Discuss usefulness and assumptions of break even analysis, What are the limitations of Break even analysis

 Usefulness of Break-even Analysis: Break even analysis is a technique of profit planning that has been used for many years by accountants, business executives and some economists. It is essentially a device for integrating costs, revenues and output of the firm in order to illustrate the probable effects of alternative courses of action upon net profits. It is an aid to profit planning. Break even analysis provides useful information to management and lending institutions (banks) in most lucid and precise manner. It is an effective and efficient reporting tool of financial management. The importance of Break even analysis can be enumerated as under.

 1) Fair knowledge about break even analysis can help bankers/banking to examine loan proposal of a firm/enterprise.

 2) Break even analysis helps the bankers in assessing working capital requirement of a unit; it comes in handy to measure the future cost and revenue relationship and also helps to determine the level of production. As and when this level is known, the enterprise can also play its future working capital requirements for the enterprise.

 3) This analysis helps in revealing clear projections of profit planning of an enterprise at different production level vis-a-vis the financial needs. It also helps to find rate of return on investment of capital at varying levels of production.

 4) It helps the banker in studying the projection cost of production and profitability statement of a unit prepared to show net position at a given level of output. Below break even point, the average loss per unit increases as the volume of output declines. When the unit functions above Break even point they can maintain their profitability and be in a position to meet their commitments and debt obligations. In other words, when once a unit Break events from then onwards repayments of debt may begin for the terms loans granted by them. Usually, till a unit reaches the Break even level of production repayment holding is granted by banks.

 5) Break even analysis is a useful diagnostic tool. It indicates the management the causes of increasing Break even point and falling profits. The analysis of these causes will reveal to management what action should be taken. As a practical matter, knowledge of where Break even lies can be quite useful to management in determining the need for action.

 Break even analysis is based on certain assumptions. These are as follows:

 1) Fixed costs will tend to remain constant. In other words, there will not be any change in cost factor, such as, change in property tax rate, insurance rate, salaries of staffs etc. or in management policy;

2) Price of variable cost factors, i.e., wage rates, price of materials, supplies, services etc. will remain unchanged so that variable costs are truly variable;

3) Product specifications and methods of manufacturing and selling will not undergo a change;

4) Operating efficiently will not increase or decrease;

5) There will not be any change in pricing policy due to change in volume, competition etc. In other words, selling price will remain unchanged as the volume expands;

6) The number of units of sales will coincide with the units produced so that there is no closing or opening stock. Alternatively, the changes in opening and closing stocks are insignificant and that they are valued at the same price or at variable cost.

 

Q. What are the limitations of Break even analysis? Ans.:

Limitations of Break even analysis:

Break even analysis is a simple and useful concept. But it is based on certain assumptions but these assumptions may limit the utility and general applicability of Break even analysis. Therefore, the analysis should recognize these limitations and adjust the data wherever possible to get meaningful results. Break even analysis suffers from the following limitations:-

 1) It may be difficult to segregate cost into fixed and variable components;

2) It is not correct to assumption that total fixed cost into fixed and variable components: 3) The assumption of constant unit variable cost is not valid; 4) Selling price may not remain unchanged over a period of time;

5)Break even analysis is a short run concept and has a limited use in long range planning. 6.Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells you

nothing about what sales are actually likely to be for the product at these various prices. 7.It assumes that fixed costs (FC) are constant. Although this is true in the short run, an

increase in the scale of production is likely to cause fixed costs to rise;

8.It assumes average variable costs are constant per unit of output, at least in the range of

likely quantities of sales(i.e. linearity);

9.(t assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period);

10. In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant);

 Though Break even analysis suffers from a number of limitations, yet are still remains as an important tool of profit planning.

What is break even point? Discuss usefulness and assumptions of break even analysis

 The Break-Even Point: The break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain, and one has "broken even". A profit or a loss has not been made, although opportunity costs have been "paid", and capital has received the risk-adjusted, expected return.

Units

Break even point is a point at which total costs just equal or break even with sales. This is the activity point at which neither profit is made nor loss is incurred. Break even point of an enterprise/firm is a point where total revenue/sale proceeds/sale or output equals total cost. It indicates that level of output/sales/sale proceeds/revenue at which the firm recovers all its costs and neither earns a profit nor incurs any loss. In other words, this is a point of zero profitability. Once the firm/enterprise crosses its break even point, it starts earning profit.

