown of production capabilities, as well as an accurate picture of the market as a whole. This is crucial for working out how much an organization will charge for a new product, the quantities of product they will make and whether or not it is worth bringing in extra staff to help deliver.
Helping an organization understand staffing requirements; Staffing is another area in which managerial accounting can be hugely valuable. Decisions around hiring new staff and setting wages can be a real headache.
Managerial accountants can help an organization make the right decision by letting management know exactly how much they can afford to spend on staffing, and the returns they can expect for their investment in personnel.
Managerial accounting is critical in decisions concerning what they keep in-house, and what they outsource. Getting the balance right between the two is very important, and having the data to inform decisions is a great way to help navigate these tricky choices.
Risk analysis – various models are used to quantify risk and asymmetric information and to employ them in decision rules to manage risk.
The term risk analysis refers to the assessment process that identifies the potential for any adverse effects that may negatively affect organizations and the environment. Risk analysis is commonly performed by corporations (banks, construction groups, health care, etc.), governments, and nonprofits. Conducting a risk analysis can help organizations determine whether they should undertake a project or approve a financial application, and what actions they may need to take to protect their interests. This type of analysis facilitates a balance between risks and risk reduction. Risk analysts often work in with forecasting professionals to minimize future negative unforeseen effects. Risk analysis is possible through the managerial economics s this gives the business the opportunity to discover the challenges that they will face in future.
Production analysis – microeconomic techniques are used to analyze production efficiency, optimum factor allocation, costs, economies of scale and to estimate the firm’s cost function.
Pricing analysis – microeconomic techniques are used to analyze various pricing decisions including transfer pricing, joint product pricing, price discrimination, price elasticity estimations, and choosing the optimum pricing method.
Planning; The management can prepare the plan and execute the same for effective operation of business. In this context, various functional budgets are prepared and accounting information are rearranged in department wise, product wise, section wise and the like for proper planning.
Controlling; The actual performance of every business activity is measured and compared with the standard fixed or planned one. If the deviations are found that are controllable, the management can decide the course of action to exercise control. Both standard system and budgetary control system are highly help the management in this aspect.
Service to Customers; Better and improved services by management to customers are assured by this system of accounting.
Organizing; The scope of authority and responsibility of key executives are properly defined and explained under management accounting system. Hence, everyone knows who is responsible for what and to whom. It helps for proper organizing the work in an organization.
Coordinating
It is the process of integrating the various work performed in an organization to achieve the objectives effectively. Thus, perfect coordination is required for among production, purchase, finance, personnel, sales and the like departments. This is achieved through preparing and reports of performance.
Motivating; It helps to maintain high degree of morale among the employees. The reports of business operation are periodically prepared and submitted before the top management periodically. Based on the report, the management can find out whom to demote or promote or to reward or penalize. In this way, the employees are motivated.
Communication; Two-way communication is followed in an organization if management accounting system is followed. Modified accounting information and reports regarding performance are sent to top management for decision making. In another way, assignment of work and responsibilities over employees are communicated to lower level executives.
Regulation of Business Activities; Proper planning, organizing, cordintion and motivation can bring systematic regularity in the business activities.
Financial Accounting
Financial accounting and managerial accounting are two of the four largest branches of the accounting discipline (e.g. tax accounting and auditing are others). Despite many similarities in approach and usage, there are significant differences between the financial and managerial accounting. These differences primarily center around compliance, accounting standards, and target audiences.
Main Objectives of Both Accounting Practices
The main objective of managerial accounting is to produce useful information for a company’s internal use. Business managers collect information that encourages strategic planning, helps them set realistic goals, and encourages an efficient directing of company resources.
Financial accounting has some internal uses as well, but it is much more concerned with informing those outside of a company. The final accounts or financial statements produced through financial accounting are designed to disclose the firm’s business performance and financial health. If managerial accounting is created for a company’s management, financial accounting is created for its investors, creditors, and industry regulators.
