ACCA F1 Accountant in Business - 2010 - Study text

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Chapter 5: History and role of accounting in business

Cost estimating

In some businesses, cost estimations or price quotations are prepared regularly for

customers. For example, in contracting industries, contracting companies are often

asked to tender for major contracts, by submitting bids. Tendering for contracts, and

quoting prices to a customer, might involve both management accountants and the

purchasing department, together with production management.

Monitoring purchase quantities

The accountant might also be asked to provide information to senior management

about inventory control, for the purpose of working capital management. A

business should try to avoid excessive inventories, because these have to be funded

and tie up cash. Large inventory levels and slow inventory turnover are also

associated with other costs such as losses through damage, deterioration and theft.

One of the reasons for excessive inventory levels might be excessive order

quantities. Management accountants might be expected to consider suitable

purchase order quantities to minimise costs, and discuss these with the buying

department.

Example

An example of excessive buying is often found with print orders. When a quantity of

books or brochures is ordered, the cost per unit is much lower for large order

quantities. For example, it might cost $2,000 to print 500 books but only $10,000 to

print 5,000 of the same books.

The cost per book is therefore $4 for an order of 500 and only $2 for an order of

5,000. A buyer might be tempted to buy 5,000 units in order to keep unit costs low.

However, if only 500 books are used, the remaining 4,500 will be thrown away and

the ‘saving’ in unit costs becomes excess spending of $8,000.

Monitoring buying procedures

Internal audit is a completely different aspect of the relationship between

accountants and the purchasing function. Controls are applied to the buying

process, to make sure that unauthorised buying does not take place (or that

payments are made for goods that have not been purchased at all).

Internal auditors might check that controls over purchasing have been properly

applied – for example that all purchases are properly authorised and recorded.

(Internal audit is described more fully in a later chapter.)

5.2 Financial considerations in production

In manufacturing businesses, accountants record the costs of production and

calculate the cost of closing inventory at the end of each financial year.

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Accountants also provide management information about production costs for the

following purposes.

 Accountants are involved in preparing the annual budget. This should include

the expected costs of production during the financial year.

 They might also be involved in calculating expected units cost of production for

each product item, where standard items of product are manufactured. Expected

unit costs might be prepared as standard costs per unit.

 They also produce control reports throughout the financial year, providing

information about actual production costs incurred. Actual production costs

might be compared with the expected or standard costs, and the differences

reported as cost variances.

In addition to preparing financial plans and control reports, accountants might be

involved with production management in assessing the costs of various aspects of

production, and considering ways in which costs might be reduced. Here are a few

illustrative examples.

 Production management should look for ways of using resources efficiently and

productively. This means making efficient use of resources such as materials and

labour. Materials should be used efficiently, to avoid unnecessary wastage.

Management should also try to improve labour productivity, for example by

reducing time lost due to bottlenecks in production and late deliveries of

materials. Production management should also consider ways of making the

best use of available capacity, such as machine time. The accountant can help

production management by estimating the costs of inefficiencies or the financial

benefits of improvements in efficiency or capacity utilisation.

 When production managers are considering whether or not to purchase a new

item of machinery or equipment, accountants can help by providing a financial

assessment of the costs and benefits of the capital investment.

 A manufacturing business might be faced with a decision about whether to

continue to make a product ‘in-house’ in its own production department, or

whether to ‘outsource’ production and buy the items from an external supplier

instead of making them. Management accountants can assist by providing

information about the expected costs and financial benefits of any such ‘make or

buy’ decision.

 Similarly, management might be considering a decision about whether to shut

down a production facility because it seems unprofitable. Management

accountants can assist with the decision by providing reliable financial data

about the costs and financial benefits of closure.

5.3 Financial issues in marketing

Accountants should provide information to assist marketing management.

The marketing managers (and senior management) make pricing decisions, and

decide how much should be charged for goods or services. Accountants can assist

with pricing decisions by providing information about costs and ‘gross profit

margins’ (Gross profit is the difference between the sales price of an item and its

cost of sale.)

Chapter 5: History and role of accounting in business

Total profit depends partly on the profit margin per unit sold and partly on the

volume of sales. Suppose that the cost of selling an item is $5.

 If it is sold for $7 and sales volume is 10,500 units, total profit will be $21,000.

 If it is sold for $7.50 and sales volume is 8,000 units at that price, total profit will

be $20,000. In this example, the lower price of $7 would seem preferable.

The point to note, however, is that accountants can help marketing management

with pricing decisions, by estimating total profit at different price levels.

Accountants should also be involved in the preparation of marketing budgets, and

providing control report information that compares actual marketing spending with

the budget.

In addition to assisting with the preparation of marketing budgets and preparing

budgetary control reports for marketing activities, accountants might also be

involved with marketing management in assessing the financial costs or benefits of

certain courses of action, such as whether to open up a new channel of distribution;

for example whether to start selling goods on the company website.

5.4 Costs and benefits of effective service provision

Business entities that sell goods (rather than provide services) also provide a service

to their customers. The service associated with a product is a part of the ‘value

consideration’ that the customer buys.

