Pedro: “Nuts”

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In order to build up a selling price of a product, it is important that costs are communicated in the best way possible; this can be easily done by effectively making use of management accountant’s role whereby they are able to distinguish what costs are used for a product through cost classification and assigning them to cost objects. Product costs are described by Drury as cost which are “associated with goods purchases or produced for resale”, this is shown in the case of Pedro as the manufacturing costs of the peanuts that he is selling. In terms of costs assigned to cost object, it is clear that indirect costing has been used which are described as costs which cannot specifically be involved with a product. According to the extract we can identify that fixed production overheads include the rent of the restaurant, heating and lighting, weekly cleaning and wages of the cook and waitress.

In relation to the extract it is clear that Hugh Knock has based his thinking on the costing procedure known as absorption costing. CIMA (2005) has defined Absorption costing as “as cost accounting method which assigns direct costs or a proportionate part of overheads to cost units by use of one or more absorption rate”. Within absorption costing there are four techniques which you are required to undertake, these are to identify indirect cost, absorb the indirect costs, once absorbed it is necessary to apportion the costs fairly and then allocate them to the costs of the peanuts to establish a sufficient selling price and stock valuation.

Identification of direct and indirect costs are essential to Knock because it distinguishes shows whether he would base his thinking on either marginal or absorption but in the case of Pedro due to most costs being indirect to the product as they are already manufactured and for reselling purposes it is clear that absorption costing is necessary. By absorbing the fixed overhead costs such as the rack, it allows knock to recover the fixed costs by allocating them according to the amount of square feet it takes up on the counter and obtaining an absorption rate, if the actual is more than the budgeted then it suggests that you have over absorbed and if the budgeted is less than the actual volume then you have under absorbed.

Apportioning is a method whereby costs are shared out amongst various departments, it is important to appropriately apportion overhead costs fairly by different proportions due to differences in product sizes it may mean that in Pedro’s case the counter will be apportioned to the 50 units currently held however if it stock decreases or increase then it will have to be reapportioned in order to be efficient because you cannot have the same figure once stock levels have altered.

Drury (2008) has described cost allocation as “the process of assigning costs when a direct measure does not exist for the quantity of resources consumed by a particular cost object.” By Knock following the other methods stated earlier the allocation of cost will enable him to see what costs exist for each cost object which essentially allows him to identify a recommended price to Pedro which he can use to internally measure performance by profits and utilise it to help for decision making procedures.

To conclude, Hugh has supported his judgment using absorption costing, which has enabled him to positively approach building up the selling price of a bag of peanuts in steps to ensure the total costs have been included. As seen in the extract Hugh after taking the necessary four techniques was able to justify each cost so Pedro could understand his mistake to his original approach. Therefore by absorption costing, it is possible to estimate the selling price including profit margin which was originally stated by Hugh as $2.64, which gave the total cost of peanuts. However, Pedro stated ‘I will make a clear profit of 16 cents a bag’ , this assumes that in order for him to receive a profit from each sale 16 cents needs to be included in the selling price; this further raises the selling price stated by Hugh from $2.64 to $2.80.

“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.

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