Past and Present Use; The information created through financial accounting is entirely historical; financial statements contain data for a defined period of time. Managerial accounting looks at past performance and creates business. Business decisions should be informed by this type of accounting. Investors and creditors often use financial statements to create forecasts of their own. In this way, financial accounting is not entirely backward-looking. Nevertheless, no future forecasting is allowed in the statements.
Regulation and Uniformity; The biggest practical difference between financial accounting and managerial accounting relates to their legal status. Reports generated through managerial accounting are only circulated internally. Each company is free to create its own system and rules on managerial reports. This means there is no centralized system regulating reports, and it can often take much longer to find what you need.
In contrast, financial accounting reports are highly regulated, especially the income statement, balance sheet, and cashflow. Since this information is released for public consumption and is highly anticipated by investors, companies must be very careful about how they make calculations, how figures are reported, and in what order those reports are constructed.
Through this uniformity, investors and lenders compare companies directly on the basis of their financial statements. Moreover, financial statements are released on a regular schedule, establishing consistency of external information flows.
Reporting Details; For a variety of reasons, financial accounting reports tend to be aggregated, concise, and generalized. Information is simultaneously more transparent and less revealing. This is not normally the case with managerial accounting as there are many reasons to do things a specific way for each company. For example, you might want to internally report lower bonuses so as to not anger mid-to-lower level employees who might want to peruse the report.
Managerial accounting reports are highly detailed, technical, specific, and often experimental. Firms are always looking for a competitive advantage, so they examine a multitude of information that could seem pedantic or confusing to outside parties.
The Bottom Line; The key difference between managerial accounting and financial accounting relates to the intended users of the information. Managerial accounting information is aimed at helping managers within the organization make well-informed business decisions, while financial accounting is aimed at providing financial information to parties outside the organization.
Financial accounting must conform to certain standards, in accordance with GAAP as a requisite for maintaining their publicly traded status. Most other companies in the U.S. conform to GAAP in order to meet debt covenants often required by financial institutions offering lines of credit. Because managerial accounting is not for external users, it can be modified to meet the needs of its intended users. This may vary considerably by company or even by department within a company.
A cost and management accounting system.
Cost accounting is the version of Managerial Accounting, this aims to capture the company’s total cost of production. The same is done by assessing the variable costs at each step of production as well as the fixed costs as assessed such as the expense. The factors that are to be considered in standard costing are labour and materials, Activity-based costing: More often than not it is referred to as ABC, due to its initial. When the company assigns the overhead costs to the specific goods or services, Activity-based costing is used and Marginal Costing: to examine the variable costs on the total volume of the production of the output, marginal costing is used. It is beneficial and used quite often in making short-term financial decisions
The main point in this regard is that; Cost accounting is used internally by the management to make a fully assured business decision. Unlike financial accounting, which provides information to external financial statement users, cost accounting is not required to conform to any set standards which can be flexible to meet the needs of the management. Cost accounting considers all kinds of input costs that are associated with production, including both variable and fixed costs. Types of cost accounting include standard costing, activity-based costing, and marginal costing.
The following are some of the various types of Cost Accounting:
Standard Costing; Standard costing assigns ‘standards’ to the costs. The standard costs are grounded to the labour and materials to produce the goods and services under standard operating conditions.
Activity-Based Costing; Activity-Based Costing identifies the overhead costs from each department and then assigns specific cost objects like goods or services. The ABC system of cost accounting is based on these activities.
Marginal Costing; Marginal costing is also known as the cost volume profit analysis is the impact where the cost of a product is added to one additional unit into the production unit. This type of costing is useful for short-term economic decisions.
All these types of costs help the management in identifying the impact of cost in the business unit. This type of analysis is used by the management to gain analysis into them potentially to produce profitable products.
