Management Accounting Process - Example

RESEARCH PAPER ON MANAGERIAL ACCOUNTING INTRODUCTION: The research paper is based on management accounting process. Management accounting deals withthe process of producing accounts and reports that gathers the adequate and relevant information about the financial and statistical operations to help managers make effective decisions. It shows the cost allocated by every process of company, variance analysis, state of raw material, inventory, and debts. This research report has focused on evaluation of managerial costing methods and analyzing their uses and impacts on the company’s operations and decisions. For this research paper, an American aircraft company has been chosen, known as Gulfstream Aerospace Corporation. It is an aircraft manufacturing company that manufactures the parts of aircrafts as well as complete aircrafts. As the global demand of travelling is rapidly increasing, the demand for aircraft manufacturing is also boosting. According to statistics, the numbers of passengers have been increased from 82 million in 1982 to 2.7 billion in 2011 (Rchid, Bouksour, and Beidouri, 2013). However, the increased market competition, liberalization, prices and economic condition has severe impacts on airline manufacturing processes. In this regard, airline manufacturing companies have great pressure to reduce its cost to the optimum level. Most of the manufacturing companies have identified the Activity Based Costing method to allocate cost and measure performance. In this paper, discussed the concept of activity based costing and standard costing have been discussed. The benefits of using both the costing methods, including the factors that influence decision making in aircraft manufacturing company, consequences of using activity based method and standard costing method, structure the distribution of cost using both methods for Gulfstream Aerospace corporation. Further, this report will provide detail information on quantity, cost and variances and their effects in an international business environment. Moreover, this report will discuss the core benefits and analysis of appropriate costing method in a given company. In the end, report will give a detailed analysis of the use of relevant and appropriate costing methods that can help the company in making decision related to the expansion process and other future ventures. COMPANY PROFILE A company that has been selected for this research paper is Gulfstream Aerospace Corporation. The company is one of the world’s leading manufacturers of business jet aircrafts which were founded in 1980. It is a completely owned subsidiary of General Dynamics that provides the services of developing, designing, manufacturing, servicing and supporting the operations of developing the world’s most technologically sound jet aircrafts. Since 1958, Gulfstream Aerospace Corporation has manufactured around more than 2100 aircrafts for its worldwide customers. Company manufactures a wide range of products to meet diverse needs around the world. Recently, company is manufacturing six major products, with some modifications and specifications in each. Its products include the Gulfstream G150 with wide-cabin, high-speed facility; the Gulfstream G280 with modern large-cabin, mid range facility; the Gulfstream G450, with the capacity of long-range and large-cabin; the Gulfstream G550  with the capacity of ultra-long-range and large-cabin, and the Gulfstream G650 with the capacity of ultra-long-range and ultra-large-cabin. These modified capacities have given the company a competitive edge over others. The company has extensive workforce of 92,200 people with its presence in 12 major locations as according to 2012 statistics (GENERAL DYNAMICS, 2012). The business is supported in following major locations such as, Beijing, Appleton, Dallas, Brunswick, Mexicali, Luton, Lincoln, Westfield, Long Beach, Savannah, West Palm Beach, and Las Vegas. While operating in a wide market, company encounters extensive competition with major players, such as Bombardier Inc., Cessna Aircraft Company, Beechcraft, Inc., DRS Technical Services, Inc., Dayton-Granger, Inc., Avco Corporation, PTM International Inc and Milspray LLC (Bloomberg, 2014). According to annual report 2012, company generated revenues of $31,513 million while constituting the loss of $332 million in the respective year. The cash flow statement reported that cash provided by operating activities are accumulated to $2687 million, whereas its investing activities and financing operations have presented the loss of $656 million and $1,382 million respectively. Company’s balance sheet has reported the $3,296 million cash and equivalents which contributed in its total assets of $34,309 million. This shows company has fine financial position in terms of total assets. Gulfstream Aerospace Corporation has reported its total debts of $3,909 million and total equity of $11,390 million. Company represented the debt-to-equity ratio of 34.3% that is relatively very high, signifying that company can pay off its debts from total equity with ease. Its operating working capital is calculated as $746 million. Moreover, the company has demonstrated the book value per share of $32.20 million which depicts the level of safety that company has associated with its every share after paying off its