Calculating Income Statement With Marginal And Absorption Costing In Essay.

You are a Junior Management Accountant for a medium-sized enterprise in the manufacturing sector and, in an effort to promote understanding between different departments in the organisation, you and your colleagues have been asked by your line manager to deliver a presentation on the role and function of the management accounts department, covering the management accounting systems operating in the organisation as well as the range of techniques used. This assignment has two parts.

Calculate costs using appropriate techniques of cost analysis to prepare an income statement using marginal and absorption costs.Accurately apply a range of management accounting techniques and produce appropriate financial reporting documents Produce financial reports that accurately apply and interpret data for complex business activities

Assume that a manufacturing company, XYZ Limited uses FIFO when valuing stock. The company is faced with a choice of either using the marginal costing approach or the absorption costing approach to the valuation of stock in its financial statements.

The following information is also provided

(a) Total fixed indirect production overhead is £100,000 per year.

(b) Direct labour costs over each of the three years were £10 per unit.

(c) Direct material costs over each of the three years were £15 per unit.

(d) Variable expenses which vary in direct ratio to production were £5 per unit.

(e) Sales were: Year 1: 2,900 units; Year 2: 3,300 units; Year 3: 4,500 units. The selling price remained constant at £100 per unit.

(f) Production is at the rate of: Year 1: 3,700 units; Year 2: 4,100 units; Year 3: 3,900 units.

(g) Other overheads are as follows:

• Distribution overheads £30,000 for each year
• Administrative overheads £60,000 for each year

(h) Interest expense: Year 1: £1,000; Year 2: £1,500; Year 3: £1,000

(i) The company’s applicable corporation tax rate is 19%

Prepare an income statements using marginal and absorption costs for the three years (6 income statements in total- 2 for each year) with calculations / workings of closing stock and comment on the results. Also comment on the use of Marginal costing and the reasons for the difference in profit figures under these 2 methods.

Preparing Income Statement with Marginal Costing

Part A: Portfolio of calculations and comments

Preparation of Income Statement Under Marginal Costing

Marginal Costing Income Statement (Year 1)
		Amount (£)	Amount (£)
Sales Revenue (2900x100)			290000
Marginal Cost of Sales
Add:
	Direct Materials (2900x15)	43500
	Direct Labour (2900x10)	29000
	Variable Production Overhead (3700*5)	18500	91000
Contribution			199000
Fixed Costs
Total fixed indirect production overhead		100000
Interest expense		1000
Fixed Administrative overheads		60000
Fixed Distribution overheads		30000
Corporation Tax (290000*15%)		55100	246100
Net Profit			43900

Marginal Costing Income Statement (Year 2)
		Amount (£)	Amount (£)
Sales Revenue (3300x100)			330000
Marginal Cost of Sales
Add:
	Direct Materials (3300x15)	49500
	Direct Labour (3300x10)	33000
	Variable Production Overhead (4100x5)	20500	103000
Contribution			227000
Fixed Costs
Total fixed indirect production overhead		100000
Interest expense		1500
Fixed Administrative overheads		60000
Fixed Distribution overheads		30000
Corporation Tax		62700	254200
Net Profit			75800

Marginal Costing Income Statement (Year 3)
		Amount (£)	Amount (£)
Sales Revenue (4500x100)			450000
Marginal Cost of Sales
Add:
	Direct Materials (4500x15)	67500
	Direct Labour (4500x10)	45000
	Variable Production Overhead (3900x5)	19500	132000
Contribution			318000
Fixed Costs
Total fixed indirect production overhead		100000
Interest expense		1000
Fixed Administrative overheads		60000
Fixed Distribution overheads		30000
Corporation Tax		85500	276500
Net Profit			173500

Preparation of Income Statement Under Absorption Costing

Absorption Costing Income Statement (Year 1)
		Amount (£)	Amount (£)
Sales Revenue (2900x100)			290000
Marginal Cost of Sales
Add:
	Direct Materials (2900x15)	43500
	Direct Labour (2900x10)	29000
	Total fixed indirect production overhead	100000	172500
Gross profit			117500
Interest Expense		1000
Fixed Administrative overheads		60000
Fixed Distribution overheads		30000
Variable Production Overhead (3700x5)		18500
Corporation Tax (290000x19%)		55100	164600
Net Profit			172500