 

Break even point can be seen from the following example:

Output	Total cost	Total revenue/sales/sale proceed	Profit
200 units	Tk. 700	Tk. 600	Tk -100 i. ., loss
300 units	Tk. 900	Tk. 900	0
400 units	Tk.l 100	Tk. 1200	Tk.100

Why Management Accounting Principles & Its Objectives are Important

 Management accounting for use inside an organization must reflect the reality of the operations and resources used by the organization in monetary terms. Unlike financial reporting, where the objective focuses on external investors and creditors seek to compare investment options across the capital markets, management accounting focuses on the economic choices and constraints within an organization. There are two interrelated parts in understanding why management accounting principles are so important and how these principles help managers achieve their primary objective - enterprise optimization.

 

The first principle part deals with the actual modeling of a company's operations, where the management accountant establishes and builds causal relationships based on the principle of causality and related management accounting concepts. Part two involves the principle of analogy and the manager's analytical needs for decision support information provided by part one (its cause-and-effect relationships). Part two requires analyzing the information in light of one or more decision alternatives so that the decision maker(s) can reach the optimum decision. The cumulative application of both principles (causality and analogy) achieves management accounting's objectives and fulfills the managers' needs - the optimization of the company's operations, generally referred to as enterprise optimization.

First objective - managerial costing is:

•    To provide a monetary reflection of the provision and utilization of business resources and,

•    To provide cause and effect insights into past, present, or future enterprise economic activities.

Second objective - managerial costing aids managers:

·         In their planning, analysis, and decision making and,

·         Supports optimizing the achievement of an enterprise's strategic objectives.

The applications of management accounting's principles hold a number of benefits for an organization.

· Provide managers and employees with an accurate, objective cost model of the organization and cost information that reflects the use of the organization's resources.

·  Present decision support information in a flexible mold that caters to the timeline and insights needed for internal decision makers.

·  Provide decision makers insight into the marginal/incremental aspects of the alternatives they are considering.

·  Model quantitative cause and effect linkages between outputs and the inputs required to produce and deliver final outputs.

·   Accurately values all operations (support and production) of an entity (i.e. the supply and consumption of resources) in monetary terms.

·   Provides information that aids in immediate and future economic decision making for optimization, growth, and/or attainment of enterprise strategic objectives.

    Provides information to evaluate performance and learn from results.

·    Provides the basis and baseline factors for exploratory and predictive managerial activities

 

Concepts

The following concepts serve as operational guidelines and modeling building blocks to the two main principles (causality and analogy) in developing a reflective cause & effect model and then using the information the model provides. These concepts are intended to cover a variety of assumptions that would make up a model, their characteristics, and relationships and to provide rational perspectives when modeling many managerial costing issues.

The first ten concepts support the Principle of Causality the modeling of Cause&Effect­based modeling principles, while the remaining four concepts are applicable to the Principle of Analogy and informational in nature and supports managers with decision making guidelines.

Concepts Applicable to Causality and Modeling:

·                   Attributability

·                   Capacity

·                   Cost

·                   Homogeneity

·                    Integrated Data Orientation

·                     Managerial Objective

·                     Resource

·                     Responsiveness

·                     Traceability

·                                         Work

Concepts Applicable to Analogy and Information Use:

·                     Avoidability

·                     Divisibility

·                     Interdependence

·                     Interchangeability

Constraint

The following constraints have been identified for management accounting. The quantitative and qualitative characteristics of these constraints are meant to serve as controls or checks and balances when constructing a cost model or when using management accounting information. The first five constraints are specific to Causality in the cost model, while the remaining two constraints deal with Analogy and the use of the information.

Constraints Applicable to Causality:

·                    Accuracy

·                    Materiality

·                    Measurability

·                    Objectivity

·                    Verifiability

Constraints Applicable to Analogy Information Use:

·                    Congruence

·                    Impartiality

Note: Please refer to the Managerial Costing Conceptual Framework for a complete and detailed discussion of principles, concepts, and constraints along with their practical application within an organization.

