Use of Relevant Costs in Company Decision-Making: Noble Energy - Case Study Example

Noble Energy Inc. 17th, March Table of Contents Table of Contents 2 Introduction 3 Company Background Information 3 Use of Activity Based Costing (ABC) in the Company 4 Use of Standard Costs in the Company 9 Use of Relevant Costs in Company Decision-Making 10 Conclusion 12 References 13 4 -Traders. (2012). Noble Energy, Inc.: Noble Energy Announces Highlights of 2012 Analyst 13 Conference. Retrieved from http://www.4-traders.com/NOBLE-ENERGY-INC-13688/news/Noble-Energy-Inc-Noble-Energy-Announces-Highlights-of-2012-Analyst-Conference-15578867/ 13 Introduction The use of cost accounting is critical to many companies. This involves the evaluation of the costs incurred by a company in conducting its business. Therefore, the company managers use this approach to help in determining the type of costs and amount of cost the company needs to maintain its stature in the market, during the present and future times (Jablan, n.d). Cost accounting also helps company managers to make important decisions in management, through the data presented by this approach. There are various types of costing systems, from which a company chooses, depending on its specific suitability, including cost based costing and standard costing, among others (Jablan, n.d). This research paper mainly focuses on aspects of cost accounting in Noble Energy Inc. This is an international energy company based in the USA. However, specific attention is given to the applicability of activity based costing and standard costing in the company. In this paper, I will first briefly provide background information of Noble Energy Inc. After that, I will analyze the use of Activity Based Costing and standard costs by Noble Energy, and how these types of costing systems will influence the company. This is mainly a qualitative research, and most information is from textbooks with relevant information, as well as credible websites, such as that of Noble Energy. Analysis of information will mainly draw from the processes in the company, including its operations, and plans. Company Background Information Noble Energy, Inc. is among the top ranking independent public energy companies in the United States of America. This company was founded in the year 1969, and today, it has its headquarters in Houston, Texas (Noble Energy, n.d). Noble Energy Inc. specializes in the industry of oil and gas extractions. As an oil and gas company, it is engaged in activities of exploring oil and gas sources. After accessing and acquiring the oil and gas resources, this company develops them, and produces them. Finally, the company performs marketing of its natural gas and crude oil, which it has worked on to the final process. Noble Energy Inc. values its shareholders, as it includes them in its goal, in which it aims at ensuring that its shareholders get worthy returns. This company is also faced with great responsibilities in its operations. It offers a variety of products and services, including marketing and production, among others (4 -Traders, 2012). This company was founded in the year 1969, and therefore, is old enough to consider itself to be among the top pioneers of the sector of energy. As a pioneer in this sector, Noble Energy has a vision of ensuring that it becomes the best company in the energy sector, at both the national level and the international level (Noble Energy, n.d). In order to achieve this vision, the company has adopted various strategies, such as investing in technology and in people, making use of the opportunities that add value to it, and opening up to newer opportunities in the industry. On environmental conservation, the company has stakeholders who are environmentalists, governors, and legislators, who all emphasize and monitor environmental considerations by the company (4 -Traders, 2012). As far as competitors are concerned, Noble Energy faces strict competition from other companies in the energy sector, including Chevron Corporation, Anadarko Corporation, and Abraxas Petroleum Corporation. However, Noble Energy has managed to compete favorably in the market, beating its competitors, and by end of 2011, its revenue stood at $3.76 Billion (4 -Traders, 2012). Use of Activity Based Costing (ABC) in the Company Costing systems are pivotal in the general accounting systems of organizations and companies. Each company adopts a costing system depending on the nature of its operations, as well as its financial standing. The costing system chosen by a company, regardless of what type it is, helps a company to keep its focus on the expenditures it incurs. The expenditure of a company is then incorporated into the mainstream accounting system of the company (CIMA, 2008). According to Bradtke (2007) a costing system is important, basing on the fact that it allows for easy financial reporting of the company. In addition, it helps the management team of the company in the identification of the company’s performance and operational costs, for better financial management of the company. As mentioned, there are different types of costing systems, which companies can adopt. Nonetheless, a company will only adopt one that fits it. For Noble Energy Inc. the Activity Based Costing (ABC) could be of benefit to it, if employed and adhered to. The Activity Based Costing is