Absorption Costing Income Statement (Year 2)
		Amount (£)	Amount (£)
Sales Revenue (3300x100)			330000
Marginal Cost of Sales
Add:
	Direct Materials (3300x15)	49500
	Direct Labour (3300x10)	33000
	Total fixed indirect production overhead	100000	182500
Gross profit			147500
Interest Expense		1500
Fixed Administrative overheads		60000
Fixed Distribution overheads		30000
Variable Production Overhead (4100x5)		20500
Corporation Tax		62700	174700
Net Profit			182500

Absorption Costing Income Statement (Year 3)
		Amount (£)	Amount (£)
Sales Revenue (4500x100)			450000
Marginal Cost of Sales
Add:
	Direct Materials (4500x15)	67500
	Direct Labour (4500x10)	45000
	Total fixed indirect production overhead	100000	212500
Gross profit			237500
Interest Expense		1000
Fixed Administrative overheads		60000
Fixed Distribution overheads		30000
Variable Production Overhead (4100x5)		20500
Corporation Tax		85500	197000
Net Profit			212500

As per the application of the Marginal costing the following results are inferred:

• In year 1 the contribution is computed as £ 199000 and the Net Profit of £ 43900
• In year 2 the contribution is computed as £ 227000 and the Net Profit of £ 75800
• In year 3 the contribution is computed as £ 318000 and the Net Profit of £ 173500

As per the application of the Absorption costing the following results are inferred:

• In year 1 gross profit is computed as £ 117500 and the Net Profit of £ 172500
• In year 2 gross profit is computed as £ 147500 and the Net Profit of £ 182500
• In year 1 gross profit is computed as £ 237500 and the Net Profit of £ 212500

Some of the main reasons for the difference in the profit figures under the absorption costing and marginal coting are listed as follows:

• The overall value of the closing stock as per the marginal costing is relatively small as only the variable costs are taken into consideration
• In year 1 and year 2 production is more than the sales, this is reason for reporting more profits under the absorption costing. This is also identified as the reason why the value of the stock is included as a portion of the fixed cost in the current period and same is shifted to following period.
• In year 3 the production is less than the sales the previous year’s fixed cost is included in the opening stock and the same is charged against the sales revenues [1]

Part B- Presentation

Slide 1

Management Accounting definition, roles and principles

• Management accounting is defined as any advice to a company based on the provision of financial data which may be used by any organization for its development
• Management roles are aimed to serve the four core needs of the organization which includes internal management for enhancing the decision support objectives, capacity utilization for achieving the corporate goals, resource application and customer value
• Principle of causality specifies the need for cause and effect insights and
• Principle of analogy implements the application of casual insights based on the management activities

8 Management Accounting reports with their contents and purpose

1. Financial Reports

The contents of the financial report will include profit and loss statements which will depict the overall earnings and breaking these numbers into groups. The purpose of this report is seen with summarizing the total profits earned[3].

2. Pro Forma Cash Flow

The pro forma cash flow depicts the total sum of money expected in short and medium-term accounting periods and amount anticipated on the spending. This managerial accounting report is aimed at providing a month-by-month summary for the outgoing and incoming cash and at the same time predict the shortfalls and surpluses[4].

3. Sales Reports

The contents show the sources of your company's revenue and enumerates the avenues which are least and most successful for the company. This report is intended to highlight the areas in which the business activities earn the most income, such as wholesale versus retail sales in particular accounts.

4. Item Costs Reports

This management account tool is conducive for portraying the overall sales in each category for understanding the areas in which the business is most profitable. The purpose of such a report is defined to produce the breakdown costs associated to labor, materials and other expenses such as fees and licenses.

5. Budget Reports

These reports are evaluated as very critical in measuring the performance of a company which is considered as a whole for any organization. Each company prepares such a report to understand the grand scheme of their business.