all debts (GENERAL DYNAMICS, 2012). As of company’s annual report 2012, sales per employee have accumulated to $337,300 million. Also, company has identified major opportunities to boost the shareholder value by determining free cash flow of the company. Company has reported the free cash flow of $2,237 million which depicts that company has the capacity to produce enough cash after expanding or maintaining necessary operations. These figures show that the company acquires sound financial position in the market as well as company has enough cash to carry out its necessary operations. ACTIVITY BASED COSTING (ABC) Activity Based Costing (ABC) is an accounting method to identify the cost of the company’s operations. It deals with the determination of all activities and operations that a company performs and then allocates indirect costs to all products of the company. This method of costing identifies the relationship between activities, products and their associated costs and this relationship helps to assign indirect cost to products of the company in a logical method instead of the traditional method. In the Activity Based Costing, company first assigns the cost to the operations that cause to produce overheads and later the company assigns cost to those operations that are demanding the operations (Chea, 2011). Moreover, the significance of Activity Based Costing, for the company, has increased due to some major factors like increment in manufacturing overhead costs, a wide variety of products and increasing customers’ demands. There is no relation between manufacturing overhead costs and direct labor hours or machine hours and difference in production capacities of according to production batches. The Gulfstream Aerospace manufacturing company operates in highly sensitive market in terms of production, where the few products and operations can contribute to company’s most of the output, and, therefore, even a minor poor decision can create trouble for the company. The company’s expansion decision in Brunswick is a new expansion plan of the company. To implement the plan, its every process will allocate huge cost. It becomes a complex process to determine the sector of operations that contribute in pulling most of the profits. This is due to the complicated process, changing the level of output, long product manufacturing processes make it difficult to identify the product and operations are tending to produce high costs related to overhead. In such system, activity-based costing method splits all the operations and activities in the production plant and evaluates the portion of overhead used to manufacture each part and product (Bjørnenak and Kaarbøe, 2013). A comprehensive process of Activity Based Costing is given below: (Kaplan & Anderson, 2013) This method provides numbers of advantages to the manufacturing company especially the aircraft manufacturing firm. This method helps to set appropriate pricing by minimizing the prices of products that consumes a low level of activity resources and maximizing the prices of products that utilize activity resources of the company to the optimum level. Moreover, this process helps the company to produce valued services on the basis of the actual cost acquired by products. The company can also eliminate unbeneficial items that generate no profits and hence can increase profits without enhancing prices of products. Company can also increase its productivity by reducing or eliminating the cost of operating non-profitable activities. In addition, this method of costing helps to identify compatibility with performance management system by determining the contribution of every individual in the production process and its cost, and therefore profits. This method is widely chosen by companies to reduce inefficiencies to enhance company’s productivity. Also, this method makes it far easier to make decisions regarding the elimination of non-value adding operations and activities, which include unnecessary inspections and duplicate operations. Moreover, also assist in providing countable figures to make future projections and prepare effective planning process. The cost structure of Gulfstream Aerospace manufacturing company regarding Activity Based Costing is a bit different from traditional costing method. Activity Based Costing gathers indirect costs of operations/activities and allocates the cost of activity to cost object. The costs are assigned in two processes: first cost objects utilize operations/activities and operations/activities utilize resource cost. As shown in figure below, this method does not relate to expense direction unlike traditional costing approach (Rchid, Bouksour, and Beidouri, 2013). (Rchid, Bouksour, and Beidouri, 2013) Further, the process is explained by next figure, given below, which presents that based on cost driver, cost are allotted to cost pools in the first phase within an activity centre. However, this approach is different in traditional costing approach. In the second phase, costs are assigned to cost objects from the cost pools based on using activities by objects. The difference here is that Activity Based Cost uses variety of volume based cost drivers to assign overhead cost to cost objects while considering non-volume related patterns. (Rchid, Bouksour, and Beidouri, 2013) The cost structure for any Gulfstream