Accounting Information and Management Decision Making in Business
There are certain basic concepts of accounting which will be described one by one below:-
- Accounting Entity concept: Accounting entity concept is reflected by the accounting equation: assets = liabilities or assets = Liabilities + owner’s equity. Meigs says.
- Accounting information is complied for a clearly defined accounting entity. So is a business enterprise, whether conducted as a single proprietorship, partnership or corporation.
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Accounting entity is different from a legal ending though, some accounting entities are also legal entity, for example, a corporate is both accounting and legal entity; they are estates, trusts and government agencies. But a sale proprietorship is only an accounting entity and not a legal entity since liability of the sole proprietorship is unlimited, that is, he is fully responsible for his debts.
- The going concern concept: The going concern concept has an underlying assumptions.
- That an accounting entity be continuous in its operations. It ignores immediate liquidation value in assets and liabilities in presenting the balance sheet.
It is assumed that the business continue for indefinite number of years. As such, any amount paid in advance will be spread throughout the of years covered.
Periodicity- the most appropriate and accurate time to measure the result of business activities is at liquidation. But management, owners, agencies, government and users of accounting information on a more timely bases and their interests in the business activities cannot wait indefinitely for such information.
Therefore, the periodicity or time concept status demand that the accountant divides or has to divide the indefinite life span of the business into arbitrary time periods, such time period can be monthly, quarterly or even yearly, and it is during each of these periods that the accountant submits his reports.
- The monetary unit concept: This monetary unit concept indicates that money is the common denomination used in meansuring economic activity and that money also provide the basis of measuring and analyzing accounting information, support for the assumption lies in the fact that monetary unit is relevant, simple, universally enviable and understandable.
- The consistency concept: this concept states that a particular accounting method once, adopted should continue to be used in the business from one time period to another without any unnecessary changes. This enables the users of financial accounting information to be able to interprete intelligently the changes in the financial position and the amount of net income.
- ACCOUNTING INFORMATION AND MARKETING MANAGEMENT DECISION
George (1985), opinioned that a fairly obvious business requirement is that revenue should exceed lusts in order that a profit is earned. A close obvious requirement is to decide how much profit is needed and how the business can influence the profit level achieved through its product pricing policy. In view of this fact, every firm must at same stage of it development consider the question of how to price its products or services. Even non-profit making organization must set prices which will generate the necessary funds required to conduct their philanthropic services.
The materialized industries must ensure subject to political constraints, that their output is priced at a level which will ensure an acceptable return on investment to provide contained capital replacement and growth.
Pricing decision represents perhaps, that most delicate and important of the problems facing a company. Those who are responsible for financial planning and control will also be accurately aware that relatively small differences is price can have a dramatic effect on the profitability of a product or service. For this better reason alone, an error in establishing the price can nullify at one stroke the reality of the formations plain and the most efficient control of the subsequent performance. If too high a price is set, there is a danger that there will be little demand for the product. If too low a price is set, the firm may find itself faced with unsatisfied demand.
Vause, (1983), emphasized pricing decision as the most exacting and exiting decision a manager has to under take. It brings together both quantitative and qualitative factors of the firm and its environment into single decision.
Competition by its very nature tends to set an upper limit on pricing. Whenever a company desires to make any price more, it must anticipate the action of its competitors. Firms which are operating in competition must know and the accountant can collect all available, information on their activities and supplement the sales manager’s knowledge of their marketing activities and products. Unless this information is available, the firm will be unable to predict likely competitor’s reaction and to their pricing activities. It is important to note that competitors in a poor financial situation will react to the firm’s pricing policy in a manner differing from a health company.
THE ROLE OF COSTS IN PRICING
It has often been claimed that pricing of identical products in derived from or based on costs. Akin (1975), adduced that, indeed, so far as goods ultimately have to be sold at a profit for the firm to survive, it is inevitable that lost will enter into the pricing equation in some firms. He further explained that there are two main concepts or procedures cost-based-pricing.
- Absorption of full cost pricing
- Variable cost or incremental cost pricing.
