Management Accounting - Assignment Example

Management Accounting Q Start the report with a discussion of the concept of relevant costing and how it might apply to a manufacturing company. You may illustrate your discussion with suitable examples. Cost system is the base for ascertaining the profit of manufacturing or trading operations. The type of cost system is also a crucial factor in costing decision making. Basically, there are two costing systems, namely Absorption Costing and Marginal Costing. The Classic Products Limited (CPL) has been following marginal costing system for accounting its cost information and related decision making. The concept of marginal costing is highly relevant for manufacturing concerns where huge amount has been spent for fixed capital investment. Avoiding fixed expenses to find the profitability of operations is the crux of marginal costing system. For the purpose of understanding the importance of marginal costing system in the firm, let us start with the very fundamentals of marginal costing. Marginal costing is the system of ascertaining the marginal cost and its use for decision making. Marginal cost is the extra cost incurred for producing an additional output. The extra cost incurred usually is the one which is likely to change in direct proportion to the change in output. Such costs are known as variable cost and hence the costing system is also called variable costing system. The basic idea behind marginal costing system is that all variable costs are deducted from the sales to find out the contribution ( from which fixed expenses is later deducted to ascertain the profit) on the plea that fixed cost remains constant irrespective of the volume of output or sales. There are many applications of marginal costing in manufacturing concern. One of such applications is the decision with regard to the make or buy decision. In the make or buy decision, the management accountant undertakes a cost benefit analysis. Such a decision making requires the firm to know through marginal costing what contributes to fixed costs will result from a make decision. The points to be taken care of at the time of make or buy decision are: The capacity of the company in terms of people, plant space etc to achieve the required quantity and quality The differential costs of making or buying the item The opportunity cost of using existing capacity to manufacture alternative items. The level of variable overheads, which are charged to the item Make or buy decision in a manufacturing company will be taken with the help of marginal costing in the following manner: When the capacity is available it cannot be utilized for manufacture of other products, then the purchase cost is compared with the marginal cost or total cost is compared with the purchase cost plus fixed cost of manufacture to take the decision to make or buy. When the capacity is available and it can be utilized for manufacture of other products, the purchase price is compared with the marginal cost of the product and plus opportunity cost, i.e., the loss of contribution of other product replace When there is no additional capacity available and it is proposed to acquire additional facilities for manufacture, the purchase price should be compared with the marginal cost plus fixed cost likely to be incurred for manufacturing with additional facility. Q. 2) Without any calculations, identify the business options indicated in the CPL case and comment, without using figures, on the possible costs and benefits of each option. Classic Products Limited (CPL), the UK based manufacturing company producing high quality goods uses good looking packages with a unique patented lining on the containers. The company’s general manager, Mathew Goodman is of the opinion that the company can save money by buying the containers from an outside source Just-a-Box Company (JBC) without sacrificing quality of the containers. JBC is agreed to supply the required number of containers for an agreed period of five years from now. However, the period can be extended in accordance with the further discussions of two companies. In addition to that, irrespective of whether the contract between JBC and CPL is agreed upon or not, CPL will incur a certain amount as maintenance on containers. The situation here is well described as the one that calls for the expert opinion of the management accountant. The situation here is known as Make or Buy decision. The two options which confront the general manager Goodman are: 1. The company can manufacture containers (Make Decision) 2. The company can buy the same containers from outside firms. These two situations are not easy to analyze as there are many factors to be taken care of to arrive at a final decision. The basic principle to be applied by the management accountant in this context is that which of these two options is more beneficial to the company in economic terms. The management accountant, Mr. John Dobson will go for only the one which outweighs cost and reject straight way the one which is likely to incur more cost than benefits. The cost and benefits of both options are qualitatively described as below: Make Decision If Mr. Mathew Goodman goes ahead with the decision to continue the production of containers, the company will have to maintain a separate department- Container Department- which will incur costs in the form of manager’s remuneration and other labour costs. Furthermore, the cost of remuneration of Goodman of Container Department is increased by 10% annually. In addition to that the cost of labor is also expected to increase by 5%. This will together increase the cost of manufacturing container by 15% per annum. Even though, the container production is given to JBC, a certain amount is incurred by the company by means of maintenance work on containers. But, if the company is deciding to maintain the department, the initial investment for fixed assets in the form of machinery and the investment in materials can be fruitfully utilized. Moreover, Hamilton reminds Goodman that the cost of material and machinery have been increased substantially since its acquisition. Therefore, Hamilton warned that the decision to closed own the department will incur huge loss to the company. But, Dobson categorically opposes the decision to maintain the department on the plea that if the department is closed down, the space can be utilized for warehouse for which the company has been paying much efforts and