Aerospace Corporation is clearly defined in the below figure, where overhead costs are allotted to three main activity centers which include machining activity cost, quality inspection activity cost and assembly activity cost. Further, cost drivers are assigned a cost from activity centers and finally allot to products of company (Horngren, et al., 2008). STANDARD COSTING This method of costing is defined as the predetermined cost based on technical estimations for labor, material and overhead for a particular period, for a specific set of work conditions. This costing method pre-defines all costs matches them with actual costs incurred and assess the causes for variance. The company then takes measures to avoid or remove the variances. Standard costing is the most preferred method to allocate the cost as it helps the companies to control the cost. When standard costs are compared with actual costs, it indicates the areas or operations where costs have turned uncontrollable and provide an opportunity to the management to take corrective actions. The variances calculated, provides company with the specified fixed numerical targets which make even easier to take corrective actions. This encourages the cost consciousness by emphasizing on variations, and thus supports efficiency across the organization and controls costs. Moreover, this method also helps the company by providing the measures of the advance developments, for instance, increasing prices, adjusting selling prices and major processes. The variances are identified as the differences between actual and planned costs, and these variances can help the companies to improve their operations and thus increase profits. Total direct wages variance is identified by the variances of wage rate and labor efficiency. Assessing the labor efficiency will help the company to keep increasing the productivity of the company by maintaining a low cost. However, the direct material variance is divided into material consumption and price variance. Price variances are affected by quality and quantity purchased and delivery process of material. Fine quality material helps the company to maintain the favorable variance if the employees are well trained to perform tasks. For the Gulfstream Aerospace Corporation, it will be beneficial to adopt standard costing method to monitor the key issues of the company. It will alarm the management when company experiences cost that goes beyond the standards, identifies the problems so that management can take remedial actions. Moreover, standard costing is favorable for employees as well, as they use this approach to assess their own performance and thus can improve efficiency of their work. Gulfstream Aerospace Corporation can make bookkeeping an easy process by charging the standard cost for overhead, labor, and material rather than the actual cost for every job. Moreover, this method of costing provides an integrated system of accounting and holds everyone responsible at their place to control and plan the cost (Farid, 2014). With regards to decision making process, standard costing helps the company to determine prices and develop manufacturing policies in advance. Also, it allows company to make decisions regarding product planning and pre-production phase. For the international companies specifically, it can easily perform valuation of stocks by transferring the difference between actual costs and standard cost in a specified variance account. Standard costing also evaluates the cost of individual products or operations. Thus the company can be well-aware of the approaches to use toward profit maximization and budget planning process. In addition, this method of costing provides the ready-made targets to set the company’s goals and foundation of an incentive system easily. Hence this shows that standard costing will help the Gulfstream Aerospace Corporation in budget planning, costing of inventory, applying overhead and formulating prices. USING COSTING FOR DECISION MAKING PROCESS Considering the given company, Gulfstream Aerospace Corporation, which is US based company is planning to expand its operations in other locations as well. Recently it has begun to work on Service Center at Brunswick. This move is expected to boost the economic condition of the coastal Georgia city, which will introduce 100 new jobs in the city. The company will encounter the huge cost of $25 million on various facilities as repair, maintenance and revamping at the space of around 110,000 square feet. The company has built its expansion strategy which is expected to grow its operations by $500 million of additional expansion that will add more than 2500 jobs in the coming three years. This expansion plan of Gulfstream Aerospace Corporation needs to be undertaken by effective costing method to minimize the cost and maximize the output and profits. In this regard, the cost will incur to the company with respect to a specific decision. The decision of expansion made by company and cost that will incur to put that plan into action is known as the relevant cost. This cost varies with the changes in decisions and plans. It does not remain constant as the decision changes lead to a different course of actions. Such cost is also known as differential costs. The cost incurred in the expansion will become irrelevant and useless in other situations