1) Explain the concept of the break-even point. The break-even point (BEP) is the spot at which cost and income are identical: there is no net loss or profit, and one has "broken even" in Economics, Business specifically cost Accounting. In other words according to Prof.Hossein Arsham, the break-even point is the point at which your manufactured goods stop costing you money to produce and sell, and starts to make a profit for your company. According to Michael.E.Cafferky and Jon Wentworth, "Overall break-even thinking is a way of comparing the amount of incoming value that an organization needs in order to serve its customers by delivering outgoing value of an equal amount". For example, if an Automobile manufacturing company sells less than 500 cars each month it will make a loss, if it sells more than 500 cars each month will make a profit. According to this knowledge, the business managers need to see if they expect to be able to make and sell 500 cars per month.
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Variable costs and fixed costs are the two types of costs in business faces. Fixed costs are stable throughout the relevant range and are typically considered sunk for the relevant range. Fixed costs are independent of output. Fixed costs include buildings, machinery, rent, etc.
Generally variable costs increase at a constant rate relative to work and capital. Variable costs vary with output. Variable costs include utilities, wages, materials used in production, etc.
There are two basic methods of information that we needed to calculate the break-even point:
Break-even sales (in pounds) = fixed costs/unit contribution as a % of sales.
Break-even sales (in units) = fixed costs/unit contribution
According to Rob Holland (1998), No change in variable, fixed and selling price once the break-even is achieved. The change in the break even, result will not remain constant in many cases for fixed or variable costs and selling price. To maintain profitability or to make adjustments in the product line, the break even should calculate on a regular basis to reflect changes in costs and prices.
2) Comment briefly on the major differences between financial and management accounting.
Introduction (Edmonds C., et al, 2006)
Financial and management accounting both are used to prepare and evaluate financial data. Conversely, certain features of these two are dissimilar with each other. The differing features to be considered include the types of data, the users of information, regulatory error, and rate of reporting.
Users of Information: Financial accounting and management accounting provide data of two unlike user groups. Financial accounting mainly provides data for external users, such as investors and creditors. Whereas, management accounting provides data for internal users namely employees, managers etc.
Types of Information: Different users require different types of information. External users mostly depend on financial information on the company. They study this information in combination with general economic information, such as information about the diligence in which the company drive. External users point up on broad information that discloses the on the whole performance of the company. In addition, financial accounting only reports information on financial dealings that have happened in the past.
Internal users want to re-examine the financial information of the company, such as financial statement information. They also utilize non-financial information of the company, such as customer satisfaction levels and competitor data. Internal user's focal point is on the detailed information that reveals the performance of particular subunits of the company, such as divisions or departments. But, management accounting focuses on both past and present information, also on the future financial transactions.
Financial accounting is regulated by the Public Company Accounting Oversight Board (PCAOB), Securities and Exchange Commission (SEC), and Financial Accounting Standards Board (FASB), in order to guard public awareness. But, management accounting is not synchronized by any particular agencies. The reason is, the information provided by management accounting is proposed for internal users only and is not offered to the public.
Frequency of Reporting
Financial accounting only focuses on past information. The information is accounted regularly, basically monthly, quarterly, and/or annual reporting periods. At least, once in a year financial accounting information must be reported.
Always on Time
Marked to Standard
On the divergent, management accounting information is a continuous reporting process. Internal users need to assess past, present, and possible future information so that a conclusion can be made.
3) Explain why the level of profit/loss shown in the profit and loss account does not equate with the increase/decrease in cash during the year.
Profit and loss statement (P&L) is a financial statement that shows how profits are transformed into net income for an Organisation. ( Shermin ,2007)
In general the level of Profit and loss exposed in the P&L account does not equate with the increase and decrease in cash during the year because the cash flow statement shows the decrease of the cash by mentioning where it is spent in brief and the increase of the cash by mentioning the source from where it comes. In operating activities the increase and decrease of the cash are shown in the cash flow report which includes cash inflow of fee receipt and cash outflow to suppliers and for purchase and sales of goods. On the other hand the outstanding salary and outstanding bill are also entered in the P&L account. These are added in the net profit to generate the company and these are not receivable and payable items.
