Performance Management: Gwent Housing Association - Essay Example

Performance Management: Gwent Housing Association The recent turmoil within the global economy has changed the focus of many organizations towards a budgeting and forecasting manner. Many recognized bodies such as the Chartered Institute of Management Accountants and the Association of Chartered Certified Accountants have encouraged managers to adopt suitable budgeting and costing techniques within their organization so as to reduce the impact of the economic recession. The recent conference conducted by the Chartered Institute of Management Accountants heavily emphasized on creating value and improving performance during such torrid times. The boost in performance and the value creation was only deemed to be achievable if certain costing techniques were followed and those different costing techniques are evaluated further in order to give a better picture. Evaluation of the techniques discussed Marginal Costing “Marginal costing is a costing methodology that takes into account only the variable or marginal costs in the valuation of cost of sales” (Mtetwa, 2010). The marginal costing technique values the stock at variable production cost. Marginal cost is considered to be the cost of producing an additional item or product and in marginal costing technique only these techniques are allocated as the costs of sales while the fixed costs are treated as pertaining to a particular period and are allocated in full against the profit of the period in which they are sustained. Marginal costing technique is a good decision making tool, the basic issue with marginal costing is that the use of this technique would alter the contribution with respect to the number of products sold which means that profits would increase with respect to the additional number of products sold, this would be as a result of the extra contribution earned. The draw back within Marginal Costing is that it ignores the prepaid sunk costs and any future committed costs within the short-term, this as a result affect the profit statement of the firm within the medium and the long term (Steven, 2005). Absorption Costing “Absorption costing is a costing method which charges both variable and fixed costs in the valuation of cost of sales” (Mtetwa, 2010). Absorption costing is a three stage technique which involves allocation, apportionment and absorption. The allocation step involves the direct overhead costs to be charged to their respective cost centers/units. The apportionment stage involves charging the overhead costs through primary and secondary apportionment. Primary apportionment involves charging overhead costs to both production as well as the service cost centers while secondary apportionment engages the non-production and the service costs to the production centers. Finally the overheads are absorbed into the product costs using a suitable absorption rate. This overhead absorption rate is based upon the budgeted costs and the budgeted activity levels. With absorption costing, there is no relationship between profit and the sales volume (as seen in Marginal costing). Under absorption costing, the revenue and the total profit would increase with respect to the total gross profit per unit and the amount of the overhead absorbed per unit. The mere benefit of using absorption costing is that it includes the entire costs pertaining to a particular product and hence this helps in better pricing of the product. The only setback of this method is that it is a rather complex method of monitoring profitability (Smith, 2007). Activity Based Costing Activity based costing, also known as ABC, is a costing technique that has evolved rapidly and has made a huge mark within management accountants. The traditional cost allocation technique (i.e. the absorption technique) was developed in an era when most firms usually produced narrow range of products and overhead costs were only a small fraction of total costs. These traditional costing techniques assumed that all the different products within an organization consumed resources with proportion to their production volumes, this as a result lead to a higher allocation of resources to high volume products and a little amount proportioned to low volume products. The support services used up by these products were also not made a part of this allocation and hence to answer this dilemma, ABC was introduced as better costing technique (Srinivisan, 2008). Activity Based Costing (ABC) identifies the factors that affect the costs of an organization’s major activities. These factors are usually known as the Cost Drivers. Cost Driver is best defined as any factor that may bring upon a change in the cost of an activity. “Cost Driver Analysis and ABC accounting are “tools” for gathering data on an organization’s costs of doing business: costs to serve their customers, costs to purchase, carry, and sell to their vendors’ products and services, and their costs to engage in various “activities” (ordering products, receiving products, selling products, delivering products, etc.)” (Harvey et al, 2003). Besides the cost drivers, the other thing within ABC is the Support Overheads. These Support Overheads are charged onto the products with respect to their usage of an activity. The difference between absorption costing and ABC is that absorption costing uses two common absorption basis i.e. the machine hour basis and the labor hour basis whilst the ABC uses different cost drivers as a basis for absorbing the overheads (Srinivisan, 2008). The ABC system has four stages. These stages should be properly planned so as to correctly implement the ABC system. The first step involves the identification of the organization’s core activities. The second step involves the identification of the cost drivers e.g. the cost driver for material handling costs would be the number of production runs. The third step within ABC would involve the collection of costs, linked to every cost driver, within a cost pool and finally these costs would be charged to the products with respect to their activity’s usage. The major benefit of using Activity Based Costing is that each allocated center (either profit or cost) is responsible for its negative or positive variances. Besides the benefit, there are some drawbacks of the technique as well but the major drawback of the technique is that it is usually difficult to ascertain the cost drivers and that the cost apportionment requires personal judgment (which can be incorrect) at the time of cost pooling (CIMA, 2006). Target and Life Cycle Costing According to the definition provided by CIMA, target costing is “A management process responsible for identifying, anticipating and satisfying customer requirements profitably” (Garrett, 2011). The basic phenomenon within target costing is to set up a target cost for a product by reducing a pre-determined profit margin from a competitive price offered within the market. Target costing was developed in Japan in order to answer the market demand for a large range of versatile and diversified products having shorter product life cycles. This was only possible if companies redesigned their products through continuous development and on-going processes. Japanese companies thought of target costing as an answer to the problem of restricting and reducing costs over a product’s life cycle. It is always considered difficult to launch a new product within a market by a company dictating its own terms over the