Discuss about Management accounting principles

 Management accounting principles (MAP) were developed to serve the core needs of internal business managers to improve decision support objectives, internal business processes, resource application, customer value, and capacity utilization needed to achieve corporate goals in an optimal manner. Another term often used for management accounting principles for these purposes is managerial costing principles.

 The two management accounting principles are:

 1) Principle of Causality (i.e., the need for cause and effect insights) - the relation between a managerial objective's quantitative output and the input quantities that must be, or must have been, consumed if the output is to be achieved. Principle of Causality enables modeling the organization's costs based on the relationship between the inputs and outputs of the resources involved in the production of products and services it provides. Often this is straightforward when dealing with strong causal relationships (i.e. raw materials to make product A). However, where weaker causal relationships exist, costs need to be attributed according to the concept of attributability, which maintains the integrity of causality.

 2) Principle of Analogy (i.e., the application of causal insights by managers in their activities) -- the use of causal insights to infer past or future outcomes. Principle o1' Analogy go~erns the user of management accounting information's ability to apply the knowledge or insights gained from the causal relationships modeled (e.g., in planniny~. control, what-if analysis) using inductive and deductive reasoning about past and future outcomes for continuous optimization efforts.

 These two principles serve the management accounting community and its customers - the managers of businesses. The above principles are incorporated into the Managerial Costing Conceptual Framework (MCCF) along with concepts and constraints to help govern the management accounting practice. The framework ends decades of confusion surrounding management accounting approaches, tools and techniques and their capabilities.

 The framework of principles, concepts, and constraints will drive the classification of management accounting practices in the profession to "enable a better understanding both inside the profession and outside, of the compromises that result from inappropriate principles". Without foundational principles, managers and accounting professionals have no consistent footing on which to challenge or evaluate new theories of methods for managerial costing.

 In contrast, management accounting principles have been overlooked from both a conceptual and a standards point of view and, for the most part, overshadowed by financial accounting standards. Generally accepted accounting principles applies strictly to financial accounting because it was either the only guidance they had at the time, or did not know what else to do.

What are the Objectives of Financial Accounting , Write some Financial statements name

 Ans.:

 Objectives of Financial Accounting:

 · To kno%\ the results of the business

· To ascertain the financial position of the business

· o ensure control over the assets

· To facilitate proper management of cash

To provide requisite information

Q. Write some Financial statements name.  Ans.:

·                    Balance Sheet

·                    Cash flow statement

·                    Income statement

·                    Statement of retained earnings

·                    Notes

·                    Management discussion and analysis

Auditing

·     Auditor's report

·     Control self-assessment

·     Financial audit

·          GAAS % ISA

·     Internal audit

Define Financial accountancy

 Financial accounting is the field of accountancy concerned with the preparation of financial statements for decision makers, such as stockholders, suppliers, banks, employees, government agencies, owners, and other stakeholders. Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power. The fundamental need for financial accounting is to reduce principal-agent problem by measuring and monitoring agents' performance and reporting the results to interested users.

Financial accountancy is used to prepare accounting information for people outside the organization or not involved in the day-to-day running of the compan\-. Management accounting provides accounting information to help managers make decisions to manage the business.

In short, financial accounting is the process of summarizing financial data taken from an oroanization's accounting records and publishing in the form uf annual (ot^­rnore ti^-cquent) reports for the benefit ofpeople outside the organization.

Financial accountancy is (overned b_both local and international accounting standard;.

Describe briefly the uses and limitations of financial statement analysis.

 Financial statement analysis is a formal record of the financial activities of a business, person, or other entity. A financial statement analysis is often referred to as accounting activities, although the term financial statement is also used, particularly by accountants.

 For a business enterprise, all the relevant financial infonnation, presented in a structured manner and in a for^-in easy to understand, are called the financial statement analysis. The typical uses of financial statement analysis, accompanied by a management discussion and analysis are as:

 1. Analysis of the statement of Financial Position referred to as a balance sheet analysis, reports on a company's assets, liabilities, and ownership equity at a given point in time.

2. Statement of Comprehensive Income analysis referred to as Profit and Loss statement analysis, reports on a compani's income. expenses, and profits over a period of time.

