An analisys of Management Accounting - Essay Example

?Finance and Accounting From, The Financial Director Manac Plc, United Kingdom. To, The Board of Directors. Manac Plc, United Kingdom. Sir, Sub: The real reason for the lower than expected profits of the company. And also various models to identify those areas which have not met budgeted expectations. I am the financial director of the company. The company uses standard costing and absorption costing as part of its approach to strategic management accounting. But the Board of Directors is concerned that the business is not meeting its budgeted target earnings. So, this report includes various models and concepts affecting the pricing decisions, the role of standard costing and variance analysis in management accounting and “the advantages and disadvantages of introducing an Activity Based Costing system to replace the current Absorption Costing system” (The Models and Concepts Affecting the Pricing Decisions Taken by Organizations, Critically Reflecting Upon Their Usefulness 2011). i. The models and concepts affecting the pricing decisions taken by organizations, critically reflecting upon their usefulness. The price variable is the one of the significant ingredients in marketing mix of the organization. Price itself can effectively communicate with the consumers regarding the product or service. So, “when the pricing decision is made, the organization must consider several factors. These factors” (Chapter Eight – How is the Pricing Decision Made? n.d., p. 1) such factor includes, Regulation of government, Perceptions in the market, supply, desired pricing position of the organization, demand and finally Competitors and Competition pricing policies. The final price of any product or service is influenced by various factors; these can be summarized into two that are internal and external factors. Internal Factors – Internal factors are those which are controllable by the organization and also, if required, it can be altered. Although, the company may have control over these internal factors creating a quick alteration is not always practical or realistic. For example, pricing of the product may depend closely on the efficiency of a manufacturing capability (e.g., how much can be manufactured in a certain time). The marketer recognizes that rising productivity can decrease the cost of manufacturing of every product and therefore it is important to permit the marketer to potentially lesser the product’s price. But rising productivity may need major alterations at the manufacturing capability that will take time. External Factors - There are a numeral of influencing factors which are not restricted to the organization but will influence pricing decisions. The marketer needs to identify these factors to carry out various researches to observe what is happening in every marketplace that the organization serves, since result of these factors can change by marketplace. The Pricing Decision: As mentioned above, the pricing decision of the organization is impacted by various dissimilar factors. So, pricing decision at initial stage can be very time- consuming though these are exemptions. Normally pricing decision of the organization is complicated, hence it must involve the various cautions consideration of all these factors listed above to make a good decision. “The pricing strategy can be viewed as a function of competitive product quality and stage of the product life cycle” (Rashid et al. 1988, p. 194). Various models which influenced the pricing decision of the organizations are discussed below. Cost and Demand Oriented Pricing Models: In this model, organization uses demand or cost as a foundation for setting the price of the service or product. Traditionally, this type of orientation or model is applied to the theory of micro economics by forming demand curve on the basis of summation or outline of the person’s utility functions for consumers in the market. Thus, first thing is that to assess and identity the consumers perception regarding the product or services. Perception of the consumer regarding how much they would look forward to pay for a service or product of the organization based on the utility (or convenience), they would suppose to derive from service or product and combine all these personal utility functions to generate a demand curve for the manufactured goods or service. At the same time as this approach is simple and easy theoretically, it frequently defies realistic application. On the other hand, the common lesson that helps to study from this particular model is an important one which says that the price based on a demand-oriented method can be based on the anticipated usefulness (benefits) that consumers of the market expect to take delivery of from obtaining the product or service as compared to any of the other products or service available in the market. Pricing Models Based on Cost: Probably, this is the oldest form utilized for pricing. This approach employs cost to the supplier to find out the price of selling. For instance, for days a ‘keystone’ or ‘key-stoning’ policy has been employed by many sellers to set price. This model basically doubles the price and arrives at the price of selling. Numerous other models utilized cost as a basis of pricing. For instance, internal rate of return pricing generally starts with the determination of cost and then calculates dissimilar projected levels of return for future periods of time on investment. This pricing model used by the organization was accepted by General Motors early in the history of the organizations and was used for decades with their goods. At the same time, as this model is simple and has the benefit of guarantee some of the profit margin of the company, the approach ignores the most significant aspect in pricing i.e. demand. Therefore, by using only a cost-based approach the retailer may miss various opportunities for extra profit or set a price too high to comprehend sufficient sales to even cover price. “In today’s marketing-driven world, cost-based pricing is much less relevant than it