Some entities provide a better service than others. The effectiveness of service can be

measured in several ways:

 Promptness. Good service is often associated with providing a prompt service.

An example is the speed with which a maintenance or repair engineer comes to

fix a reported fault (such as a car broken down on the motorway, or a leak in the

plumbing).

 After-sales service. Some manufacturers provide a good after-sales service, in

the form of warranties and guarantees, training in the use of the item for the

buyer’s employees, and maintenance and repair services.

 Friendliness. Customers are often impressed by a friendly personal service.

 Skills of the service provider. A service can only be effective if it is provided

properly and without mistakes.

A problem for businesses that provide a service to customers is to decide on the

appropriate standard or quality of service. Providing a better service often costs

more money. However, a better service should improve customer satisfaction,

which in turn might lead to more sales (such as repeat orders).

Accountants might be asked to assess the costs and benefits of service provision.

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Better service provision

Costs Benefits

More resources (such as more employees to

provide the service)

Some revenue benefits (for example

a maintenance contract with the

customer, or a system support

service for a customer’s IT system

Cost of providing warranties or guarantees More customer satisfaction from

better service quality, greater

promptness and speed, or greater

reliability

Costs of training own staff to provide a

good standard of service

The financial benefits of customer

satisfaction should come from

higher sales

Costs of training customer’s staff

Concluding remarks

This section has tried to show that there are financial aspects to every business

system or business process, and accountants are often involved in providing

management information for the management of the system or process.

Accounting is more than just a matter of recording costs and calculating annual

profits!

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AccountantinBusiness

CHAPTER

Functions of accounting and

internal financial control

Contents

1 Specific functions of accounting

2 External and internal auditing

3 Internal financial control

4 IT system security and controls

5 Fraud and fraud prevention

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Specific functions of accounting

 The broad functions of accounting and finance

 Financial accounting and reporting

 Management accounting and performance management

 Finance and treasury function

1 Specific functions of accounting

1.1 The broad functions of accounting and finance

The main objective of a business entity is financial in nature. As specialists in

accounting and finance, accountants are involved in helping to set financial targets,

and in developing financial policies and accounting procedures that should

contribute towards the achievement of targets.

 At a strategic level, the accountant should provide advice to management about

setting profit targets and other financial targets.

 For many business entities, the annual budget is an important system for

planning and control. The accountant is involved in preparing the annual

budget and in providing advice on financial targets within the framework of the

budget.

 Many business entities have reward schemes for managers (and possibly other

employees). For example, individual managers might be awarded an annual

bonus for the achievement of specific targets. The accountant is often involved in

providing information and advice to senior management about suitable

performance targets and the potential cost of bonus schemes.

 Accountants have direct responsibility for the finance function, and contribute to

funding policy decisions and activities connected with raising new funds, the

payment of debt obligations (interest to lenders) and cash management.

The accountant also contributes towards control within an organisation.

 Accountants should establish financial controls within an organisation, and they

may also be required to check whether these controls are effective.

 The accountancy function is usually responsible for performance reporting

systems, providing reports on actual performance and comparing this with

targets. Performance reporting systems are used for control purposes, as well as

for bonus incentive schemes.

The contribution of the accounting function to an organisation can be summarised

as:

 Record-keeping and preparing financial statements

 Providing management information and giving advice to management

 Direct responsibility for finance (funding and cash flow)

Chapter 6: Functions of accounting and internal financial control

 Checking controls, particularly financial controls, and compliance with those

controls.

1.2 Financial accounting and reporting

The financial accounting function is concerned with record-keeping and financial

reporting.

 All transactions of a financial nature are recorded in the book-keeping system.

Accountants (or book-keepers) keep the records, which are prepared from

source documents such as invoices, credit notes, receipts and payroll records.

 When transactions are recorded in the accounting system, they are coded and

categorised so that the nature of the transaction can be analysed and entered into

the appropriate accounts in the system.

 Some transactions must be processed after they have been entered in the

accounting system. For example, invoices from suppliers are entered into the

accounting system, and must subsequently be paid. Similarly after invoices are

sent to customers and recorded in the accounting system, subsequent processing

is needed to record the receipt of the payment.

 The information in the accounting system also provides the starting point for the

preparation of the financial statements (balance sheet and income statement).

1.3 Management accounting and performance management

A cost and management accounting function should exist in all large entities, but

might not exist in smaller organisations. Its main purpose is to provide management

information.

Cost accounting

Cost accounting is a system for providing management with detailed information

about costs. The financial accounts record transactions about sales and expenses,

from which a profit or loss can be calculated. However, the financial accounts do

not provide detailed information about sales, costs and profits for individual

products or activities.

For example, for a company that manufactures cars, the cost accounting system

should provide information, for each model of car produced, about:

 what raw materials and components were used in the production of a car, and

how much these materials cost

 how much labour time went into the production of a car, and what the labour

time cost

 other costs incurred in the production of the car.

Costing systems are also used to establish costs of individual jobs or contracts, or

costs of manufacturing processes, or costs of business activities such as order

processing and order delivery.

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Detailed information about costs can help management to plan and control

expenditures, and to measure the profitability of individual products, services or

activities.

