Accounting for Management Valley Plc

Question: Valley Plc is embarking on a profitability enhancement policy through cost savings in the current (2015) accounting period, following a dismal performance in the previous year. With revenues consistent with expectations, rising expenditure was judged to be the source of the poor performance, and the raw materials department was seen as a contributor to this. In 2014, the department spent 2m (a 70% increase on 2013)on ordering material cx235 to meet production demand and avoid shortage, using the newly approved Just in Time (JIT) inventory management system.In 2015, it is estimated that 1million units of material cx235 will be purchased by Valley Plc (consistent with 2014 production levels). The item is purchased in boxes, each containing 200 units at 4,000 per box. The cost of ordering a box can be estimated from 2014, where 2m was spent on 200 orders.The cost of holding a unit of cx235 for one year (including insurance, interest and space costs) is estimated to be 30% of the purchas e price. The new managing director has asked you, the management accountant to intervene and come up with a new inventory management system which will minimise total inventory costs. He is particularly interested in a change from the JIT system in order to utilise the spare capacity in the raw materials warehouse for the storage of cx235.Required Write a report to the managing director addressing the following issues: Discuss the role of management accounting in an organisation (make comparisons to financial accounting). Discuss the classification of costs by function (production, non-production); by type (direct, indirect); by behaviour (fixed, variable, stepped fixed). Provide examples and diagrams where necessary. Calculate the economic order quantity (EOQ) from the information provided above (place your calculation in the appendix of the report). Also calculate the total inventory cost (excluding purchase cost), the number of orders to be made in 2015, and the order frequency (i n days). Provide an analysis of the Just in Time inventory control system, contrasting it with the re-order level (two-bin) system.Discuss the benefits and limitations of both systems. Compare the total inventory cost (excluding purchase cost) for 2015 with that of 2014. Based on your calculations, make a recommendation to the managing director on the continuation or discontinuationof the JIT system. Answer: Introduction Inventory management play major role within the manufacturing company. Managing inventory help the company to keep smooth running of production, sales, and profitability with the low cost. In the contemporary business scenario most of the manufacturing business fails because of the shortage and huge amount of inventory (Stoltz, 2007). Inventory management is not been limited to the certain fixed parameters. In fact, inventory gives the company to opportunity to sell the products in the market. In order to manage and control the inventory, management accountant are being hired for making the budget and analyse the actual presence of inventory within the business. The aim of the study is to understand the importance and function of inventory management (View, 2007). The purpose and Role of management accounting In order to manage inventory, management accounting plays important role. Management accounting helps the company to understand its internal strength and weakness of the company. Management accounting plays vital role in forecasting the sales, budget and cost etc which helps the organization in decision making. Management accountant prepare these budget report and advise the company to overcome with problems (Wahlen And Brown, 2010). Some of the major role played by the management accountant is managing cost of the organizations. Management accountant dig within the company progress in order to bring actual truth for the management. Management account analysis the risk associated with the business and option available for mitigating the risk (Warren et.al. 2001). Management make strategies and plan the make sure that plan goes in right way. Management account has role to play in supervising the lower level of accountant who are responsible for managing the internal accounting of the company. It comprise of recoding of expenditure which occurred due to actual production (Weetman, 2008). These people make the standard budget which also known as the forecasted budget and match with actual budget spending. There is difference between the management accounting and the financial accounting: Management accounting: Management accounting gives the report of internal informations of the company performance. The main job of the management handling of Sales forecasting, budget, costing etc are some the major work of management accountant (Weygandt and Kieso, 2009). Management accounting is very much concern over the only particular part of the organizations which production part rather than looking after the entire organization financial health. Management accounting helps to keep up the current asset intact and cash flow manageable in order to reduce the smooth functioning of the asset. Management conduct series of internal accounting task which ensure the company has enough financial security that will be helpful for the company in near future (Brigham and Houston, 2009). There are there type of management accountants at entry level general staff or junior accountant, at middle level senior auditor and accounting manager , finally coming to the senior level CFO or auditor controller. Financial accounting: Financial accounting gives the information which is very much related to the outside of the organizations. Financial account are very much responsible for preparing the financial statements that comprises of the Cash flows, Balance sheet and Income statements for the shareholder, government, and the investors (Campbell and Shiller, 2008). Financial accounting is concern with companys entire function rather than only looking after production departments. Financial manager are very much concern over the company entire function and activities from production to official expenditure to cash inflow to cash outflows. Financial prepare financial report which cater the entire stakeholders that gives clear and concise value of the total asset and total liabilities has been occurred throughout the year (Dechow, 2008). Financial accountant need to follow the IFRS norms while preparing the financial statements. Classifications of costs By function : Classification of the cost on the basis of the function is given below: Figure 1: Classification of cost on the basis of function (Source: Finger, 2008, pp-31) Production cost are very much related with the direct and indirect cost related to the manufacturing. Some of direct cost would be raw materials and direct labour along with indirect cost are very much salary and inventory expenses. Administration cost is related with the salaries of official staff expense of the office like rent and taxes etc (Balakrishnan and Sivaramakrishnan, 2008). The administration cost also comprise of telephone cost, stationary cost and electricity cost etc which help the organization to work smoothly. Selling and distribution cost helps the company to seller their products in the market (Banker and Chen, 2006). Some of selling and distribution cost are transportation costs and warehouse rent, marketing of products via various modes , television, social media etc. By type: There are various types of cost thart are give below : Direct cost: Direct cost are those cost which is occurred during the time of products. for examples