Question No. 5 - MMPC-004 Accounting for Managers

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MMPC - 004 - Accounting for Managers

Solutions to Question No. 5

If you turn on the news today, you will likely see a story related to fraudulent activity. As criminals and scammers adapt to a world that revolves around the internet, committing fraud has become far easier. According to the Global Fraud and Identity Report, 33% of businesses experienced more fraud losses than they did in the prior year. Thankfully, people with excellent numerical skills are seeking employment as forensic accountants. Forensic accountants use their auditing abilities combined with investigative skills to determine what causes suspicious financial activity. Businesses use this information as credible evidence in trials and/or to recover losses from a scam.

Forensic accounting is the term used to describe the type of engagement. It is the whole process of carrying out a forensic investigation, including preparing an expert’s report or witness statement, and potentially acting as an expert witness in legal proceedings.

Forensic investigation is a part of a forensic accounting engagement. Forensic investigation is the process of gathering evidence so that the expert’s report or witness statement can be prepared. It includes forensic auditing, but incorporates a much broader range of investigative techniques, such as interviewing witnesses and suspects, imaging or recovering computer files including emails, physical searches of premises etc.

Forensic auditing is the application of traditional auditing procedures and techniques in order to gather evidence as part of the forensic investigation.

• Method of Fraud Detection in Forensic Audit

The major applications of forensic accounting include fraud investigations, negligence cases and insurance claims.

An insurance claim would require determination of how much the client should claim from the insurer. The first step would be a detailed review of the insurance policy to determine ‘coverage’, ie what is insured and any clauses that might restrict the amount that can be claimed or invalidate the claim.

The second step would be to gather evidence to quantify the loss, ie the amount to be claimed. Insurance claims might include claims following misappropriation of assets, ie theft of goods or money. In such cases, the forensic accountant will review inventory or cash records and details of sales and purchases to reconcile the amounts held and determine the value of the goods or cash stolen. They will also test the reliability of the information held by counting a sample of inventory or cash currently held in comparison with the client’s records. The forensic accountant will not assume that there has been a theft; they will consider other possibilities such as an error in the data held.

Insurance claims may however, be much more complicated than this, such as in the case of business interruptions arising as a result of fire or flood. In these types of engagements the forensic accountant will review prospective financial information in comparison with reported outturn to evaluate the loss of profit arising as a result of the business interruption. The forensic accountant will not assume that there has been any loss of profit due to the business interruption; they will consider other possibilities such as a straightforward loss of market share to a competitor.

Forensic engagements often require the forensic accountant to quantify a loss. One such engagement is in professional negligence claims, ie when another accountant has breached their duty of care to a client or third party resulting in a loss for that client. In these types of engagement, the forensic accountant would also provide an opinion on whether the duty of care owed has been breached, ie whether the audit or other accountancy service was performed in accordance with current standards in practice, legislation and techniques. In relation to an audit, this would require consideration of whether the International Standards on Auditing were followed.

The need for a forensic accountant may also arise because two parties cannot agree on the amount owed by one party to another, and the accountant is engaged to provide an expert valuation, of a business for example.

This might be the case in a matrimonial dispute, where a divorcing couple whose assets include shares in a company or partnership, engage a forensic accountant to value the company so that a settlement can be reached. A similar process might apply in partnerships, when one partner wishes to leave the partnership and is being bought out by the remaining partner(s). 

• Techniques in Forensic Audit

There are several techniques for conducting a forensic review of the business. The ones provided below are generic but effective. These are the forensic techniques that apply to almost all companies. These are:

1. Reviewing Public Documents and Conducting Background Checks

The documents made available to the public are scrutinized as they are the easiest to obtain. Also, thorough background checks of a particular company are done to see the past dealings of the business. Public Documents would include any information in the public database, the corporate records, and any legally available information on the internet.

2. Conducting Detailed Interviews

Conducting an interview is an essential technique that can transform an unwilling person into a source of valuable information. It helps in fully understanding all the facts. An interview should be conducted by accurately assessing the gravity of the situation and preparing the questions according to it. Discussions should take every detail into account and look at the greater picture to figure out the magnitude of the illegal activity and the culprit responsible.

3. Gathering Information from Trustworthy Sources

Information provided by a confidential and trustworthy source can be precious to any case. When a piece of information is gained from a confidential source or a confidential informant, all the necessary precautions should be taken to hide the identity of the so-called cause. A forensic accountant should try to have as many confidential sources as possible because such sources can virtually guarantee a correct result.

4. Analyzing Evidence Gathered

Proper analysis of the obtained evidence can point to the guilty party and assist in understanding the extent of the fraud committed in the business. Furthermore, this analysis would also help understand how secure the company is against financial scams and installing various austerity measures to prevent any such future situation.

5. Conducting Surveillance

This can be done physically or electronically and is one of the conventional measures to uncover any fraud. It can be done by monitoring and tracking all the official emails and messages.               

