Criticism in Management and Accounting Systems - Coursework Example

ACCOUNTING AND FINANCE Over the recent years, management and accounting systems have been s of intense condemnation as regards to the appropriateness and efficacy of costs allocation. The criticism is based on the assertion by some costs analysts that traditional techniques of assigning costs to various goods, production actions, services, or functions are no longer applicable to management in today’s businesses. The criticism, therefore, prompts an in-depth assessment of the relevance of both the traditional and the ABC costing methods to management today. Today, most established companies and business organizations are applying the activity based costing strategy in the allocation of their overheads. Activity based costing is loved for its ability to enable the cost control team to enhance accuracy. Accuracy here is in terms of closeness to the actual cost and actual profitability of each product and service. ABC helps managers to have a better comprehension of the company’s actual costs as well as its returns on investments. The returns on investments are usually computed by considering the number of projects and activities that the business engages in. Accounting for costs (2010) show that ABC improves the accuracy levels through transforming some of the costs that traditional costing techniques deem not to be direct into direct costs. The process is done as follows; Firms that have applied ABC successfully did so by employing a number of strategic costing and management factors. The management of such firms does ensure they support and participate in every pricing decision. They have to know when to add or delete items from the product portfolio. Finally, they must know when to consider outsourcing or producing the product in-house (Plowman 2011, p.43). While performing all these, the management is always cautious about improving all the process initiatives.   Activity Based Costing (ABC) is an organized style of passing on indirect costs to goods and services. It entails obtaining the cost of each activity drawn in the process of production and assigning costs to each product according to the use of each activity. Alternatively, activity-based costing (ABC) is a more refined way of costing goods and services. Activity based management is the application of ABC as a technique of managing costs at the activity level. It is an area that involves ensuring effective and efficient control f activities as to promote the product value and customer satisfaction. Activity Based Management makes use of the information obtained from ABC to establish the drivers behind activities and how to improve them to raise the company’s profitability (Bragg 2005, p.56). Costing as used in business accounting procedures is a means of ascertaining the costs of production as compared to the returns from the sale of the product. Costing involves establishing the production overhead and assigning them to the products. A part of the activity-based costing system, there are other costing systems known as the ‘traditional costing methods.’ The traditional costing methods allocate costs to products as per the average overhead rate. It puts together the indirect costs of production while applying them equally across (Belkaoui 2000, p.117). It entails the use of a single most relevant cost driver, like the hours of labor. To address the importance of ABC in a company, the following points are discussed; ABC is different from the traditional costing methods in the line of accuracy. In terms of accuracy, ABC is better than traditional costing methods. It is better because it considers the most important things before allocating any cost to a product. Due to this feature, the ABC process is, therefore, more detailed and consumes more time. It is more complex as it also involves the non-manufacturing expenses like managerial and administrative costs. Traditional costing methods are simpler because they only entail the allocation of the average overhead rates. The production expenses are not involved in these costing methods (Collins 2008, p.214). They also fail to establish how overhead costs influence definite products. These methods are, therefore, not very accurate as compared to ABC. ABC increases the number of cost pools that are applied to the accumulation of overheads. In ABC system, costs build up according to activities, regardless of whether overheads are amassed in a ‘general company pool’ or a single ‘departmental pool.’ The ABC system also charges overhead costs to unique jobs and products as per the percentage of the cost driven by the activities. It does not involve the use of a ‘blanket rate’ that will depend on direct hours, costs and machine hours. In the ABC system, costs are identified by the activities and their causes to aid the simpler computation of costs. It also involves the deduction of the non-value added activities (Plowman 2011, p.122). The reason for such elimination is to minimize the cost of production. ABC is known to enhance the traceability of overhead costs, which brings simpler unit cost information for the management. ABC is mostly appropriate for companies that are actively engaging in the manufacturing business. Such companies have established investments and well-scheduled manufacturing operations. It is unlikely for any company, other than manufacturing company to use the activity based costing system, as it involves which tend to benefit from ABC allocation of fixed costs to products. These products are usually manufactured internally or purchased from an external supplier, depending on a company’s preferred strategy. However, ABC may not work successfully for every manufacturer if certain things do not hold (Corcoran 