direct labour, direct raw materials and direct carriage inward etc are some of the major examples. Direct cost is those cost which helps the company to smooth running of the manufacturing. Direct cost is also known as the actual cost that firms incur while producing the products (Bjornenak and Ax, 2005). This cost is laso knwn as the Absolute cost and outlay cost. Indirect cost: Indirect cost are very much known as administrative expenses like, administrative cost comprises of the office salary, rent , taxes and telephone bill and electricity bill etc. Apart from the above, indirect expenses plays vital role in selling and distributing the goods. Indirect cost is very much are variable in nature. These cost are generally named as the non traceable cost because it can be variable in nature and does not changes as per the production. By Behaviour: While coming to the classification of cost on the basis of behvaiour are given below: Figure 2: Classification of cost on the basis of Behvaiour (Source: Chapman, 2012, pp-62) Fixed Cost: Fixed cost are those cost that does not changes as per the change in the production for examples land building, machinery , loose tools. Fixed costs are very much fixed irrespective of the production or activities (Drumm, 2008). Fixed cost are very much expensive and depreciation has to be charged as per the investment made by the company in order to be ready with money in future after the full use of machine life. Variable cost : Variable cost are those cost which varies as per the change in the production activities or sales volume. Some of the major examples of the variable cost are office salary, rent, taxes, electricity etc are some of the examples of the variable cost (Drury, 2009). Steeped fixed cost: step fixed cost is based on the changing nature of business. For examples if the business is expanding or diversifying then company is looking to increase the working hours from 20 hours a week to 30 hours for which company has to pay higher salary (Duh et al. 2009). Analysis of Inventory control systems Just in time : Just in time inventory is one of the major strategy which helps the production company to manage their inventory level intact. Just in time inventory helps the manufacturing concern to increase its ROI and maintain the optimum level of inventory management within the organizations. Some of the major companies are very much follows the JIT techniques are Toyota and Ford (Ismail, 2008). JIT approach helps the organization to storage of optimum of raw materials and excess of the inventory is waste. This is one of the major philosophies for the company. Since the above case study, Valley Plc is looking buy the more raw materials in order to manage its shortage of materials which will help the organization to cater the large customer base. Since the company is looking to spend more than 1 million in order to buy the raw materials so that there is consistency maintained within the production which can only be possible via JIT (Jong et.al. 2008). JIT is very much technical operation , it give both suppliers and the buyers and alarm when the raw materials is going to finish. JIT helps the manufacturing organization to keep intact with its minimum inventory in order to reduce the waste. JIT will also help the valley Plc to reduce its cost of products and reduce the waste which will help to reduce the carbon emission for the company (Drury, 2009).However, JIT is very much used in the large manufacturing organization because it is high costly and has multiple delivers are often made by its cycle. It increase the quality of products intact as the it reduce the traffic of operations. Record Level (bin system) Large organization who are producing large must need to understand when to re order and how much re order. Re order level help the company to keep tab with existing inventory level and required inventory level. Re order level gives the actual amount require to produce the products which will reduce the burden of traffic within the operations (Ismail, 2008). Re-order level of Valley Plc company is looking to buy the 1 million of cx235 in order to reduce the shortage of the raw materials. The cost of the re-ordering will be around 2 million for which company has to spend more than 200 hours. Reorder level will create optimum level of the demand and supply (Drumm, 2008). This can only be possible only with holding of inventory and cost of inventory in and out. In order to simplify the inventory management process there are two bin system : Two bin system: In order to explain the two bin system , considered X and Y. Here the inventory is taken from X unless the inventory X is empty company cannot order the raw materials. After the empting the bin X when the order is paced by the customers , inventory is used from Y (Drumm, 2008). this helps the company to order its raw materials while time between order is placed and sock is arriving. One Bin: The one bin system is very much adopted by the small firms where the amount of red line indicates the shortage of inventory which help the company to place the order for the raw materials. Summary Two bin From the above , it has been found that, Two bin is one of the useful way of handling the operation which helps the company to reduce its cost by managing lead time and time of arrival for raw materials for the company. Two bin has been only been made for the large manufacturing organizations (Balakrishnan and Sivaramakrishnan, 2008). For examples if the new order arrives , Y is been filled as per the its level and rest is being given to place in A. One Bin: IT is most useful for the smaller manufacturing company because it is less costly and help the company understand the actual investment made by the company. One bin method assumes lead time and demand in the lead time (Banker and Chen, 2006). It work as per the case, if the inventory fall below the red line and exceed the present inventory . Recommendations While assessing the best suitable way of pricing the manufacturing for the Valley Plc , JIT method of 2015 will be most suitable because of the cost of the products is been decreased. As the cost of inventory is been reduce by 30% which was initially more than 70%. In 2015, company has sales and are growth but the difference its income which is higher in 2015 by 10, 300,600. JIT: JIT system has help the company to use the Two Bin system that has reduced the cost of the products by more than 40% as per the Valley Plc report. JIT system will give company enough spent manage and control the process of the inventory optimally. The total inventory cost invested by the company is more than 20,300,600 which was initially more 20,70000. As per the given report and calculation done, EOQ level of the 2015 is being good because of the use of JIT that has help the company to reduce its cost. Conclusion From the above scenario, it has been found that, inventory management is one of the toughest parts for the most of the manufacturing companies. Management accountant prepares the sales forecasts and budget for the manufacturing company in order to maintain constancy within its operations. Apart from that, the study will also takes us through the difference between the financial management and management accounting. Financial management helps to see only particular department which is to manage the production efficiency whereas financial accounting looks after the entire organizations. Inventory management can be categoriesd on the basis of the fixed variables, various cost like production, selling and distribution and direct and indirect cost. 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