once was. The application of cost-based pricing, while easy to apply and administer, does not maximize company profitability because it ignores market and competitive forces” (The Highs and Lows of Cost-Based Pricing 2009). Pricing Models Based on Demand: Prices of the products or service can also set by way of using the demand for the service or product as a guide. “ For example, if an analysis of demand indicates that buyers, based on the benefits they would derive from it, would expect to pay $30,000 dollars for a new kind of testing device, this at least gives the seller some guidance in setting price” (Chapter Eight – How is the Pricing Decision Made? n.d., p. 5). This model is recognized as the expected price model and also is the basis for setting price of the product on the basis of demand in Microeconomics. Obviously, this model needs a time consuming investigation and is not as easy as just based on the cost to set the price of the product or service. On the other hand, if a retailer focuses merely on cost to set a price of the product, then s/he could be either set price so high that there will be no demand, or preceding considerable proceeds. “For example, if demand is very high there are times when we can virtually ignore cost structures. For example, if a professional athlete has a remarkable season of performance, s/he can sometimes demand an incredibly high salary based on his/her performance the previous season. In some cases, there may be .an expected price. The expected price is a price that consumers would anticipate being reasonable for the benefits derived from using the product” (Chapter Eight – How is the Pricing Decision Made? n.d., p. 5). There may also be a usual price for a manufactured goods or service. The usual price is a price level that customers are expected to paying based on normal or past expectations. For instance, if customer testers attempt out a new, innovatory vacuum cleaner, while asked they point out that they would pay usually the expected amount of $500 or less for the manufactured goods, though the retailer cost structure would mean losing cash at a price of less than $500. This pricing model thinks that the manufactured goods or service faces a marketplace structure distinguished by monopolistic competition. Therefore, prospective consumers perceive dissimilarity in products based on the difference or status of particular brands. ii. The role of standard costing and variance analysis in management accounting and a critically discussion of the value and limitations of variance analysis as a means of identifying key areas which have contributed to the overall profit figure. The role of standard costing and variance analysis in management accounting: Management accounting is concerned with the conditions and makes use of information about the accounting and managers inside companies to offer them by the basis to make knowledgeable decision of the business that will permit them to be superior equipped in their organization and control functions. A standard cost is the prearranged cost of manufacturing a numerous unit or any of the single unit of manufactured goods during a particular period in the immediate upcoming. It is the intended cost of goods under present and anticipated operating circumstances. Standard costing is a significant topic used in cost accounting. Standard costs are generally connected with manufacturing organizations’ prices of direct labor, direct material and overhead of manufacturing. One of the major jobs of “management accounting” (Management Accounting n.d.) is to assist managerial control and the most significant aspect of administrative control is cost control.  The competence of management depends upon the successful organization of costs.  So, it is very much significant to plan and manage cost. Standard costing is one of the mainly significant apparatus, which facilitates the organization to plan and control cost of business functions.  In standard costing, every cost is prearranged and programmed costs, and then compared with the real costs. The dissimilarity among prearranged costs and the real costs is identified as variance which is examined and considered to the reasons. The variances are then reported to organization for taking most proper corrective steps, so that the real costs adhere to prearranged costs. In past, costing actual costs are determined only as soon as they have been incurred.  They are helpful only when they are contrasted with prearranged costs. Such costs are not helpful to organization in decision-making and manage the cost. So, the method of standard costing is employed as an instrument for planning, Performance measurement, Product pricing, decision-making, development and alteration, control and manage of business functions.  In this unit you will study the basic concepts of standard costing. These consist of: * Just-in-time systems related to flexible production systems intended to guarantee that consumer demand may be pleased on a the basis of pull through. * Total quality plan intend at constant development, with the recognition and removal of non-value added actions and the successful provision of value added actions. * superior importance on the value chain, from close connections with dealers of input materials and services to recognition of consumer requirements with regard to superiority, delivery and altering necessities through time. * Precise product costing and data related to pricing to assist development in decision-making and planning. This will consist of the make use of activity-based price and budgeting schemes and the make use of target costing. * Enhanced speed and elasticity of availability of information. This may be connected to the ease of use of on-line data in a computer incorporated manufacturing surroundings. Variance Analysis: Variance analysis is a tool to assess standard to actual performance. It can be done by distribution, subdivision, program, manufactured goods, region, or any other accountability part. When more departments are employed in a manufacturing process, certain standards