Fixed vs. Variable Costs
A company incurs costs during the production of its products. The costs that go into a product can be classified as either fixed or variable. Fixed costs are expenses that do not change over a period of time, irrespective of the volume of the output. Examples of fixed costs include rent on-premises, tax on property, and depreciation on equipment. Variable costs, on the other hand, are costs that vary with the volume of output produced by the firm (Marshall et al., 2020). They include such expenses as taxes, direct labor, and operation expense (Carlson, 2020). Variable costs decrease and decrease as the quantity of products changes. When the quantity produced goes up, variable costs also go up, and when the volume drops, variable costs also go down.
Fixed costs are always incurred even when the company produces zero quantity. Variable costs of a product depend on the industry. It would not be practical to compare a watch manufacturer to that a restaurant. For this reason, when making variable costs comparison, it is advisable to do so for products that are in the same industry (Marshall et al., 2020). Variable costs are calculated by multiplying the output quantity by the variable cost per unit output. Companies can also have semi-variable costs, which are a mash-up of both fixed and variable costs.
Financial Accounting
Financial accounting is a field of accounting that deals with summarizing, analyzing, and reporting a business’s financial transactions. These financial statements are usually available for the public to view. Many stakeholders would be typically interested in such financial reports, such as governments, investors, business owners, banks, suppliers, and others (Marshall et al., 2020). Financial accounting is a very strict form of accounting that is governed by local and international accounting standards such as Generally Accepted Accounting Principles that apply to virtually all jurisdictions (Marshall et al., 2020). International Financial Reporting Standards(IFRS) are a set of standards issued by the International Accounting Standards Board(IASB); IFRS standards provide guidance on how to report certain transactions in financial statements.
Managerial Accounting
Management accounting is a branch of accounting used internally within an organization by managers to inform themselves better as they decide on matters that concern the organization. It is simply a way of providing financial information to managers and directors to enable them to make better decisions (Marshall et al., 2020). Managerial accounting can also be called cost accounting. It differs from financial accounting in that it is not meant for external stakeholders and is not meant for public availability (Marshall et al., 2020). It is not historical in nature but is forward-looking. Managerial accounting is also model-based as opposed to the case-based nature of financial accounting (Marshall et al., 2020). Another difference with financial accounting is that managerial accounting is not computed based on general accounting standards but in reference to the needs of the managers using management information systems.
Advantages of Managerial Accounting
Managerial accounting can help management to prepare and execute effective business operations. In the context of Acme, costs are recalculated to help decide on whether to make a deal. It also helps in controlling as the performance of business activities is measured and compared with standard ones. If deviations are discovered, management can decide on a course of action. Budgetary control systems and standard costing can be used by management in this aspect (Management Accounting, n.d.). Managerial accounting also helps in service to customers since customers can come up with offers that may seem bad at face value, but upon further scrutiny, they end up being good deals.
Limitations of Managerial Accounting
Despite the many merits of managerial accounting, there exist some shortcomings. One demerit is that it is heavily dependent on the accuracy of financial cost records. The records determine the strength and weaknesses of management accounting. The other weakness associated with managerial accounting is that it is prone to personal bias and is not as objective as financial accounting (Limitations of Management Accounting, n.d.). Personal prejudices can seep into conclusions and recommendations. Managerial accounting is highly related to financial accounting, statistics, cost accounting, economics, sociology, and psychology. It would be effective if a management accountant had a good understanding of these other related disciplines.
Recalculating the Pickle Production Cost
In the above example (detailed in the appendix) of calculating the cost of producing pickles, the total cost of producing 9,000 cases was calculated as ($24,000+$66,000)/9,000 = $10 per case of a pickle. However, the calculation did not take into account that some of the costs are fixed while others are variable. Fixed costs from the list are line supervisors, depreciation on the factory, property taxes on the factory, and insurance on the factory. These are the costs that would be there even if the company produced zero cases of pickles. On the other hand, the variable costs increase as the volume of production increases. In this case, the variable costs are cucumbers, spices and vinegar, jars and lids, and direct labor. Total fixed costs were $24,000 while variable costs totalled $66,000.
Pickle Problem: Recalculating Cost
After separating the fixed costs from the variable ones, it has been established that Acme Pickle company’s total direct cost of producing 9,000 cases of pickles is $66,000; this amounts to $7.33 dollars per case. Since the company already made profits from the first sale that would have covered the fixed costs, selling the second batch at $9.5 per case would mean a profit of $2.16 per case. This means that they can afford to be flexible since the buyer will also be offering them free promotions. Acme Pickle Company simply can not turn down this offer and can negotiate subsequent deals.
Advantage of Recalculating
The advantage of Acme Pickle Company recalculating their cost of production is that they can use financial knowledge to make management decisions. If the company had stuck to their cost calculation and decided that they could not do business with the new client because it would have been a loss, it would have been a mistake. Recalculating can help a business make quick decisions to make a quick buck that allows them to keep producing as opposed to keeping equipment and workers idle.
Recommendations
Acme has been producing 8,000-9,000 cases of pickles for ten years. It has been reported that 9,000 cases are well beyond their break-even point, and they have already paid their fixed costs by this point. After recalculation of their cost of production, it has been established that selling at $9.50 per case will yield a profit of $2.16 per case. Since the new company will be stocking the products in a supermarket, it can be counted as free promotion, adding to the profit margin. As a matter of fact, the new supermarket will not only be stocking Acme’s pickles but will offer a promotion to encourage people to buy. It is therefore recommended that Acme accept the new offer.
Conclusion
It has been established that fixed costs are costs that do not vary with the volume of production but will be incurred even at zero output. Variable costs, on the other hand, are costs that vary with the quantity produced as they go directly into the product. Financial accounting is a branch of accounting concerned with the preparation of reports for outside parties, while managerial accounting is concerned with using financial knowledge to imagine scenarios that help in decision-making. After an examination of Acme Pickle Company’s cost calculation methodology, it was revealed that it was not the ideal way of calculating costs by lumping together both fixed and variable costs. After separating the two types of costs, it was revealed that they could manage to accept a new customer that they wouldn’t have accepted with the earlier model of calculation. This is a classic case of using managerial accounting to help management come up with a better decision for the good of the company. Management accounting also helps in the improvement of efficiency since there is an elimination of wastage in production. Moreover, management accounting helps in increasing motivation and communication.
References
Carlson, R. (2020). What every entrepreneur should know about fixed and variable costs. The Balance Small Business. Web.
Limitations or disadvantages of management accounting. (n.d.). Web.
Management accounting | advantages, merits, uses or utility. (n.d.). Web.
Marshall, D. H., McManus, W. W., & Viele, D. F. (2020). Accounting: What the numbers mean (12th ed.). McGraw-Hill.
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