6. Account Receivable Aging Reports

These reports include all the necessary information about the accounts receivable from the trade debtors. The purpose of such a report is seen with Breaking down the remaining balances as per specific time periods, which allows the managers for identifying the defaulters and any issue which exists in the collection process.

7. Cost Managerial Accounting Reports

Managerial accounting is responsible for calculating the costs of articles that are manufactured. This report offers the details of the capacity to procure the cost prices of items against their selling prices.

8. Performance Reports

These reports are aimed at reviewing the performance of the companies as a whole for the individual employees. These reports are used for taking key strategic decisions about the future of an organization[5].

Slide 6

Management accounting benefits and their application within an organization

• Provides better understand of the proceedings of the business with statements such as profit and loss, which is able to specify how the financial performance has unfolded over time
• Management Accounting can track and use information in a quantified manner
• Capacity of presenting the financial picture in a clearer manner for the bankers and potential investors
• Better projection of the overall profitability of the company [6]

Slide 7

Critical evaluation of integration

• Real Time Data Processing through remote tracking of financial information. For instance, this may be used in remotely tracking of the number of vacant rooms, occupied rooms and new reservations.
• Functional Simplicity is integrated with automated data processing with simplifying the accounts and bookkeeping by the use of integrated accounting system
• The integration is identified with use of such efficient systems to maximize your business performance

The various types of the advantages of the planning tool are

• It is useful for defining the goals, policies and plans of an enterprise
• Budgetary control establishes specific targets for every department which allows an employee to work efficiently
• Helpful in securing better co-ordination among the different departments
• The planning tools for the budgetary control are effective in facilitating centralized control with decentralized activity

The various types of the disadvantages of the planning tool are

• Difficulty in preparing the budget accurately in inflationary conditions
• Heavy expenditure for the small business
• It cannot substitute the management in replacing the decision-making process

The use of different planning tools and their application for preparing and forecasting budgets useful for

• Identification of the areas challenges for difficultly in the planning
• Useful in controlling Finances
• Measuring the Performance with preplanned parameters [7]

The organizations are adapting management accounting systems to respond to financial problems in the following manner:

• Identification of the financial problems
• Identification of the non-financial problems [8]

Responding to financial problems, management accounting can lead organizations to sustainable success in the following manner

• Computation of Liquidity, solvency and debt ratio -Indicates the ability of paying short term debts
• Profitability ratio- Percentage of sales which a company has left to pay the operating cost
• Revenue Ratios- Provides tracking of the sales equation with CRM systems
• Management of Human Resource- Evacuating the main reason for staff turn over
• Product and service quality- Analyze Service quality to evaluate service quality effecting long-term sustainability
• Brands awareness and profile of the company- Useful in Reflecting future growth of the company [9]

            Planning tools for accounting respond appropriately to solving financial problems in the following manner:

• Planning and controlling
• Implementing plans
• Providing a competitive edge

References

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Fullerton, Rosemary R., Frances A. Kennedy, and Sally K. Widener. "Lean manufacturing and firm performance: The incremental contribution of lean management accounting practices." Journal of Operations Management 32.7-8 (2014): 414-428.

Kaplan, Robert S., and Anthony A. Atkinson. Advanced management accounting. PHI Learning, 2015.

Kihn, Lili-Anne, and Eeva-Mari Ihantola. "Approaches to validation and evaluation in qualitative studies of management accounting." Qualitative Research in Accounting & Management 12.3 (2015): 230-255.

Malmi, Teemu. "Managerialist studies in management accounting: 1990–2014." Management Accounting Research31 (2016): 31-44.

Otley, David. "The contingency theory of management accounting and control: 1980–2014." Management accounting research 31 (2016): 45-62.

Tappura, S., et al. "A management accounting perspective on safety." Safety science 71 (2015): 151-159.

Wagenhofer, Alfred. "Exploiting regulatory changes for research in management accounting." Management Accounting Research 31 (2016): 112-117.