Importance of Cost Accounting
The importance of cost accounting is very much useful to the management of an organization, the importance of Cost Accounting is discussed in the following section vividly:
Classification of Costs
Cost is a generic term that needs to be classified for further use. Cost Accounting involves the recording and classification of all such costs. Costs involve the prime cost, direct cost, factory cost, selling cost and more other costs. Classification allows the management of the costs and to ascertain the profitability of any such processes and further activities. This also helps in calculating the efficiency.
Cost Control
This is efficient for the business to focus on controlling the cost of the inventory, labour, and various other kind overhead costs. For example, to achieve maximum efficiency in their inventory management they can adopt the EOQ technique which is the costing technique. Similarly, by analysing the costs of labour and the capacity of machinery their efficiency can be improved also. Cost accounting classifies the overheads into fixed and variable.
Price Determination
Cost accounting makes the basic distinction between fixed and variable costs. This is then used by the company or the business unit to fix the prices of the products, according to their costs of the product. The management here finds the most ideal price for the product or the service, which is not too high and not too low. For example, where the economy suffers a depression period.
The businessman lowers the prices of his products to survive the depression circumstances in the economy. He can start this by trying to control the variable costs and to allow him to fix the product’s prices.
Fixing of the Standards
The organizations use the standards to make the estimates and the budgets for their future. They use this as the basis to measure the actual efficiency of the process or about the department.
This is an entire branch of cost accounting which is known as Standard Costing dedicated priorly to this process.
Helps in managing costs: As said earlier, the main idea behind implementing cost accounting into the business is to manage the various types of costs. It also helps the management to have an idea of the cost price and selling price of the product and service.
Helps determine the total per-unit cost: The business needs to fix the selling price of the product or the service that they provide, beforehand. For doing so, it is important to know the per-unit cost of production. And hence, the techniques of cost accounting help the manager in knowing the total-per unit cost of production.
Helps in understanding the profitable and non-profitable activities: In any business, many activities are going on at any specific point in time, but the thing is that not all business activities are profitable. Hence, the manager needs to know about all the activities which are not making any profit. And cost accounting helps in identifying all those activities.
Helps in Fixing the Standards: The business needs to have fixed standards regarding everything. It helps in estimating the budgets for the future. And Cost accounting helps in that there is a whole field of costing dedicated to this called Standard Costing.
QUESTION TWO
Budgeting
Budgeting is the process of preparing and overseeing a financial document that estimates income and expenses for a period. For business owners, executives, and managers, budgeting is a key skill for ensuring organizations and teams have the resources to execute initiatives and reach goals (Ho, 2018).
A basic budget consists of projected income and expenses for a given period (for instance, the upcoming quarter or year). After expenses are subtracted from projected income, the leftover money can be allocated to projects and initiatives, ensuring you’re not planning to overspend.
Budgets from previous periods can be compared to the company’s actual financial allocation and performance, giving an idea of how close predictions were to actual spend.
Types of Budgeting
There are several budgeting types that each prioritize different factors when approaching a financial plan. These include: Zero-based budgeting, which sets each item at zero dollars at the start of periods before reallocating. Static budgeting or incremental-based budgeting, which uses historical data to add or subtract a percentage from the previous period to create the upcoming period’s budget. Performance-based budgeting, which emphasizes the cash flow per unit of product or service. Activity-based budgeting, which starts with the company’s goals and works backward to determine the cost of attaining them. Value proposition budgeting, which assumes no line item should be included in the budget unless it directly provides value to the organization (Chohan, & Jacobs, 2018).
Relevance of budgeting to an organization
It Ensures Resource Availability; At its core, budgeting’s primary function is to ensure an organization has enough resources to meet its goals. By planning financials in advance, an organization can determine which teams and initiatives require more resources and areas where they can cut back.
It Can Help Set and Report on Internal Goals; Budgeting for an upcoming period isn’t just about allocating spend; it’s also about determining how much revenue is needed to reach company goals. An organization can use budgeting to set company-wide and team financial goals that align with them. This is especially prominent when using activity-based budgeting, but it’s beneficial no matter which type an organization uses. Financial goals should be attainable enough that an organization count on them to inform the rest of your budget allocations. An organization goals inform the expenses needed to reach them and vice versa.