Providing management information for decision-making

Management accountants also provide information to management that should help

management to make well-informed decisions. The information is mainly financial

in nature, although some management accounting systems provide information of a

non-financial as well as a financial nature.

Examples of management accounting information include the following:

 estimates of profitability at different selling prices, which helps management to

make pricing decisions

 information about the costs and benefits of closing down an operation, which

helps management to decide whether the operation should be closed down

 information that helps management to make the most profitable use of scarce

resources, where business activity is restricted by a limited resource (such as

skilled labour)

 information about the expected costs and benefits of a proposed new capital

investment.

Budgeting and budgetary control

The management accounting function assists with the preparation of the annual

budget, which is a detailed financial plan for a specified period, usually a financial

year. Budgeting (budget preparation) involves a large number of managers, but

management accountants are often responsible for integrating the budgets of the

many different functional and departmental managers into a comprehensive

‘master budget’ for the entire business.

For example, the budget for a manufacturing company co-ordinates the following

functional and departmental budgets:

 a material purchases budget for production

 a labour budget for production activities and each production department

 a budget for other production expenses

 departmental or functional budgets for each department in administration, sales

and marketing

 a sales budget.

Budgets are based on detailed estimates of costs and sales revenues. Within the

budgeting process, management accountants are involved in establishing budgeted

costs for particular products and activities, or standard costs.

Many business organisations have a system of budgetary control. Budgetary control

is based on regular reporting (typically every month) of actual sales, costs and

profits, and comparing these actual results with the budget for the same period.

Chapter 6: Functions of accounting and internal financial control

Differences between actual performance and budget are reported as variances to the

managers responsible. These managers are then expected to:

 explain why the variance happened

 explain the measures that he is taking to deal with the cause of the variance (if it

is adverse or unfavourable).

Other performance reporting systems

A budgetary control system is a form of performance reporting system, because it

compares actual and budgeted performance. Other performance reporting systems

might be used, without the need for a budget, in which actual performance by

individuals, groups or departments is compared with a target or plan.

The management accountant is usually involved with gathering and reporting

information about actual performance within these systems.

1.4 Finance and treasury function

The finance function is sometimes called the treasury function or treasury

department. It has direct responsibility for funding and cash management.

Funding

Funding refers to long-term financing for a business entity. A business entity must

have capital (long-term financing), because capital provides essential financial

stability. Long-term finance for a company comes from two main sources:

 equity capital, also called shareholders’ capital, and

 long-term debt capital.

Equity capital is obtained by issuing new shares. The shares are purchased by

investors, who become shareholders of the company. The money they pay for the

new shares provides capital for the company.

Equity is also obtained by making profits. Some of the profits earned by a company

are paid to shareholders as dividends on their shares, but some profits are retained

within the business (and reinvested). These retained profits add to shareholders’

capital.

The treasury function is not responsible for deciding how much profit to retain.

However, when new capital is raised by issuing new shares, the treasury function is

likely to be involved in the preparations for the share issue.

Long-term debt capital can be either:

 bank loans, or

 borrowing in the form of bonds, debentures or loan stock.

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A company might issue bonds or debentures to investors as a form of long-term

loan. It pays interest on the bonds, and eventually redeems the bonds and repays

the capital borrowed.

When companies borrow through bank loans or by issuing bonds, the

finance/treasury function is involved in the process. The finance director or

treasurer will try to obtain funds at a low cost, for example by borrowing from a

bank on the best terms that can be negotiated. Having borrowed money, the

treasury function is also responsible for ensuring that interest payments are made

on time, and that the loan capital is eventually repaid as scheduled.

Large and growing companies often need to obtain new finance regularly. The

finance/treasury function provides advice to senior management on the most

appropriate method of obtaining new funds – as equity or debt capital.

Cash management

The treasury department is responsible for the management of cash. In a large

business organisation, the cashier’s section is a part of treasury, and the cashier

controls the business bank accounts. It controls payments into and out of the bank.

It is also responsible for monitoring cash flows and ensuring that there is always

sufficient cash (or unused bank overdraft) available to make payments when these

fall due.

The cashier’s department should prepare regular cash budgets that forecast cash

receipts and cash payments in the near future. In some companies, cash budgets are

prepared on a weekly or even a daily basis. The purpose of a cash budget is to check

that there will be enough cash to make essential payments. If there will not be

enough cash, measures can be taken to find the amount required (for example by

selling investments or negotiating a larger bank overdraft).

Some companies have temporary cash surpluses. A treasury function is responsible

for investing the surplus securely in short-term investments, so that the cash earns

some return until it is eventually needed.

Working capital management

Working capital management involves monitoring the total investment in working

capital. This should be a treasury concern, because working capital must be

financed.

Some of the responsibility for working capital management rests with operational

managers. Inventory control for example is the responsibility of operational

managers (and possibly also the purchasing department). The finance/treasury

department might also have some direct responsibility for working capital

management.

 The purchasing department is responsible for negotiating payment terms with

suppliers, but actual payments to suppliers are made by the cashier.

ACCA F1 Accountant in Business - 2010 - Study text - Emile Woolf Publishing

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