6. Going Undercover

This is an extreme measure and should be used only as a last resort. It is best left to the professionals as they know how and where to conduct the investigations. Even a small mistake while being undercover can signal the offender that something is wrong, and the person might vanish.

7. Analyzing the Financial Statements

This is a special tool for finding out the fraud committed. All the necessary details are summarised in the financial statement, and the analysis of these statements can help a forensic accountant figure out the scam.

Nowadays, the economic conditions are getting stricter, and each country’s government is now implementing tighter laws regarding the governance of the businesses. As the companies are increasing the level of sophistication, so is fraud. This has led to a higher sensitivity to fraud which can be interpreted as massive demand for the services of forensic accountants by all the businesses.

Question No. 3 - MMPC-004 Accounting for Managers

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MMPC - 004 - Accounting for Managers

Solutions to Question No. 3

Variance analysis can be summarized as an analysis of the difference between planned and actual numbers. The sum of all variances gives a picture of the overall over-performance or under-performance for a particular reporting period. For each item, companies assess their favorability by comparing actual costs to standard costs in the industry.

For example, if the actual cost is lower than the standard cost for raw materials, assuming the same volume of materials, it would lead to a favorable price variance (i.e., cost savings). However, if the standard quantity was 10,000 pieces of material and 15,000 pieces were required in production, this would be an unfavorable quantity variance because more materials were used than anticipated.

When standards are compared to actual performance numbers, the difference is what we call a “variance.” Variances are computed for both the price and quantity of materials, labor, and variable overhead, and are reported to management. However, not all variances are important.

Management should only pay attention to those that are unusual or particularly significant. Often, by analyzing these variances, companies are able to use the information to identify a problem so that it can be fixed or simply to improve overall company performance.

There are several types of variance analysis that companies can use. For example, companies can use sales or cost variances to examine specific areas of interest. Similarly, companies may further divide variances into those caused by prices and those caused by usage or efficiency. Some companies may also use variance analysis to investigate product mixes, yields, or for planning variances.

The variance analysis process starts with establishing standards or preparing forecasts. Once companies do so, they must monitor their actual performance closely and identify any inefficiencies. Sometimes, the process may not be as straightforward, though. Therefore, companies will have to wait until the end of their accounting periods to obtain actual performance results.

Need and Importance of Variance Control

Variance analysis plays a significant role in management and cost accounting. These are both areas in accounting that relate to controlling, monitoring and decision-making. Companies primarily use variance analysis to monitor actual costs and control them when needed. However, there is much more to that process apart from the basics.

Variance analysis can be of significant importance to companies for the following reasons.

1. Acts As A Monitoring And Control Tool

Technically, variance analysis isn’t a monitoring tool. Instead, forecasts and budgets provide a basis for analyzing costs. However, companies cannot actually monitor their costs if they don’t compare them with actual results. It is where variance analysis is helpful. Companies can use variance analysis to calculate any differences between budgets and actual results. Through this process, companies can actively identify any efficiencies and eliminate them on time. This way, companies can control any deviations from the set plans for performance. Similarly, companies can also accumulate all the information and perform variance analysis at the end of each period. Based on this process, they can make changes that can help avoid any inefficiencies in the future.

2. Focuses On Favourable And Adverse Variances

Unlike some other tools, variance analysis focuses on both favorable and adverse variances. Although favorable variances are beneficial for companies, they still need to the reason behind it. Sometimes, these variances may come from miscalculations or improper budgeting, which companies should investigate. If that is not the case, companies still need to understand how these variances generated so they can build on the favorable performance. Adverse variances, on the other hand, are harmful to the company. By analyzing these, companies can identify problem areas within their processes. By doing so, they can eliminate any problems which can be beneficial in the future. Some companies may only focus on adverse variances, though. However, variance analysis provides a tool to identify both favorable and adverse variances.

3. Considers Significant Variances

Variance analysis is a great tool to catch and rectify significant variances. Companies can suffer variances in actual performance due to several reasons. Sometimes, these reasons may be random or seasonal. However, variance analysis allows companies to adjust for these variances and allows a better performance analysis. Similarly, variance analysis allows companies to consider material variances only. During the process, companies can set a threshold for the difference that they want to investigate. If any variance does not meet this threshold, companies can ignore that. This way, the process is much straightforward.

4. Detects Inefficiencies In Planning Or Operations

Variance analysis takes a budget and compares actual performances with it. However, it doesn’t focus on operational inefficiencies only. It also allows companies to examine their budgets for any unrealistic expectations. This way, companies can identify any problems with their forecasts and rectify them for the future. Most of the time, however, variance analysis catches operational inefficiencies. It is one of the reasons why companies use it. Operational anomalies are common in every business environment. By identifying these, companies can uncover any problematic areas within their process and correct any errors.

