PART B
As stated in part A , it was identified that Hugh Knock has based his thinking on absorption costing; therefore, it is vital to understand the necessity of the procedures undertaken by Knock. Absorption costing possesses many benefits according to (Bhattacharyya 2011) it recognises the importance of including fixed overhead costs in production by absorbing them. It allows Pedro's nut stock inventory from use of overhead absorption rate(OAR) to be accurately evaluated as seen in the extract, Hugh Knock has identified that his venture’s total cost will amount to $5625. Another aspect of the absorption costing is that it is required draw up financial accounts and due to absorption costing incorporating OAR; it allows profits to be higher.
We know from the extract that Pedro operates an Italian bar and restaurant which suggests his business sells more than one product, therefore with the use of the absorption costing procedure it assists in both Knock and Pedro to judge how profitable each product they sell due to costs being fairly shared and apportioned to ensure that it will be charged to the selling price of the peanuts. (RESOURCES 2011)
The use of absorption costing has allowed Knock to explain to Pedro the full costing's of the production of his peanut venture and resulted in him estimating a selling price which includes a sufficient margin of profit; earlier as mentioned in part a, the full costs per bag of peanuts was $2.65 but including Pedro's preferred 16 cent profit it rose to an estimated selling price of $2.80.
Overall, the benefits of using a absorption costing procedure is to that it is a cost control tool, which in the case of Pedro clearly identified the most realistic price to charge to consumers to establish if a profit was being made but also to compete with competitors, to understand if production within the business is efficient and if it is inefficient then it is clear another cost evaluation is required and to ensure we comply with SSAP 9 legislation of using absorption costing for external reporting to be consistent with stock valuation.
PART C
As stated in Part B, I explained why absorption costing procedures are necessary. However in relation to Pedro’s business it is clear that absorption costing can prove to have limitations as Hugh mentions “the bigger the operation, the more general overhead costs that must be allocated”, which means an increase in stock will suggest an higher absorption rate which will be ineffective for Pedro to implement because it will mean that he will incur higher costs than planned. In terms of decision making, absorption costing is not the most favoured in assisting with managerial decisions because it only considers total production overheads and ignores cost volume profits resulting in managers making a decision based on own initiatives.
Marginal costing as described by CIMA terminology is “ assignment of only variable to costs to cost units while fixed costs are disregarded as period costs”, which shows that this method only looks at variable costs of production overheads as they not absorbed into products; in other words the cost margin of producing an additional unit. A marginal costing technique which is subsequently useful and not included in absorption costing is the concept of contribution which is sales revenue less variable costs incurred, this acts as basis in identifying the profitability of a product or service.
Unlike absorption costing marginal costing values inventory at variable cost and essentially means that unfinished or finish stocks will be accounted for within the calculation this proves to be a limitation as it does not comply with the SSAP9 legislation of stock valuation because of the element of fixed production costs not being absorbed in stock. Also marginal costing can lead to under-pricing at the margin especially if the level of contribution is low.
Therefore, although it is clear that Pedro is at currently looking as his peanut venture costs from an old fashioned perspective, it is clear that he still needs to focus his enterprise on absorption costing, however as Pedro stated "I started a plan to gets some more money to go and see Momma or the super reds, Barnsley, Barnsley" , this suggests that Pedro intentions to pursue trading in the nut industry was on a short term profit plan , just to gather funds to go abroad or to attend a football match. Therefore, Knock should have opted to use a marginal costing procedure as it does not include use of an overhead absorption rate and dismisses fixed costs which ultimately would have been easier and quicker for Pedro during his short term decision making process.
In terms of whether Knock should be applying those accounting policies and procedures, it is clear that marginal costing would be the best suited option for Pedro’s peanut venture because it is a simple costing methods which is better for managerial decision making because it identifies variable costs and contribution which assists in budgeting is essential for Pedro at this early stage, also it avoids identifying a overhead apportionment basis due to not incurring fixed costs which suggests it is less time consuming compared to absorption costing.
PART D
The definition of accounting as described by Wood & Sangster (2008) is:
"The process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of information"
Financial accounting is defined as the recording of transactions, for example, sales of goods; also it includes the preparation of financial statements such as cash flow forecasts and profit and loss statements. This type of accounting is used by large range of external parties for example in particular shareholders. Financial accounting as stated by Drury (2008) is "concerned with the provision of information to external parties outside the organisation" , which suggests that specifically they only look at accounting information that is required to be seen by persons who have an genuine interest in the organisation such as investors.
Governmental agencies such as Her Majesty Revenue & Customs (HMRC) are required to collect financial information for taxation purposes in order to record if a company is paying the right amount of tax such as corporation tax.
In addition, HMRC make use of this financial data to identify the effects the institution has on the economy in terms of improving economic growth by increasing aggregate demand factors. Shareholders in particular are those who have an interest in the business, and most notably have own a share within a company. Hugh Knocks stated “the business made a profit” which relates to financial accounting because shareholders within a business are required to understand the financial position within the company due to having a shared investment including interest in the company but also essentially due to there aim to get a dividend, in other words is a payment is given to them at the end of the financial year once a profit is made. Therefore the need of shareholders in a business is important because it helps not only in monetary value as it makes capital easier to obtain if needed but also it assists towards the businesses performance as the input they provide may improve the business overall.