There are some non-operating items apart from this outstanding income and expense such as depreciation also recorded in the profit and loss account. This is the reason that level of Profit and loss shown in the Profit and loss account does not go with the cash flow during the year.
When there are no receivable or payable balances in the balance sheet there is a chance for profit and loss account can match with cash flow. (Martin coles,1997)
4) Explain the advantages and limitations of ratio analysis
Definition: it is aÂ instrument used by individuals to conduct a quantitative study of informationÂ in a company's financial statements. Ratios areÂ calculated from present year numbers and are then compared to the previous years, the industries, other companies, or economy to judge the presentation of the company.Â Ratio analysis is mainly used by proponents of fundamental analysis.
Advantages of ratio analysis
1. Ratio is a simplified figure of complex financial statements that can be easily understood by a person who does not have the accounting knowledge.
2. With the help of ratios, it is easy to make comparison between companies in the same industry and determine the position of the company with respect to its competitors.
3. As ratios are easy to understand it becomes easy for a company to communicate the ratios to people who are interested in the financial performance of the company.
4. Ratios simplify and review several accounting data in an orderly manner so that the simplified data can be used effectively for analytical studies.
5. Ratios avoid distortions that may result the study of absolute data or figures.
6. Ratios analyze the financial health, future prospects and operating efficiency by inter-relating the variety of financial data found in the financial statement.
7. Ratios are not so valuable guides to management. They assist the management to acquit their functions of planning, forecasting, etc. economically.
8. Ratios study the past and relate the result to the present. Thus the future can be projected by drawing useful inferences.
9. By using this ratio we can conclude the profitability of business by calculating a range of profitability ratio.(Rajesekaran.V and lalitha.R,2001)
Limitations of ratio analysis
Although ratios offer a quick and useful method of analysing the position and performance of a business, they are not without their limitations. Some limitations are as follows
1. When comparing businesses, no two businesses are identical and the greater the
differences between the businesses are compared, the greater the limitation of ratio analysis.
2. Choices in accounting policies impact reporting of income and assets and affect ratios.
Companies being compared won't essentially be using the same rules.
3. Ratios are only indicators, they cannot be considered as final towards making business conclusions like a good or bad financial position of the business. Other factors must also be considered (mukherjee and hanif, 2006)
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4. Ratios are tools of quantitative analysis, which do not take into account the qualitative points of view.
5. Ratios are calculated on the basis of old data. Therefore, they do not provide all the information for future forecasting.
6. Ratios may be misleading, if they are based on false or window dressed accounting information.
Ratio analysis is useful, but analysts should be alert of these problems and make adjustments as vital. Ratio analysis conducted in a mechanical, inconsiderate manner is risky, but used wisely and with good judgment. It can provide useful insights into a firm's operations.
5. Explain the concept of Relevant Costs.
Relevant costs are the costs which are relevant with respect to a decision making task. A relevant cost for a particular decision will change, if a different choice of action is taken. Relevant costs are alternatively known as differential costs.
Relevant costs are costs that vary with respect to a particular decision. Sunk costs are not relevant. Future costs can be or cannot be relevant, it depends. If the future costs are going to be gained in any case of the conclusion that is through, those costs may not be relevant. Future costs that committed are not relevant. Even if the future costs are not committed and we anticipate acquiring those costs apart from of the decision that we make, those costs are not relevant. Those costs that differ between the alternatives and are being considered are only called relevant costs. (classes.bus.)
Management needs adequate and pertinent data to make correct decisions. Therefore, it is always required to understand which all relevant costs are. Because of the difference amongst alternative, hence it has a bearing on the decision to be made.
Irrelevant costs purely are costs that will not have an effect on the decision. By examining these types of irrelevant costs, management will desecrate their period and hard work as these costs do not affect the decision that is made. (www.basiccollegeaccounting.com)
Counting sunk costs in a decision can direct to a bad selection. On the other hand, including future irrelevant costs normally will not lead to a bad selection; it will always obscure the analysis. For example, if one makes a decision whether to buy a Mercedes Benz or a BMW, and if the auto insurance is same for both the cars, the person's consideration of insurance costs will not affect his decision, although it will add a few complications for his analysis. (classes.bus.)