5. Provides A Basis For Accountability

As mentioned, companies may focus on variance analysis toward specific areas. This way, variance analysis can allow companies to hold their managers accountable for their performance. Furthermore, companies can differentiate between controllable and uncontrollable variance. Through this process, they can further identify the departments or managers responsible for variances. Some companies may also use variance analysis as a part of their performance appraisal. Similarly, companies may also reward managers for favorable variances. This way, variance analysis can provide an accountability tool for companies. Likewise, if the expectations are reasonable, companies can use variance analysis as a motivation tool.

Question No. 2 - MMPC-004 Accounting for Managers

 

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MMPC - 004 - Accounting for Managers

Solutions to Question No. 2

Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical manner than the traditional approach of simply allocating costs on the basis of machine hours. Activity based costing first assigns costs to the activities that are the real cause of the overhead. It then assigns the cost of those activities only to the products that are actually demanding the activities.

Let's discuss activity based costing by looking at two products manufactured by the same company. Product 124 is a low volume item which requires certain activities such as special engineering, additional testing, and many machine setups because it is ordered in small quantities. A similar product, Product 366, is a high volume product—running continuously—and requires little attention and no special activities. If this company used traditional costing, it might allocate or "spread" all of its overhead to products based on the number of machine hours. This will result in little overhead cost allocated to Product 124, because it did not have many machine hours. However, it did demand lots of engineering, testing, and setup activities. In contrast, Product 366 will be allocated an enormous amount of overhead (due to all those machine hours), but it demanded little overhead activity. The result will be a miscalculation of each product's true cost of manufacturing overhead. Activity based costing will overcome this shortcoming by assigning overhead on more than the one activity, running the machine.

Activity based costing recognises that the special engineering, special testing, machine setups, and others are activities that cause costs—they cause the company to consume resources. 

Under ABC, the company will calculate the cost of the resources used in each of these activities. Next, the cost of each of these activities will be assigned only to the products that demanded the activities. In our example, Product 124 will be assigned some of the company's costs of special engineering, special testing, and machine setup. Other products that use any of these activities will also be assigned some of their costs. Product 366 will not be assigned any cost of special engineering or special testing, and it will be assigned only a small amount of machine setup.

How to determine the cost under ABC

Activity-based costing includes the following steps:

• Identify activities that are required to complete a product.
• Trace costs to activities and objects and then assign them to different pools.
• Assign specific drivers to each pool, like an hour or unit.
• Calculate cost driver's rates by dividing overhead costs by total cost drivers.
• Divide the total overhead of each pool by total cost drivers to get the cost driver rate of each.
• Multiply your cost driver rate by the number of cost drivers.

You can compare activity-based costing to absorption-costing. Absorption-costing refers to equally assigning the value of overhead costs across all inventory. This accounting method doesn't account for products that may have higher indirect costs, but activity-based costing does.

Benefits of ABC

1. It gives you a realistic and more accurate production cost of specific items

Activity-based costing gives managers more accurate production costs. This can help businesses make more informed decisions about which products to produce or help them find cheaper methods of production. It can also help when determining pricing for individual products.

In addition to having a clearer understanding of the manufacturing costs, the process of gathering the data is also easy with activity-based costing. Most management members can identify the costs of each activity once they have the necessary data. This may also help with making production decisions that affect pricing.

2. It allows you to assign specific overhead costs to more expensive products

Instead of assigning an equal value to all products, you can allocate the necessary budget in each area when using activity-based costing. Some products may be costlier to produce, depending on their indirect costs. This can also help with identifying costs that apply to more than one pool of manufacturing products, which can make resources more valuable.

3. It allows you to evaluate the efficiency of productions and make improvements

This method allows managers to assign value to indirect costs, treating them as if they were direct costs. By breaking down the indirect cost of each activity, they can make improvements. Managers can use the activity-based costing method to evaluate things like management influence, efficient processes and the overall cost of different departments.

4. It gives you more accurate data for profit margins

Because activity-based costing accounts for non-manufacturing costs or indirect costs that you may not have otherwise considered, it can help with improving profit margins. Having more accurate profit margins can help business leaders make important decisions. It can also help reduce or transfer production costs, allowing management to improve their profit margins even further with effective pricing strategies.

Managers can easily identify products of little to no value when using activity-based costing. They can use this information to remove products from inventory and to allocate those manufacturing resources to more profitable items. It also makes it easier to identify products that can be wasteful when it comes to required resources. Some products may not only be of low value but also use necessary resources.

5. It provides benefits in industries that other methods don't work

Traditional costing methods don't always work in certain industries, such as the service industry. This is because service industries have minimal direct costs. However, you can use activity-based costing in these industries since you apply the cost directly to the type of service. This means you can use it to improve results and pricing in industries that are otherwise left out.

Question No. 4 - MMPC-004 Accounting for Managers

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MMPC - 004 - Accounting for Managers

Solutions to Question No. 4

Question No. 1 MMPC-004 Accounting for Managers

 

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MMPC - 004 - Accounting for Managers

Solutions to Question No. 1