It Helps Prioritize Projects; A byproduct of the budgeting process is that it requires prioritizing projects and initiatives. When prioritizing, consider the potential return on investment for each project, how each aligns with your company’s values, and the extent they could impact broader financial goals. The value proposition budgeting method forces you to determine and explain each line item’s value to your organization, which can be useful for prioritizing tasks and larger initiatives.
It Can Lead to Financing Opportunities; If you work at a startup or are considering seeking outside investors it’s important to have documented budgetary information. When deciding whether to fund a company, investors highly value its current, past, and predicted financial performance. Providing documents for previous periods with budgeted and actual spend can show your ability to handle a company’s finances, allocate funds, and pivot when appropriate. Some investors may ask for the current budget to see your predicted performance and priorities based on it.
It Provides a Pivotable Plan; A budget is a financial roadmap for the upcoming period; if all goes according to plan, it shows how much should be earned and spent on specific items. Yet, the business world is anything but predictable. Circumstances outside an organization control can impact your revenue or cause priorities to change at a moment’s notice.
List of the Advantages of Zero-Based Budgeting
It keeps you aware of your cash flows, when a company are using a zero-based budget, then they are entirely aware of how much money is going into and out of their accounts each month. This method makes it easier to stop spending on credit which is money that you don’t really have at the moment. If the company aren’t tracking where organizations’ cash is going each month or it feels like your spending is out of control, then this option can get company back into a better place of financial security.
A company can customize the budget to fit your specific needs.
If a company are new to managing money or have specific needs to meet each month, then zero-based budgeting gives you a way to handle your expenses effectively. You can add or subtract line-item needs each month so that you always know where your cash is going. This recognition makes it easier to find places where you could cut back on your expenses so that you can establish an emergency fund, save for a vacation, or pay for the costs of youth sports. This advantage makes it a lot easier to keep corporate legacy expenses in check. Traditional budgeting might not examine this issue for several years, waiting until an economic shock disrupts the system. Since costs tend to grow over time, teams cut budgets instead of looking at costs. When done correctly, the zero-based budgeting avoids issues with myopic views (Ulmer, Mattfeld, & Köster, 2018).
It looks at the reasons why company are spending money.
Traditional budgeting processes look at how much a company are spending every time an expense occurs. The zero-based budgeting method also takes into account the reasons why you make spending decisions. It looks at the root of each choice that an organization make, steering you toward specific objectives even at an organizational level. Instead of looking at what an organization accomplished in the past, it ignores their previous habits to focus on the present.
It shows places for improvement each month.
The preparation of zero-based budgeting comes with the same assumption that a base from a previous period isn’t required. Self-employed individuals may make an exception to this advantage if their income is variable. an organization will then analyze expenses for the month, quarter, or year to ensure that every spending habit comes from a necessary place and provides a tangible benefit in some way.
Zero-based budgeting can discontinue obsolete processes.
The zero-based budget seeks to find inefficiencies in your financial systems by eliminating anything that isn’t useful to an organization overall monetary health. That means any obsolete process from a personal or commercial standpoint will get found and removed so that you’re not spending on things that you’re not using. It’s like the idea of having four streaming services, but you’re only using one of them each month. This budget would have you eliminate the three that you don’t use.
It quickly detects inflated budgets.
If an organization have too much money in a specific line item in your budget, then the zero-based budgeting method will detect the issue quickly. It looks at the exact amount that you need for a specific review period with the expectation that you run out of money there. When an organization have a remaining balance, then this indicates that other areas of your finances need more attention.
This budget can identify opportunities for outsourcing.
The zero-based budgeting approach looks at cost-savings opportunities from a variety of perspectives. If you can save money without sacrificing the quality of your needs or wants, then it can highlight places where outsourcing might be possible. If an organization at look at this advantage from a residential standpoint, then it might suggest moving from a full-time housekeeper to a cleaning service that works on a contracted basis.
