Management Accounting for Engineers Lecture 3

M1 Question Paper Pattern

Management Accounting (MA)

1. Need of Management Accounting

• Management accounting provides critical financial and non-financial information to managers for decision-making, planning, and control.
• It helps in optimizing resources, improving efficiency, and achieving organizational goals.

2. Importance of MA for Engineering

• Engineers often deal with project costing, budgeting, and resource allocation.
• Management accounting helps engineers make informed decisions by providing cost analysis, profitability reports, and performance metrics.

3. Branches of Accounting

• Financial Accounting: Focuses on recording and reporting financial transactions for external stakeholders.
• Cost Accounting: Deals with the calculation and control of costs.
• Management Accounting: Provides internal information for managerial decision-making.
• Users of Financial Information: Investors, creditors, management, government, and employees.

4. Limitations of Financial Accounting

• Historical in nature; does not provide future-oriented insights.
• Lacks detailed cost analysis for decision-making.
• Does not account for non-financial factors like employee morale or market trends.

5. Importance of Management Accounting

• Facilitates strategic planning and goal setting.
• Helps in performance evaluation and control.
• Provides tools for budgeting, forecasting, and variance analysis.

6. Cost Accounting

• Definition: A branch of accounting that focuses on capturing, analyzing, and controlling costs.
• Distinguish between Cost Accounting and Financial Accounting:
  • Purpose: Cost accounting is for internal use, while financial accounting is for external reporting.
  • Focus: Cost accounting focuses on cost control, whereas financial accounting focuses on profitability and financial position.
• Items Excluded in Cost Accounting:
  • Non-operational incomes (e.g., interest earned).
  • Capital expenditures (e.g., purchase of fixed assets).
• Advantages of Cost Accounting:
  • Helps in cost reduction and control.
  • Aids in pricing decisions.
  • Improves profitability and efficiency.
• Essentials of a Good Cost Accounting System:
  • Accuracy in cost allocation.
  • Timely reporting.
  • Flexibility to adapt to changes.
  • Integration with other accounting systems.

7. Cost Classification

• By Nature: Material, Labor, and Expenses.
• By Function: Production, Administration, Selling, and Distribution.
• By Behavior: Fixed, Variable, and Semi-variable.
• By Relevance: Relevant and Irrelevant Costs.

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Inventory Management

1. Inventory as an Asset

• Inventory is often the largest asset for manufacturing and trading businesses.
• Proper inventory management ensures smooth operations and customer satisfaction.

2. Challenges of Holding Inventory

• Inventory Insurance: Cost of insuring inventory against damage or theft.
• Pilferage: Loss of inventory due to theft or mismanagement.
• Storage Costs: Expenses related to warehousing and handling.
• Obsolescence: Risk of inventory becoming outdated or unsellable.

3. Types of Costs in Inventory Management

• Holding Costs: Costs associated with storing inventory (e.g., rent, insurance, utilities).
• Ordering Costs: Costs incurred when placing orders (e.g., administrative expenses, shipping).
• Shortage Costs: Costs arising from stockouts (e.g., lost sales, customer dissatisfaction).

4. Inventory Purchase Strategy

• Bulk Purchasing:
  • Buying more inventory at once can lead to discounts and lower per-unit costs.
  • However, it increases holding costs and risks of obsolescence.
• Just-in-Time (JIT):
  • Minimizes inventory levels by ordering only when needed.
  • Reduces holding costs but requires reliable suppliers.

5. Economic Order Quantity (EOQ)

• Definition: EOQ is the optimal order quantity that minimizes total inventory costs, including holding and ordering costs.
• Formula: $$EOQ=\sqrt{\frac{2\times A\times B}{C}}$$ Where:
  • ( A ) = Annual demand
  • ( B ) = Ordering cost per order
  • ( C ) = Carrying cost per unit per year
• Explanation:
  • The EOQ formula balances the cost of ordering inventory (e.g., administrative and shipping costs) with the cost of holding inventory (e.g., storage and insurance costs).
  • It helps businesses determine the most cost-effective quantity to order at a time.

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Got it! I will now use inline LaTeX formulas within $ for inline math expressions and block-level LaTeX within $$ for centered or block-level math in markdown, as per your instructions for Obsidian. Here’s the updated solution for the illustrations:

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Illustration 4

Given:

• Annual Demand ($A$) = 2,000 units
• Storage Cost = 2% p.a.
• Interest Rate = 8% p.a.
• Unit Price ($P$) = Rs. 20
• Ordering Cost per Order ($B$) = Rs. 20

Step 1: Calculate Carrying Cost ($C$)

Carrying cost is the sum of storage cost and interest cost:

$$C=(\text{Storage Cost}+\text{Interest Rate})\times P$$ $$C=(2\%+8\%)\times 20=10\%\times 20=Rs.2\text{ per unit per year}$$

Step 2: Calculate EOQ

Using the EOQ formula:

$$EOQ=\sqrt{\frac{2\times A\times B}{C}}$$ $$EOQ=\sqrt{\frac{2\times 2000\times 20}{2}}=\sqrt{\frac{80000}{2}}=\sqrt{40000}=200\text{ units}$$