must be built up for every department in order to allocate responsibility to department heads. Variances may be as completed as obligatory, identifying the cost/benefit affiliation. Assessment of variances may be completed yearly, weekly, monthly, every day, or hourly, based on the importance of recognizing a dilemma speedily. As real figures (e.g., hours taken) are not identified till the ending of the period, variances can be identified only at this instance. Material variances involve advising the person responsible and making corrective action. Irrelevant variances must not be glanced into more except they return frequently and replicate probable complexity. Normally, a variance should be examined when the investigation is estimated to result in curative action that will lessen expenses by an amount beyond the cost of the investigation. When the manufacturing cycle is lengthy, variances that are calculated at the occasion of product finishing point will be much delayed for rapid remedial act to be taken. In such a case, examination may be taken at key points throughout the processing stage. This allows for spoilage, labor inadequacy, and other expenditure related with troubles to be acknowledged ahead of product end. One determination of materiality is to segregate the variance by the standard cost. A variance fewer than 5 percent may be considered as irrelevant. A 10 percent variation is further adequate to a company by means of stretched standards contrasted to a 5 percent deviation to a company occupying movable standards. In some cases, materiality is gazed in requisites of dollar quantity. For example, if a company set a strategy glancing into any variance that go above $10,000 or 20,000 units, whichever is the smaller amount? Guiding principle for materiality also relies on the behavior of the certain phase as it affects performance and decision-making. Additional statistical techniques can be employed to determine the implication of cost and revenue variances. An adequate range of acceptance should be recognized for manager. Constantly, if a variance by no means exceeds a minimum permissible proportion or minimum dollar sum, the manager may desire to bring it to top management’s consideration, if the variance is constantly close to the approved limit each year. This may specify that the average is out of date and good modification to existing levels is consent to develop in general profit planning. As the critical costs, such as promotion and upholding, materiality strategies are stricter. Normally, the reason for the variance is obsolete standards or a pitiable budgetary practice and not real performance. The utility charges are not handy within the firm. Standards may vary at diverse operational dimension levels. Additionally, values should be evaluated occasionally, and when they are no longer sensibly replicate conditions, they should be customized. Standards may not be practical any longer as of internal actions, such as manufactured goods design, or exterior situation, such as management and aggressive competition. For example, standards should be improved when cost, objects specifications, product design, employment rates, labor effectiveness, and construction methods vary to such a degree that existing standards no longer offer a functional performance. Alteration in the method or operational changes would necessitate in advertising and managerial actions. Important positive variances must also be examined and must be taken benefit for further. Those dependable for good performance are to be appreciated. Regression analysis may present consistently among costs and revenue. Variances are consistent, and hence the net result has to be examined. The diverse limitations for the Variance analysis frequently are complex by the trouble of calculating the numeral of corresponding units in the production. Variances might be convenient, partly convenient, or unmanageable. It is not constantly simple to allocate accountability, even when dealing with the controllable variances. The degree to which a variance is convenient relies on the nature of the standard, the price incurred, and the individual factors sourcing the variance. There are various key factors that are identified. The Fixed costs are the costs which stay stable inside a given choice of action such as sales, marketing or production. Example comprises rent, assurance, reduction, administration salaries, etc. despite of whether sales increase or decrease, the fixed costs stay static. Variable costs, on the further side, vary openly and proportionately with change in that identical behavior like the sales, production, etc. If a business produce more manufactured goods, they should acquire extra raw materials which raise their costs directly and proportionately to rise in production. The consideration of cost performance should be available to assist the owner and the manager to forecast profits. If the performance prototype of fixed and variable costs are implicit, by assumption that they are correctly categorized, the management can establish the "bottom line" result in these costs. This is at times considered as the cost/volume/profit correlation. If you recognize this link, it is easy to calculate, if the profits will increase or decrease by taking positive measures. As an illustration, the manufacturer presently manufacturing one million products at $1.00 each and the total sales incurred is $1,000,000. The fixed costs is $500,000 and the current cost is 40? in raw materials and labor, to manufacture the same, the variable costs are $400,000 (1 million x 40?). It is understood that the pr-tax profits of $100,000 or a 10% profit margin is incurred finally. iii. The advantages and disadvantages of introducing an Activity Based Costing system to replace the current Absorption Costing system: Costing systems are the mechanism of a vast accounting classification used by the specific organization. The major task of the costing system is to stay focused on expenditures provided by the company. “ABC is an economic model that identifies the cost pools or activity