Zero-based budgeting creates a need to justify each expenditure.
Whether it is a need or a want, the zero-based budgeting method forces people to make choices about their spending habits. You must have a specific reason for every purchase that you make. If there isn’t a valid justification to pursue something, then this approach suggests that you shouldn’t change your cash flows.
That’s why this method facilitates an effective delegation of authority, especially from a corporate viewpoint. Instead of having money move unpredictably based on dozens of different perspectives, you can have one group or team in control of the decisions. Families can take a similar approach where one person manages a majority of the financial decisions.
List of the Disadvantages of Zero-Based Budgeting
It takes a lot of time to manage a zero-based budget.
If an organization are going to hold yourself accountable to your overall budget, then you must closely monitor your spending every month. Because every household faces a set of variable expenses, it can be a challenge to create this structure if you’re new to budgeting. You must account for irregular costs every month or this approach can leave you without enough money to take care of everything.
Having an unpredictable income can make this budgeting method impossible to use.
The zero-based budgeting method works best when you have predictable monthly income levels. If you work as a freelancer, in the gig economy, or as an independent contractor, then you never know how much money to allocate each month. Even hourly workers with fluctuating schedules can encounter this disadvantage. You can use the income from the previous month as a budget for the next one, but that also means having the ability to have a month’s worth of income as a savings buffer to maintain the budget.
A zero-based budget has more subjectivity in the decision-making process.
Some of an organization expenses can be challenging to classify as a need or a want. How you decide things are essential is based on your personal perspective. There are qualitative considerations where value goes beyond the cash that you’ve got available, which means numbers, needs, and wants can’t be your only points of reference.
It could be detrimental to your long-term financial goals.
The zero-based budgeting method looks at a cost-benefit analysis in the present time. That means you’re accounting for all of the cash flows in a specific snapshot. You’re not looking toward the future or reliving the past. That means an expense that could feel like a long-term need is seen in the present tense as a short-term want.
Zero-based budgeting may have some flexibility, but it is also rigid.
The goal of zero-based budgeting is to avoid debt whenever possible. It can be an essential practice that eliminates problems with credit card spending because you’re only using the money that you earn each month. This rigidity can also create problems when you run out of cash in your budget for some reason.
It requires financial skills to implement.
Conflicts can arise when taking the zero-based budgeting approach because it requires a significant amount of skill and time to implement. If that is not available within a household, then there isn’t a way to implement this method successfully. You can always take time to learn how to manage finances like this from industry experts, but then that means you’re taking another commitment that you may not have time to manage.
Savvy budgeters can manipulate the zero-based process.
People who know how to manipulate the approaches that the zero-based budgeting method encourages can use it to increase resources for themselves or their departments. When this disadvantage occurs in a family, then it can lead to enough discord that can result in a separation or worse. Workplaces that experience this issue often see a change in their culture that includes a decrease in cooperative spirit. It often causes people to feel like their expendable or viewed as a commodity instead of as an individual.
REFERENCES
Ho, A. T. K. (2018). From performance budgeting to performance budget management: theory and practice. Public Administration Review, 78(5), 748-758.
Chohan, U. W., & Jacobs, K. (2018). Public Value as Rhetoric: a budgeting approach. International Journal of Public Administration, 41(15), 1217-1227.
Ulmer, M. W., Mattfeld, D. C., & Köster, F. (2018). Budgeting time for dynamic vehicle routing with stochastic customer requests. Transportation Science, 52(1), 20-37.
Malesios, C., Skouloudis, A., Dey, P. K., Abdelaziz, F. B., Kantartzis, A., & Evangelinos, K. (2018). Impact of small‐and medium‐sized enterprises sustainability practices and performance on economic growth from a managerial perspective: Modeling considerations and empirical analysis results. Business strategy and the environment, 27(7), 960-972.