The absorption costing as opinioned by Bourke (1981) is that inventories should carry a fixed cost component because both fixed and variable cost are necessary to produce. Therefore, both of these costs should be attached to products and inventories regardless of the difference in their behavioural pattern. Thus, absorption cost pricing to put it simple, involves the principle of adding a predetermined mark-up to total unit costs derived from the formular.
Total of fixed and variable costs attributable to the products and profit percentage.
TOTAL UNITS PRODUCED
Absorption cost pricing is particularly useful where extensive contract work is involved and the pricing objective is to set a fair price as against profit maximization.
Variable cost pricing is based on the principle of relating prices to total costs but to variable cost only with the make up on cost (or the prices less variable cost if the prices are set by a procedure independent of costs) making a contribution to fixed cost and to profit, the scale of which depends on sales objectives being achieved.
Incremental cost pricing is a concept particularly appropriate to pricing individual orders, in cases where demand is made of batches, or in evaluating the relative contribution of alternative possible orders where the price available is fixed by some other means, perhaps beyond the firms direct control.
In conclusion, the marketer should set the final price based on qualitative considerations for example, likely effect on overall market penetration, competitive strength and long-term prospects. This will clearly include an element of psychological pricing. All companies are vulnerable to carry degrees of price. Some may die if they get their pricing wrong and others could gain through better pricing policies. To this later fact, Grandy, (1961) emphasized that all functional areas must therefore co-ordinate pr9icing decisions much more tightly in future using the decision support tools that are now readily available.
- ACCOUNTING INFORMATION AND PRODUCTION LINES POLICIES
MAKE OR BUYM ADD, DELETE, DROP AND EXPAND DECISION:
Decision which faces management are many and varied, these involve closing between alternative courses of action such decision takes many firms, some of which are:-
- make or buy
- add or delete
- drop or expand.
MAKE OR BUY DECISION: Manufacturers are often confronted with the question of whether to make or buy a product. Morugren, (1985), has recognized and asked the question, what are the quantitative factors relevant to the decision or whether to make or buy? The answer, again, depends on the context. A key factor is whether there are idle facilities.
DELETION OF A PRODUCT: This situation arises where a firm or department has been making losses for a long time and hence the question is whether to delete the product or leave it to continue existing.
To this decision problem, the accountant may use the incremental analysis to provide the necessary information for management. In using the incremental analysis, two specific types of costs:- avoidable cost and unavoidable costs are used in conjunction with the decision making.
Avoidable costs are those costs that will not continue if an on-going operation is changed or deleted while unavoidable costs are those that will continue even if the operation is discontinued.
Consider these three departments and the products are: G,M and D with following data.
|Sales in Naria||1900||1000||800||100|
|Less: variable cost||1420||800||560||60|
|Less: fixed costs avoidable||265||180||100||15|
The question is, should the company delete or keep the department that is making loss that G.
KEEP DROP DIFFERENCE
Sales 1900 900 1000
Variable cost 1420 620 800
480 280 200
avoidable 265 115 150
215 165 50
unavoidable 180 180 –
35 (15) 50
in this decision problem, it is first assumed that the only alternative to be considered are to drop or continue the G. department, that total assets invested would not be affected by the decision and finally, the unavoidable costs will not change. To this regard, the decision is that product G should not be dropped because, if we drop the G’s department, we are going to be worse than now buy about #50,000.00.
DROP AND EXPAND DECISION
Considering the fact that in our analysis above, dropping G should be detrimental but we have to, that the facilities of G department could be used to expand the other departments of M and D, the management is now faced with the problem of deciding whether to drop G department and expand either of M or D. the illustration above could help further in analyzing this particular decision problem. Consider the capacity released can be available for the expansion of M department and this could inverse sales by #50,000 thereby generating a 30% contribution margin ratio and also have avoidable fixed cost of #20,000.
The management is to be advised as to drop G department and expand that of M.
DROP EXPAND DIFFERENCE
Sales 1000 500 500 (A)
Variable costs 800 350 450 (f)
Contribution 200 150 50 (A)
Costs 150 70 80(F)
50 80 30(F)
from the analysis provided by the accountant, M management is left to decide whether to drop the G department and expand M, from the analysis, dropping G department and expanding M department is considerable and should be accepted by management.