2014, p.89). It only works for manufacturers who ensure that the overhead costs are allocated to the products and jobs as per the percentage of the cost drivers per activity. The traditional costing systems are often expensive to implement and rigid whenever modification was required. There are many companies today that use activity-based costing and the number differs significantly as per the industry where each company falls. According to Horngren (2013, p.33), surveys conducted between 2010 and 2014 revealed the following statistics about the usage of ABC among firms per industry. The highest proportion of companies using ABC is in the manufacturing industry. The percentage is between 20% and 50%. Next are companies that offer financial services that constitute 15% to 25%. Firms in the public sector constitute 12% to 18%, and those in the communications sector were between 6% and 12%. Both the ABC and the traditional cost accounting methods can be best illustrated in terms of their different applications and outcomes, using a product manufacturing example. The elements and approaches in the examples given next even apply in other business situations (Meigs and Meigs 2010, p.201). Traditional costing methods classify costs into two; direct costs or indirect (overhead) costs. The direct costs are the expenses, which can be allocated to particular commodity units. In production, they include; direct labor costs and direct materials. Indirect costs comprise production overheads, which may not be allocated to particular commodity units directly. They are, therefore, assigned to particular manufacturing runs, batches, or time periods. Such costs are; materials purchase order costs, machine set up costs, product packaging costs, machine testing and calibration costs, machine maintenance and cleaning costs (Horngren, 2007, p.61). The example provided in the appendices section (Table 1) provides a case in two product models produced and traded by one company. Take an example of a corporation, which produces vehicle parts using a series of machine procedures on metal supply. The costs will be classified into the two subdivisions. According to Matz and Curry (2011, p.102), management should always estimate the profitability of every product before deciding the products to manufacture and sell or even setting their prices. The cost of each product must thus be well known. The direct costs for every unit can be computed through the costing criteria. Since the two costing methods differ in the manner of allocating overheads, the two costing approaches give different results of the profitability of particular products.  Bibliography Accounting for costs. (2010). London: BPP. Belkaoui, A. (2000). Advanced Management Accounting. Santa Barbara: ABC-CLIO. Bragg, S. (2005). Controllers guide to costing. Hoboken, NJ: John Wiley & Sons. Collins, F. (2008). Implementing activity based costing. New York, N.Y.: Executive Enterprises Publications. Corcoran, A. (2014). Costs: Accounting, analysis, and control. (Reprint.). Santa Barbara, Calif.: Wiley. Horngren, C. (2013). Cost accounting: A managerial emphasis (Reprint.). Englewood Cliffs, N.J.: Prentice-Hall. Horngren, C. (2007). Management and cost accounting. London: Prentice Hall Europe. Matz, A., & Curry, O. (2011). Cost accounting (4th ed.). Cincinnati: South-western Pub. Meigs, R., & Meigs, W. (2010). Accouting: The basis for business decisions (8th ed.). New York [etc.: McGraw-Hill Publishing Company. Plowman, B. (2011). Activity based management improving processes and profitability. Aldershot, Hants, England: Gower. Appendices Traditional Costing Example. The corporation made and supplied 900000 units of commodity A for sale at $3.00 per product. Its total sales for product B were 2100000 units, and each went for $2.00. In table two (next), the final revenues together with the direct expenses costs are given for each of the sales. Commodities under comparison Commodity A Commodity B Total Manufactured and sold units 900000 2100000 3000000 Each unit’s selling price $3.00 $2.00   Cost of direct labor, for each unit $0.50 $0.50 Cost of direct materials, for each unit $0.75 $0.50 Revenues from sales  = 1x2 $2700000 $4200000 $6900000 Direct costs   Cost of direct labor = 1x3 $450000 $1050000 $1500000 Direct materials costs  = 1x4 $675000 $1050000 $1725000 Total Direct costs = 6 + 7 $1125000 $2100000 $3225000 Revenue from sales and costs that are direct for Commodities A and B (Table two). The accountants responsible for assessing the costs of the corporation must also deduce the total cost incurred in support activities all through manufacturing period, for commodity A and commodity B. The appropriate name used to refer to these, in traditional costing methods is ‘overheads.’ They are also known as ‘indirect costs.’ They can be illustrated in summary form as indicated in table three (next).  Items that are considered indirect Commodity A and B Indirect Total percentage of indirect costs items   Purchasing materials $180000 12.6%   Setting up machines $375000 26.4%   Packaging of commodities $280000 19.7%  Testing and calibration of machines $300000 21.1%   Maintaining and cleaning machines $287000 20.2% Indirect costs in total      $1422500 100.0% Table three. Items considered ‘indirect cost items’ in traditional cost accounting In the ordinary structure of traditional cost accounting provided above, the total indirect cost line given in table three is applied. In traditional cost accounting, the cost total obtained is assigned to the two commodities A and B. The assigning of these costs is done as per the percentage usage of a resource. It is always among the direct cost components. The method is also referred to as “production volume based cost allocation (PVB).” Read More