Within financial accounting profit and loss is a characteristic which enables a firm to identify performance of the company as a whole , because an organisation has managed to make a profit it suggests all costs have been covered and additional revenue has been made to either provide dividends payments to shareholders if necessary or retained as profit to be invested back into the business whereas if the company make a loss this shows that total revenue was not high enough to cover operating costs resulting in shareholders not being able to get a return on there investment and shows that your venture has proved unsuccessful .
According to Gowthorpe (2008), management accounting is described as “Accounting carried out within a business for its own internal uses to assist management in controlling the business and in making business decisions"; unlike financial accounting, it is used to look at accounting information internally within a company and is seen as reliable, secure and confidential in the case of decision making, There role in accountancy is specifically to provide and communicate economic information to managers within an organisation to establish informed judgements and decisions according to American Accounting Association , management fulfil many roles and are considered ultimate decision makers in a business. In order for managers to proactively establish decisions, they can do so by utilising Fayol’s Function of Management; he stated that you need to do implement the following six role which are Forecast, Plan, Organise, Communicate, Coordinate and Control, in order to make the decision making process less tedious for managers to essentially come to a successful conclusion for there business decisions.
In relation to Pedro’s peanut venture, it is essential that he forecasts in order to look into the future; this can essentially be done by use of a sales budget which is necessary to both Knock and Pedro as it show predictions of total revenue gained from the volume of sales which is the case of Hugh’s estimated calculations could equate to $132 weekly revenue based on selling price of $2.64, multiplied by weekly units sold of 50 bags. Planning is a role which is vital to Pedro’s nut business because he needs to plan the amount of units needed to be sold in order to cover his operating cost but ultimately to make a profit. Without organisation Pedro will be unable to organise redelivery of stock, labour provided by the cook and arrange payment to his window cleaner.
Communication is necessary to a management accountant as you are able to effectively discuss and maintain activities suggested by the accountant and to come to distinct conclusions if current businesses are inefficient and provide improvements. Coordination is essentially important because Pedro is required to work together with Hugh Knock in order to unite to make improvements to his current venture activities. Control is important to Pedro as it ensures that everything targeted conforms accordingly against actual outcomes and will show the performance of an organisation because if Pedro does not sell the recommended target selling price by Hugh then he will make a huge loss which may hinder his current business in the long term.
However, years later another philosopher called Tocher researched further to gain a in-depth insight into Fayol’s ‘control’ function of management, to assist managers in becoming complacent with procedures and policies. Tochers four conditions of control as stated by J.Joyce are to state objectives which in the case of Pedro could be to make a short term profit from his new venture, Pedro’s ability to measure progress towards the objective would be to weekly break even on his peanut sales, a predictive model that’s can be undertaken is to ask Hugh Knock to for assistance in making informed judgements for the business and the ability to take control is to ensure that he seeks Hugh’s attention early in his decision making process.
To conclude, the statement by Hugh Knock “The sole purpose of accounting is to ensure that all costs have been covered, the business made a profit and that shareholders know about” is incorrect due to his generalised view that there is only one type of accounting, this has resulted in his hypothesis being unbalanced. It is important to understand that there are many different types of accountants within business of which there roles differ in accordance to an organisation. Since management accountants act as internal decision makers within an organisation ultimately they will want to ensure costs are classified and fully covered to allow businesses to operate efficiently, however, it is necessary not to dismiss that it requires information from financial accountants to assist with its key decision. Whereas both management and financial accountants essentially aim for an organisation to make a profit, it is more important for financial accountants to inform shareholders of the financial position of an organisation as they need to ensure whether they will get a return on there investment they opted in after purchasing shares on the stock exchange, these returns are in the form of dividend payments which can be made annually or on a quarterly basis.
BIBLIOGRAPHY
Books
Drury, Colin (2008). Management and Cost Accounting. 7th Edition. , Hampshire. Cengage Learning EMEA
Gowthorpe, Susan (2008). Management Accounting, London. Cengage Learning EMEA.
Wood, Frank & Sangster, Alan (2008). Frank Woods Business Accounting: v.1, 11th Ed. United Kingdom, Business Financial times/Prentice Hall
Electronic Books
CIMA Official Terminology, 2005 Edition [online].Oxford, CIMA Publishing. Book from Scribd, last accessed 10 February 2012 at:
Dutta, Manash (2004) . Cost accounting. Principles & Practices. [online]. Singapore, Pearson. Book from Google Books , last accessed 11 February 2012 at:
Debarshi, Bhattacharyya (2011) pp 616 Management Accounting, 1st Ed. [online] India, Pearson Education. Book from Google books, last accessed 11 February 2012
Web Pages
Marginal Costing and Absorption Costing (2011) [online]. Last accessed 10 February 2012 at
CAT – ACCA Resources (2012) Reasons and justifications for using Absorption costing (advantages) [online]. Last accessed 12th February 2012 at :
Hubpages (2011) Managerial accounting – Absorption, variable and throughout costing [online]. Last accessed 14 February 2012 at :