- ACCOUNTING INFORMATION AND CAPITAL INVESTMENT DECISION:
The term which we are quite familiar. Wilkes, (1982) expressed both capital an investment as “capital” relates to non human resources. “investment” is a set of changes in the income stream (or more specifically, the cash flow) of a business. A combination of the two terms relating to the finance and deployment of the non-human resources, that is, capital assets, for the purposes of maximum benefit in terms of profitability.
Virtually, every organization or individual has economic limits imposed on what he wants to do and as such for longer term investments, the management should ensure that there is effective formulation of plans to meet objectives, obtaining and controlling finance respectively.
Lynch and Williamson, (1980), expressed that funds for long-term capital investments are essentially scare, the various investment projects open to management at any given time are likely to be in competition with one another.
The alert, progressive management will always be on the look-out for ways of improving the profit-making capacity of the company by wise investment of available capital.
Capital investment decision is defined by Nemmers, (1979), as the analysis of investment projects to determine the rates of return of the investment and the cost of capital required to undertake the investment so as to compare the proposed investment with other opportunity and to arrive at a decision under all the circumstances whether to make the commitment or not irrespective of real world considerations, the long-term capital investment decision facing any firm may be classified. Accruing from the investment in terms of the present value of future cash flows.
Many accountants claim it is the most realistic method of evaluating the value of capital projects because, it reveals the estimated cash flow during the life of the assets and it is also discounts such future cash flow to show the present value of them. In recognition of this fact, Horngren, (1980), asserted that because the discounted cash flow model explicitly and systematically weighs the time value of money cash, it is the best method to use for long-term decision.
There are two main variation of discounting cash flow:-
- the net present value
- The internal rate of return.
NET PRESENT VALUE
Wooten, (1985), describes net present value in a nutshell as the approach that take all the cash flow generated by an investment both negative appropriate discount rate (the company’s list of capital) and sum the discounted values. Thi methods takes into consideration, the time value of money, by postulating cash flows arising at different time periods which differ in value and are comparable only when their equivalents presents values are used.
In application of this method, the appropriate rate of interest should be chosen which is the firm’s cost of capital or its minimum rate of return expected by the investors.
Then, this will be used in discounting the cash flows and inflows to arrive at the net present value (NPU) by setting of the two opposite cash flows.
According to Pendey, (1985), net present value as a method of calculating the present value of cash flows (inflows and outflows) of an investment proposal, using the cost of capital as the appropriate discounting rate and extracting the net present value by deducting the present value of cash flows from the present value of cash inflows.
NPV = R1 + R2 — + RN – C
(1+K) (1+K)2 (1+K)N
Where R1 R2 and so forth represent the net cash flows:
K is the marginal cost of capital
C is the initial cost of the project and
N is the project’s expected life Acceptance rule: Accept the project if the net present value is positive.
THE INTERNAL RATE OF RETURN:
This is another discounted cash flow technique which considers the magnitude and timing of cans flows.
It is also called marginal efficiency of investment or (capital) or yield of an investment. Internal rate of return of a project is defined as the interest rate that equates the present value of the expected returns of cash inflows, or receipts to the initial outlay (or with the present value of cash outflows).
It is called internal rate of return because it depends solely on the outlay and proceeds associated with the project and not any rate determined outside the investment. The equation for calculating the internal rate of return is:-
R + R2 + —-+ RN – C = ).
(1+2) (1+2) (1+2)N
R1, R2 and so forth represent the net cash inflos,
R is the marginal cost of capital
C is the initial cost of the project and
N is the project’s expected life.
Acceptance rule: project are accepted if:-
IRR> Target rate of return (RR> cost of capital and ranked according to the size of the IRRs under conditions of capital rationing, then a choice must be made between mutually exclusive alternatives.
Internal rate of return is often favoured in practice because investment decision can be assessed by reference to percentages which are easily understood.
—This article is not complete———–This article is not complete————
This article was extracted from a Project Research Work/Material Topic
“ACCOUNTING INFORMATION AND MANAGEMENT DECISION MAKING IN NIGERIAN BREWERIES PLC 9TH MILE CONER NGWO”
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