3. A Financial statement analysis provides information on the operation of the enterprise. These include sale and the various expenses incurred during the processing state.

4. Financial statement analysis gives information about the of changes in equity which helps to explain the changes of the company's equit\ throughout the reporting period

5. Financial statement analysis provides information about cash t1o\\s which helps to prepare reports on a company's cash flovv activities, particularly its operating, investing and financing activities.

6. Financial statement analysis gives information to owners and managers to make important business decisions that affect its continued operations.

7. Financial statement analysis is performed a more detailed understanding of the figures which provide relevant information to management.

8. Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings, at these points financial statement analysis helps to them.

9. Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and are prepared by professionals (financial analysts), thus providing them with the basis for making investment decisions.

 

l0.Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.

1 l. Government entities (tax authorities) need financial statements to ascertain the propriety and accuracy of taxes and other duties declared and paid by a company.

12. Vendors who extend credit to a business require financial statemems to assess the creditworthiness of the business.

13.Media and the general public are also interested in financial statements for a variety of reasons.

Limitations of Financial Statement Analysis:

Although financial statement analysis is highly useful tool, it has limitations also. The limitations involve the comparability of financial data between companies and the need to look beyond ratios.

Comparison of one company xith another can provide valuable clues about the financial health of an organization. Unfortunately, differences in accounting methods between companies sometimes make it difficult tO compare the companies' financial data.

The analyst should keep in mind the lack of comparability of the data before drawing any definite conclusion. Nevertheless, even with this limitation in mind, comparisons of key ratios with other companies and with industry average often suggest avenues for further investigation.

An inexperienced analyst may assume that ratios are sufficient in themselves as a basis for judgment about the future. Nothing could be further from the truth. Conclusions based on ratios analysis must be regarded as tentative. In addition to ratios, other sources of data should be analyzed in order to make judgment about the future of an organization.

Define Management accounting. Explain the rule of management accounting for a Banker

 Management accounting:

Management accounting or managerial accounting is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions.

 According to the Chartered Institute of Management Accountants (LIMA), Management Accounting is "The process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources. Management accounting also comprises tine preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies and tax authorities".

 The Institute of Management Accountants (IMA) recently updated its definition as i()llows: "Management accounting is a profession that involves partnering in management decision making, devising planning and performance management systems and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization's strategy". Management accounting information is:

·      Primarily forward-looking, instead of historical;

•      Model based with a degree of abstraction to support decision making generically. instead of case based;

•    Designed and intended for use by managers within the organization, instead of being intended for use by shareholders, creditors, and public regulators:

·      Usually confidential and used by management, instead of publicly reported:

•    Computed by reference to the needs of managers, often using management information systems, instead of by reference to general financial accounting standards.

 .Role of Management Accounting are as:

 •      Breaking down of cost/expenditure into functions and processes to facilitate cost control at each operational level.

•     Developing standards for all operating areas and evaluating actuals with the standards.

·     Analyzing business and operational data.

·     Suggesting alternatives to improve productivity.

·     Identifying areas of wastages, leakages and inefficiencies or invisible losses.

·     Ensuring optimum utilization of available resources.

·     Deploying informatic tools for a management information system.

·     Contributing to Total Quality Management (TQM).

·      Assisting in decision-making process.

Management accounting tasks/ services provided:

Listed below are the primary tasks/ services performed by management accountants. The degree of complexity relative to these activities is dependent on the experience level and abilities of any one individual.

·         Rate and volume analysis

·         Business metrics development

·         Price modeling

·        Product profitability

·        Geographic vs. Industry or client segment reporting

·        Sales management scorecards

·        Cost analysis

·        Cost-benefit analysis

·        Cost-volume-profit analysis

·        Life cycle cost analysis

·        Client profitability analysis

·        IT cost transparency

·        Capital budgeting

·        Buy vs. lease analysis

·        Strategic planning

·        Strategic management advice, Internal financial

presentation and communication, Sales forecasting, Financial forecasting, Annual budgeting, Cost allocation

 Methods

1.Activity-based costing, 2.Grenzplankostenrechnung (GPK), 3.Lean accounting,

4.Resource Consumption Accounting

5.Standard costing,