money. Goodman also agrees with Dobson’s point, but he is confused over the relocation of the department workers, especially those reaching retirement age. Buy Decision Just-a-Box Company is ready to process CPL’s requirement, provided all the company’s direction and requirements are followed by CPL. JBC is ready to supply all the container requirement of the company, which is annually 30, 000. The total cost for 30, 000 containers is estimated to be £1,080,000, which is likely to change in direct proportion to the change in number of containers. This estimates reveals that the per container cost to be paid by CPL is £36. Also, JBC has offered the tenure of contract initially for five years, which can later be renewed, if CPL finds necessary. Even when the Containers Department is closed down, the manager, Hamilton will be posted in another position of the same status and pay. The workers in the department are expected to be relocated to various positions in the company except those having old age. One of the strong arguments against buy decision is that even if the department is shut down and purchase containers from JBC, the company will incur a maintenance cost on containers, which is not negligible. Q.3) With the assistance of relevant calculations, determine and explain which of the alternatives identified in (b) above is most attractive, ignoring the time value of money, for the period indicated. Justify the approach that you adopt In order to compare the two situations of CPL, an in-depth quantitative analysis has to be carried out by the General Manager. Goodman has information with him provided by the management accountant as well as those of manager of container department. In order to undertake the analysis, Goodman prefers to carry out a cost benefit analysis by which the most profitable decision out of make or buy decision is expected to be selected. The cost benefit analysis means and includes the comparison of the benefits and costs of each course of action and weighing the importance of course of action in terms of benefits. The course of action which has more benefits than costs shall be selected. When benefits and costs are compared, the concept of time value of money is ignored for convenience. The benefits and costs include present and probable items which could be estimated out of the experience of the management accountant and that of JBC. The information provided by the management accountant includes cost of operation including administrative costs for a period of one year for a certain number of containers. The company has a requirement of 30, 000 containers per annum. JBC has assured to supply the required number of containers for a total cost of £1,080,000. It reveals that per unit cost of container demanded by JBC comes to £ 36 (£1,080,000/30000). But, CPL will incur another £464,650 per annum for maintenance work on containers. When both these costs are taken into account, the per unit cost of container, in effect, is amounted to £51.49 (£464,650/30000). This calculation is as per the information provided by the JBC and the maintenance cost of containers. However, the management accountant, Mr. Dobson has supplied company’s cost data to help cost benefit analysis and final decision making as to whether the container must be bought of made. CPL’s cost data supplied by Dobson is given below, which is used to calculate per unit cost of container. Cost Sheet of CPL for the production of 30000 container Component Cost Amount in £ Materials 490,000 Labour (cost expected to increase by 5% each year) 200,000 Neil Hamilton’s salary (expected to increase by 10% each year) 40,600 Rent 30,150 Depreciation of machinery 100,500 Maintenance of machinery 20,520 Other departmental expenses 110,025 Proportion of CPL’s general administrative overhead 150,750 Total 1,142,545 Number of Container produced by the company 30,000 (nos) Per unit cost of Container (£1,142,545/ 30000) 38.0848333 The above table reveals that per unit cost of container comes to £38.08 as disclosed by the cost data supplied by the management accountant. When the container maintenance cost is added to the total cost given in the cost sheet, cost per unit of container would be £53.57 (1,142,545 +464,650)/ 30000) Therefore, it can be concluded that buy decision is advisable for the company as CPL’s per unit cost of container is higher than that is offered by JBC. This recommendation is taken by taking into account the cost information provided by JBC and CPL’s management accountant. However, practically, the company may have to consider many other factors which have a bearing upon make or buy decisions. Q.4) Discuss other factors which Mathew Goodman should consider before finalizing his decision and indicate how he could obtain the necessary information As mentioned earlier, cost data alone is not sufficient to take managerial decisions, especially those having strategic importance. Cost data reveals only the quantitative information which will not exhibit the entire story of business affairs. Qualitative information will also be of paramount importance to organizations in taking certain decisions. For example, majority of information concerning the work force of an organisation is of qualitative nature and it can be seldom expressed in quantitatively. Therefore, taking strategic decisions neglecting the qualitative features of an organisation will rarely work out. The other factors which will have to be taken care of by Goodman include: 1. Quality of Container 2. The possibility of contract renewal with JBC 3. Hamilton’s Relocation in the organisation with same status and pay 4. Investment in machinery 5. Investment in inventory 6. Savings in warehouse rent on account of the closing of container department 7. Relocation of Containers department workers References Marginal Costing-3, (2007), Advantages of Marginal Costing: Make or Buy Decisions, Writing Campus, writingcampus.com, viewed 12 January 2009, Mott Graham, (2005), Accounting for Non-accountants: A Manual for Managers and Students, Kogan Page Publishers, 2005, 146-148 Ohmae Kenichi, (1991), The Mind of the Strategist: The Art of Japanese Business, McGraw-Hill Professional, 1991, 116-120 Stephen & Offenbacker, (2004), introduction: Marginal Costing as a Management Tool, All Business.com, viewed 12 January 2009, West Colston, Mike Bendrey, Michael Bendrey & Roger Hussey, (2003), Essentials of Management Accounting in Business, Cengage Learning EMEA, 2005, 134-135 Read More