centers in an organization and assigns costs to cost drivers based on the number of each activity used” (Akyol et al. 2005, p. 44). While the data that is composed and made by the costing system is also incorporated into the general accounting system, the costing approach allocate for simple withdrawal of the data for information to superior management. Operational costs are frequently the base of the data gathered by a costing system. The Manac Plc management is capable to acquire a synopsis of all expenditures that are openly linked with the common process of the business, particularly in terms of manufacturing costs. Many large companies have transformed to the ABC system because years back as 1980 s the system has revealed its usability in the suitable product mix conclusion, expenses management etc. Advantages of an Activity Based Costing System: The primary and most significant advantage is the exactness in the development of costing with consideration to the manufactured goods line, the end-users of the product, the stock-keeping units engaged by the management and the channel and grouping which simplify the stream of the manufactured goods from the manufacturer to the end user. “More accurate costing of products/services, customers, SKUs, distribution channels Better understanding overhead Easier to understand for everyone Utilizes unit cost rather than just total cost Integrates well with Six Sigma and other continuous improvement programs” (Activity Based Costing Advantages Disadvantages 1984). The ABC system well supports the process of considering the concept of overhead costs which is the allotment of ordinary business assets as they are used by specific product lines and their relation to specific cost driver. The system is simple to realize and understand; it is reachable, usable and sensibly implemented throughout the standard of business set-ups. This method uses unitary cost or marginal cost as the calculation base on the contrary to the conventional cost accounting methods which utilize total cost. The system facility extremely well resolves the value improvement and up progression programs like the Six Sigma. This system is mainly helpful in recognizing and ear-marking some of the topics of business activities which are on much stress on the business which is much wasteful. The system works outstandingly with performance management which is engaged by most human resource departments in existing businesses. The process permit the companies to execute costing strategy across an additional diagonal of the firm as commerce processes, supply chains and the implication of totaling channels are proficiently and optimally analyze in the development. Disadvantages of an Activity Based Costing System: Data collection procedure for this system is much time consuming. The capital expenses on the activity based system and its succeeding running costs can be a barrier for firms. The system is much obvious where some managers would not support as they would like to remain some things out of the analysis of the possessors of the company. “Many overheads or indirect expenses can easily assign to products. We can easily calculate inspection expenses per product, if we multiply per inspection rate with total no. of inspections. But some indirect expenses’ cost can not calculate relating to its product in activity base costing system” (Two Disadvantages of Activity Based Costing on the Basis of Reasonable Ground 2009).   To conclude, we can see that activity based costing is not basically a pioneering accounting theory; it is just an accomplishments to glance at the costing mechanism from a completely diverse outlook. Cost drivers which are firm in agreement with each group certainly have their settlement which we have sufficiently resolute in the study, but the most significant feature of activity based costing which is occasionally unseen is the eagerly unplanned system that come as part and parcel of executing an activity based costing system. The capability to modify the entire system at any step of the method is definitely a benefit which cannot and possibly should not be unobserved even as one is conducting a cost/benefit analysis of the convention of an activity based costing system. The report s consists of critical assessment of the models and various ideas proposed outlining their qualities and limitations. Application of this will helps the company to meeting its budgeted target profits. Place: Yours faithfully. Date: Reference List Activity Based Costing Advantages Disadvantages. 1984. Value Creation Group, Inc. Available at [Accessed on 06 January, 2012]. Akyol et al. 2005. A Comparative Analysis of Activity – Based Costing and Traditional Costing. World Academy of Science. Available at < https://docs.google.com/viewer?a=v&q=cache:pGgd7l_AyTUJ:www.waset.org/journals/waset/v3/v3-11.pdf+activity+based+costing&hl=en&gl=in&pid=bl&srcid=ADGEESiGgDWFfkUYmk3bbk3QYGeBKIe4rGSEsObPefIkKFvQE1bwktzzarFDT6Sc5oE63GBe-9EU5tEONtdmuAcdyYaaBpJC9qxCn6-OMglsMa5UyVpZrgObpiFRj7OMrXPxNg06gPRt&sig=AHIEtbQy09xVg-sUv08npDJx4iQMeZyR0g> [Accessed on 03 January, 2012]. Chapter Eight – How is the Pricing Decision Made?. n.d. Available at [Accessed on 03 January, 2012]. Management Accounting. n.d. Business Dictionary. Available at [Accessed on 06 January, 2012]. Rashid et al. 1988. Developments in Business Simulation & Experiential Excersises. Vol. 15. Available at < http://sbaweb.wayne.edu/~absel/bkl/vol15/15bq.pdf> [Accessed on 06 January, 2012]. The Highs and Lows of Cost-Based Pricing. 2009. WordPress. Available at [Accessed on 06 January, 2012]. The Models and Concepts Affecting the Pricing Decisions Taken by Organizations, Critically Reflecting Upon Their Usefulness. 2011. Transtutors.com. [Online] Available at < http://www.transtutors.com/questions/the-models-and-concepts-affecting-the-pricing-decisions-taken-by-organisations-criti-78491.htm> [Accessed on 03 January, 2012]. Two Disadvantages of Activity Based Costing on the Basis of Reasonable Ground. 2009. Accounting Education. Available at [Accessed on 06 January, 2012]. Read More