a type of costing that was developed in the mid-nineteenth century. Different studies have shown that this has had positive impacts on the organizations that adopted it, even though today, this costing system is not adopted by most organizations (Bradtke, 2007). In the Activity Based Costing, the cost of products and services in a company is determined by using both direct and overhead costs. Therefore, the cost of products and services will include the cost of the resources used on them, thus component product pricing is employed. Various procedures are involved in the process of ABC, including the analysis of activities, gathering information about cost, relating different costs to the activities involved, and the analysis of the cost, which has been arrived at (Bradtke, 2007). I have settled on ABC as a preferable costing system for Noble Energy Inc. because of one major reason. Noble Energy Inc. is an oil and gas company. Therefore, this company engages in a myriad of activities and processes, which cost it. Therefore, I consider it sensible for the company to determine the cost of its products, including services, basing on the cost of all the activities and processes it undertakes in production and other stages. The ABC therefore, is the only costing system, which would fit in this description. According to Inkpen & Moffett (2011), some of the costly processes and activities that Noble Energy undertakes can be divided into three main categories, including the primary phase, the secondary phase, and the tertiary or service phase. In the primary phase, the company engages in activities involving the exploration and extraction of gas and oil resources, mainly through mining. In the secondary phase, the company has now accessed and acquired the resources, and therefore, is now concerned with developing them into products, transforming them from their state of raw materials. In the final stage, which is tertiary or service stage, the company delivers its products to its customers (Inkpen & Moffett, 2011). Therefore, Noble Energy participates in all the processes of refining raw materials to delivering finished products. This company engages in a long chain of production, from extraction to refining and finally delivering to customers. In all these processes, the company incurs costs. Different skills and expertise are needed at each stage; therefore, the company has to pay for the employment of engineers, geologists, business analysts, environmentalists, among other related professionals. This is in addition to purchase of equipment for the various processes (Inkpen & Moffett, 2011). Therefore, all these costs by the company can be attached to the cost of products and services, using the Activity Based Costing system. Noble Energy is an international company, therefore, just like any other company, there are ramifications that will be realized when this company chooses to use the Activity Based Costing system. Kaplan & Anderson (2007) note that, the major effect of adopting an ABC in the international business environment is that this might present challenges in the company’s financial reporting. They argue that the reports in ABC are not in line with the generally accepted accounting principles (GAAP). In this case, therefore, Noble energy, or any other international company that adopts ABC might be forced to incur additional costs, since as such, the company will need to develop another cost system that conforms to the reports in the external business environment. Therefore, the ABC could be used only for the internal purposes in the company (Kaplan & Anderson, 2007). In addition, an international company might face more loses in the international business environment, if it adopts Activity Based Costing. This is because; this costing system does not identify and include all activities in the company, which are involved in the development of products and services. For instance, this system fails to account for the extra activities that employees are involved in in the process of product development in the company. This includes activities such as first aid services, which help develop the company product and services (Kaplan & Anderson, 2007). Therefore, there might occur cost leaks and disparities in pricing of final products and services, which might make the company to compete unfavorably in the international market. Nonetheless, Activity Based Costing is known to give precise estimations of the cost of products and services, despite the mentioned flaws it bears. This system also helps a company to identify its products, which do not contribute to profitability of the company, due to their inefficiencies. Therefore, such products by a company could be eliminated from the international market. These then cease to be part of the company’s product line, and are replaced by more profitable products, and this does not come with an increase in product pricing. In the international business environment, this is beneficial, especially in today’s hard economic times, as it lowers level of loses (Bradtke, 2007). Distribution of costs during ABC In Noble Energy, costs are distributed through the various activities in the company. All companies in the energy sector, despite of the costing system they adopt, will experience costs in the activities they are engaged in (Editions TECHNIP, 2007). Therefore, in