Step 3: Calculate Total Annual Inventory Cost

Total Annual Inventory Cost = Ordering Cost + Carrying Cost

$$\text{Ordering Cost}=\frac{A}{EOQ}\times B=\frac{2000}{200}\times 20=10\times 20=Rs.200$$ $$\text{Carrying Cost}=\frac{EOQ}{2}\times C=\frac{200}{2}\times 2=100\times 2=Rs.200$$ $$\text{Total Annual Inventory Cost}=200+200=Rs.400$$

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Illustration 5

Given:

• Annual Demand ($A$) = 45,000 sets
• Unit Price ($P$) = Rs. 40
• Annual Cost of Investment in Inventory = 10%
• Other Holding Cost = Rs. 1 per unit per year
• Ordering Cost ($B$) = Rs. 5

Step 1: Calculate Carrying Cost ($C$)

Carrying cost is the sum of investment cost and other holding costs:

$$C=(\text{Investment Cost}\times P)+\text{Other Holding Cost}$$ $$C=(10\%\times 40)+1=4+1=Rs.5\text{ per unit per year}$$

Step 2: Calculate EOQ

Using the EOQ formula:

$$EOQ=\sqrt{\frac{2\times A\times B}{C}}$$ $$EOQ=\sqrt{\frac{2\times 45000\times 5}{5}}=\sqrt{\frac{450000}{5}}=\sqrt{90000}=300\text{ units}$$

Step 3: Calculate Number of Orders

$$\text{Number of Orders}=\frac{A}{EOQ}=\frac{45000}{300}=150\text{ orders}$$

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Illustration 6

Given:

• Annual Demand ($A$) = 1,000 units
• Unit Price ($P$) = Rs. 10
• Interest on Locked-up Capital = 20%
• Pilferage = 5%
• Other Holding Cost = 15%
• Order Processing Cost = Rs. 100
• Inspection Cost = Rs. 50
• Follow-up Cost = Rs. 80
• Other Procurement Cost = Rs. 170

Step 1: Calculate Carrying Cost ($C$)

Carrying cost is the sum of interest, pilferage, and other holding costs:

$$C=(\text{Interest}+\text{Pilferage}+\text{Other Holding Cost})\times P$$ $$C=(20\%+5\%+15\%)\times 10=40\%\times 10=Rs.4\text{ per unit per year}$$

Step 2: Calculate Total Ordering Cost ($B$)

Total ordering cost is the sum of all ordering-related costs:

$$B=\text{Order Processing Cost}+\text{Inspection Cost}+\text{Follow-up Cost}+\text{Other Procurement Cost}$$ $$B=100+50+80+170=Rs.400$$

Step 3: Calculate EOQ

Using the EOQ formula:

$$EOQ=\sqrt{\frac{2\times A\times B}{C}}$$ $$EOQ=\sqrt{\frac{2\times 1000\times 400}{4}}=\sqrt{\frac{800000}{4}}=\sqrt{200000}=447.21\approx 447\text{ units}$$

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Illustration 7

Given:

• Annual Demand ($A$) = 8,000 units
• Ordering Cost ($B$) = Rs. 200 per order
• Unit Price ($P$) = Rs. 400
• Carrying Cost ($C$) = 20% p.a.
• Quantity Discount = 4% if order size is 4,000 units

Step 1: Calculate EOQ Without Discount

Using the EOQ formula:

$$EOQ=\sqrt{\frac{2\times A\times B}{C}}$$ $$C=20\%\times 400=Rs.80\text{ per unit per year}$$ $$EOQ=\sqrt{\frac{2\times 8000\times 200}{80}}=\sqrt{\frac{3200000}{80}}=\sqrt{40000}=200\text{ units}$$

Step 2: Evaluate Quantity Discount Offer

• Total Cost Without Discount:

  $$\text{Ordering Cost}=\frac{A}{EOQ}\times B=\frac{8000}{200}\times 200=40\times 200=Rs.8000$$ $$\text{Carrying Cost}=\frac{EOQ}{2}\times C=\frac{200}{2}\times 80=100\times 80=Rs.8000$$ $$\text{Total Cost}=8000+8000=Rs.16000$$

• Total Cost With Discount:

  • Discounted Price = $400-(4\%\times 400)=400-16=Rs.384$
  • New Carrying Cost ($C^{\prime }$) = 20% of 384 = Rs. 76.8
  • Order Size = 4,000 units
  $$\text{Ordering Cost}=\frac{8000}{4000}\times 200=2\times 200=Rs.400$$ $$\text{Carrying Cost}=\frac{4000}{2}\times 76.8=2000\times 76.8=Rs.153600$$ $$\text{Total Cost}=400+153600=Rs.154000$$

Step 3: Decision

• The total cost without the discount is Rs. 16,000, while the total cost with the discount is Rs. 154,000.
• Since the total cost with the discount is significantly higher, the quantity discount offer should not be accepted.

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Let me know if you need further clarification!

References

• Date: 2025.01.28
• Time: 10:10