of the business. Seeing the Gulfstream Aerospace Corporations’ plan for expansion, the cost that is appropriate to help in making specific expansion decision is Incremental cost. It is a type of relevant cost. This is the cost that can influence the process of expenditure, as a result, of decision making. In this case business expansion, company can either accept the expansion or avoid the process, and the cost affected by any of this decision is said to be an incremental cost. Moreover, relevant cost will help the management of the company to draw their attention to such elements whose cost is relevant to draw any final decision (Arnold, 2008). Relevant cost is beneficial for expansion projects in a manner that it provides a comparison basis to managers of the company of various alternative proposals (Noreen, Brewer and Garrison, 2011). During the expansion, aerospace company may find numerous different expansion opportunities that management can choose the one with the best opportunity. This comparison analysis will be done on the basis of relevant cost. On the other hand, relevant cost also deals with the quantitative figures of decision. It explains the consequences of decision, cost associated with decision in quantitative terms, which portrays an even clearer picture of planned actions. With this approach, company can take corrective actions that are most appropriate for the company by analyzing the results of the decision in quantitative terms. CONCLUSION Gulfstream Aerospace Corporation is a US based company that manufactures aircrafts and different parts of the aircrafts. The company is one of the world’s leading manufacturers of business jet aircrafts, which was founded in 1980. As the global demand of travelling is rapidly increasing, the demand for aircraft manufacturing is also boosting. This is the reason Gulfstream Aerospace Corporation is planning to expand its business operations in different countries. The company has extensive workforce of 92,200 people with its presence in 12 major locations as according to 2012 statistics. The business is supported in following major locations such as, Beijing, Appleton, Dallas, Mexicali, Luton, Lincoln, Westfield, Long Beach, Savannah, West Palm Beach, and Las Vegas. Now company is planning to expand its operations in Brunswick, which will be launched in 2015. This paper has discussed the concept of relevant costing, activity based costing and standard costing. The benefits of using both the costing methods, including the factors that influence decision making in aircraft manufacturing company, consequences of using activity based method and standard costing method, structure the distribution of cost using activity based costing method for Gulfstream Aerospace corporation. Activity based costing is a costing method to identify the cost of the company’s operations. It deals with the determination of all activities and operations that a company performs and then allocates indirect costs to all products of the company. This method of costing identifies the relationship between activities, products and their associated costs and this relationship helps to assign indirect cost to products of the company. This type of costing is beneficial in measuring performance, as well as cost of large companies. Also, Activity based costing supports business operations to make better decisions related to product development, market expansion. Since, Gulfstream Aerospace Corporation is leaning to expands its operations Activity based costing will be beneficial for the company. Moreover, relevant costing can give the comprehensive picture of the company regarding its extending costs during expansion, this will help the company to analyze the cost and make proper decisions. On the other hand, standard costing method is a comparison between actual and planned costs. When standard costs are compared with actual costs, it indicates the areas or operations where costs have turned uncontrollable and provide an opportunity to the management to take corrective actions. For Gulfstream Aerospace Corporation, Activity based costing technique is most effective way to allocate and measure the cost. REFERENCES: Arnold, G. (2008). Corporate Financial Management, 4th Edition. Harlow: FT Prentice Hall Bjørnenak, T., & Kaarbøe, K. (2013). The dynamics of management accounting and control systems. The Routledge Companion to Cost Management, 163-173. Bloomberg. (2014). Company Overview of Gulfstream Aerospace Corporation. Retrieved June 23, 2014, from http://investing.businessweek.com/research/stocks/private/snapshot.asp?privcapId=29220 Chea, A. (2011). Activity-Based Costing System in the service sector: a strategic approach for enhancing managerial decision making and competitiveness. International Journal of Business and Management, 6(11), p3. Farid, S. (2014). Advantages and Disadvantages of Standard Costing and Variance Analysis. Retrieved June 23, 2014, from http://www.accounting4management.com/advantages_disadvantages_standard_costing.htm GENERAL DYNAMICS. (2012). GENERAL DYNAMICS: Annual Report 2012. 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The Activity Based Costing method opportunity to assess and master the aircraft maintenance service cost for Third Party: a case study. International Journal of Computer Science Issues (IJCSI), 10(1). Read More