Noble Energy Inc. the cost distribution will be as follows: a) Acquisition Costs For Noble Energy to begin its exploration of oil and gas resources, it must have the right to do so. These rights of acquisition come with a cost, and include the cost incurred in purchasing or leasing a property, which does not belong to the company, where the extraction of oil will be conducted. This cost also includes the compensation that is given to the owner of that particular property. In addition, this will involve legal procedures, which also payments, among many other procedures that will call for payments in this process (Wright & Gallun, 2008). The Activity Based Costing system puts the acquisition costs into consideration. b) Exploration Costs In the exploration stage, Noble Energy Inc. will spend financial and non-financial resources in analyzing and evaluating the targeted area to determine its accessibility. This involves employment of skills and expertise, as well as purchase of equipment, such as drilling equipment, to facilitate the process. In the drilling activity, the costs that are incurred include both tangible and intangible costs (Wright & Gallun, 2008). The Activity Based Costing system identifies both tangible and intangible costs, and applies them in product pricing. c) Development Costs Development costs are those that will be incurred by the company while it attempts to gain access to the oil resources in the identified site. This involves activities such as drilling, installation of extractors such as pumps, and storage equipment such as tanks (Wright & Gallun, 2008). Activity Based Costing also capitalizes on activities in this stage, as these equally cost the company of considerable resources. d) Production Costs The company incurs production costs during the process of extraction. They include the payments made to the skills and expertise employed in the process, in form of labour. In addition, electricity costs for pumping oil are also included here (Wright & Gallun, 2008). This is a core process in all companies, which influences product pricing. Nonetheless, ABC recognizes activities in this stage, and links their cost to pricing of products and services. Use of Standard Costs in the Company According to Berger (2011), standard costing system is a form of cost accounting, which estimates or determines the cost of production of goods and services under the normal circumstances. Standard costs are considered to have a close relation with actual costs. However, while actual costs base on real cost data, the standard cost mainly provides an estimate, basing on an analysis of past costs, which is conducted. In addition, these two are viewed different from each other since both costs have different unpredictable factors. Unlike Activity Based Costing, which was developed in the mid-nineteenth century, standard costing was adopted in the course of the 20th century. During this period, companies were overwhelmed by immense record keeping; therefore, they had to look for an easier way of determining costs. Thus, the case of estimation in standard costs is meant to avoid collection of real cost data, which companies considered to be a demanding and time consuming process, especially, where many products and services are involved (Berger, 2011). In standard costing, the estimated costs are developed for activities and processes in the company. In this type of costing system, there is no collection of real data, as this is considered time consuming. Thus, standard costs merely approximate the actual cost. Therefore, in most cases, standard costs are not accurate, as they do not reach or reflect the actual cost. The difference between actual cost and standard cost is referred to as variance (Jablan, n.d). In Noble Energy Inc., the standard costing system cannot be of much benefit, as compared to the Activity Based Costing. This is because, the company engages in many activities, whose cost is hard to estimate, without using actual cost data. It will also be inappropriate to use past cost data to determine present cost, as standard costing does, since the cost of production in the energy sector is highly dynamic. This might therefore, lead to a great variance between the standard cost and the actual cost, which could be hard to rectify. Noble Energy is a large company, therefore, might not benefit from the use of standard costs. The use of standard costs would have various effects in the international business environment. Therefore, since Noble Energy is an international company, if it employs standard costing system, the effects of this decision will be felt in the international business environment, in which it participates and influences. First, it might not be possible for Noble Energy to get into special contracts with some of its customers in the market. This is because some contracts, such as the cost-plus contracts, it is a requirement that a company uses actual costs, since these cannot be subjected to revisions afterwards (Wright & Gallun, 2008). This way, the company might lose different business opportunities with its customers, and other companies. Use of Relevant Costs in Company Decision-Making Relevant costs are important for this company in order to analyze its future plans. Therefore, these will help the company management in making important decisions, relating to development in the company. Noble Energy is committed to growth and therefore, foresees a future where more growth strategies and projects will be employed to help the company expand further. In this case, the management of the company will be required to have relevant information, including data, which will help them in the process of decision-making. Relevant cost is a factor affecting decision-making, which bears a monetary value. This therefore, helps the company to make quantitative decisions (Rajasekaran, 2010). Noble Energy Inc. is committed to growth, as shown in its previous growth level. In the coming five years, the company has plans to expand, with regard to its on-shore exploration. By the end of 2013, Noble Energy expects to drill 10 wells, and venture more in the wet grass areas (Noble Energy, n.d). The company has also focused on ensuring that the lateral lengths adopted are higher than those previously used. This is the company’s strategy of cutting costs in drilling. In this case, therefore, the management at Noble Energy has to forecast the cost that the company will incur in this expansion and growth process. In forecasting these costs, the management will draw from relevant costs. These are costs, which help a company to make important decisions in management. These are costs based on the future. Costs of the past cannot apply, as these cannot be influenced by present costs (Rajasekaran, 2010). With regard to the company’s future plans of expansion, this company will benefit if it employs the activity based system of costing. The process of expansion and growth of a company entails additional activities in the company. These are also costly to the company, and the company has to invest heavily in the growth process. Therefore, by using activity based costing, the company will collect the relevant actual cost data and analyze it in order to determine the cost of products and services that will be produced after the growth plan. Despite the fact that this process will be demanding, in the end, it will beneficial to the company, as the company will be able to recover the costs it incurred, thus balancing its finances. Therefore, relevant cost is important, as this will help the management make appropriate decisions and plan well for the future projects. Conclusion Cost accounting is paramount in a company. Depending on the costing system a company adopts, it will be able to evaluate all the costs it incurs for conducting different business processes. Additionally, a costing system helps the management of a company to make quantitative decisions, with regard to future plans of the company. Different types of costing system are available for companies to choose one, depending on its suitability. These include the activity based costing, and the standard costing, among others. One particular system of costing might be beneficial to a company and detrimental to another. Therefore, companies need to select their costing systems carefully. In the case of the Noble Energy Inc. the activity based costing system is preferable than the standard costing system. This has been identified as more appropriate than standard costing because Noble Energy Inc. engages in a myriad of activities, from exploration to manufacture, among other activities. These activities, can therefore, be used as a basis for determination of costs. On the other hand, standard costing might not be suitable for the company as this bases on estimation of costs. Therefore, if Noble Energy was to employ this costing system, it is likely to result in a great variance, which might be hard to rectify. In addition, standard costing might bar Noble Energy from engaging in some types of contracts with other companies, or individual customers, since this does not base on actual costs. Nonetheless, all costing systems have flaws; therefore, it is the responsibility of a company to make wise decisions and choose one, which will serve the company effectively. References 4 -Traders. (2012). Noble Energy, Inc.: Noble Energy Announces Highlights of 2012 Analyst Conference. Retrieved from http://www.4-traders.com/NOBLE-ENERGY-INC-13688/news/Noble-Energy-Inc-Noble-Energy-Announces-Highlights-of-2012-Analyst-Conference-15578867/ CIMA. (2008). Activity-based Costing. Retrieved from http://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_activity_based_costing_nov08.pdf.pdf Noble Energy. (n.d). Retrieved from http://www.nobleenergyinc.com/Home-4.html Berger, A. (2011). Standard Costing, Variance Analysis and Decision-Making. New Jersey: GRIN Verlag, Bradtke, D. (2007). Activity-Based-Costing. New Jersey: GRIN Verlag, Jablan, R. S. (n.d). Cost Accounting and Company Management in a World Without Walls. Retrieved form http://www.culturaldiplomacy.org/academy/content/pdf/participant-papers/2010www/Cost_Accounting_and_Company_Management_in_a_World_without_Walls.pdf Editions TECHNIP (2007).Oil and Gas Exploration and Production: Reserves, Costs, Contracts. New Jersey: Editions TECHNIP, 2007 Inkpen, A. & Moffett, M. (2011). Global Oil and Gas Industry. New York: PennWell Books. Kaplan, S. & Anderson, S. (2007). Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits. Rajasekaran, V. (2010). Cost Accounting. Mumbai: Pearson Education India. Wright, C. & Gallun, R. (2008). Fundamentals of Oil & Gas Accounting. New York: PennWell Books. Read More