price of the products, hence to avoid any failure of such products, companies tend to follow target costing technique by calculating the targeted selling price of any product and then deducting the required profit margin from the selling price to arrive at the costs. This way the company can try to achieve those calculated costs and remain competitive within the market (CIMA, 2005). Lifecycle costing, on the other hand, tracks all the cost of a product with respect to the different stages of its lifecycle. These costs are kept separate with respect to their relative lifecycle stage and finally they are added up in the value to chain. The lifecycle costing method can help in determining the profitability of an individual product. The costs at all the different stages within a product’s life cycle can be properly addressed and they can be corrected if any discrepancy is found within the budgeted and the actual cost level at all the different stages of the product lifecycle. The issue with lifecycle costing is that it may usually not match up with the accounting system that prevails within many different organizations where the firms write off the research and development expenditure against the profit earned by the entire product line on an annual basis (Garrett, 2011). Throughput Accounting According to the definition give by CIMA, Throughput accounting is “A technique where the primary goal is to maximize throughput while simultaneously maintaining or decreasing inventory and operating costs” (CIMA, 2007). The throughput accounting concept is derived for the theory of constraints, in which the focus is on developing and producing products and selling them at a rapid and fast rate. The throughput accounting concept is considered to be theoretically parallel with the Just in Time technique. The throughput accounting concept tries to overcome the constraints that every organization faces during its cost of production, these constraints are referred to as the bottleneck resources. The theory of constraints and the throughput accounting techniques follows certain steps. The initial step is to identify the constraints, whether they are internal i.e. within the organization or external i.e. pertaining to the market, policy or any other outside element. Once the constraint has been identified, steps should be taken to eliminate the constraint using the core competencies of the organization and as soon as the constraint has been eliminated, the step would be to figure out further constraints on continuous basis and eliminating them through an on-going basis. Relevance of the Techniques to Gwent Housing Association All these costing techniques would have their own benefits and drawbacks and each and every costing technique would have its own relevance with respect to the operation of Gwent Housing Association. Marginal Costing Marginal costing can help in deciding the selling price for the Association. The Association would be able to price the houses on the mark-up basis and once this technique has been properly established, the Association would be able to reduce the selling price by reducing the pre-determined mark-up used for e.g. if the Association is building one flat at a cost of £15,000 and a mark-up of 100% is added up to reach a price of £30,000, the Association would easily understand that each additional £1 would earn them £0.5 in profits, hence this mark-up can be reduced by the Association on order to cope with the reduced funding offered by the Welsh government. Secondly, the Association can also try and figure out the costs of building one flat and this cost may be compared to any other competitors marginal cost of producing a flat. Hence, if the Association’s cost of building a flat is higher, they can outsource the building process to some other builder and still provide flats within the economy and thus they would achieve their objective of providing affordable homes to the people of Newport. Absorption Costing Absorption costing technique would help in addressing all the costs of building a flat for the Association. Unlike marginal costing, which does not constitute fixed costs, absorption costing includes the fixed costs in the total product cost and this way it is easily identified which costs are the one that are going against the budgets. This identification would help the Association to identify and reduce the costs which are increasing as opposed to the budgets and these costs would be properly addressed if once identified. Activity Based Costing Activity based costing systems helps in eliminating the information gap by providing a comprehensive knowledge about the costs of building a unit/product. The Association would be able to get the total cost structure and would be able to address the areas which are underperforming or where the costs are rising. The use of ABC would allow the Association to understand their entire business process and the relevant cost structure of building flats. ABC points out evidently towards costly and non-value adding activities and once these are identified, the Association would be able to reduce the costs and would remain competitive within the market by offering better value for money to their customers (CIMA, 2006). Target and Lifecycle Costing Target costing would be really helpful for the Association and it would suit the scenario currently faced by the Association. The Association would be able to draw a market competitive price for the flats and this way they would be able to draw the cost at which they should be building the flats. The reduced subsidy provided by the Welsh government would also be taken into account and the Association would need to reduce their profit margin with respect to the reduced subsidy and arrive at the cost. This determined cost would be targeted by the Association in order to remain in business. Lifecycle accounting would also be really helpful for the Association as their primary focus is to offer better value to the people and lifecycle accounting is considered to help in this by severe cost reduction. Research has shown that 90 percent costs of a product are committed during the development stage of a product and every penny spent on pre-manufacturing activities tends to save a lot at a later stage, hence lifecycle costing can be used to identify the proper development stage and costs would be properly incurred at the development stage so as to save costs at a later stage. Throughput Accounting The focus of throughput accounting is not on reducing costs but its main idea is to generate increased throughputs. The increased throughputs are bound to produce more cash and hence more profits because the certain costs would be eliminated such as inventory holding costs. The concept of throughput accounting is to sell products at a faster and this may require quick production as well, although this scenario matches with the fact that the demand for new flats has increased within Newport but the issue of meeting the demand seems a bit problematic for the Association because of a reduction in their budget being offered by the Welsh government and besides that there are no inventory holding costs that may be saved and overall costs may be reduced by increased throughputs. Hence the throughput accounting may seem less viable for Gwent Housing Association. Reflective Journal Name Session Date Course 1. What did I learn from producing the coursework? The important thing that I learned was that costing techniques are really useful when it comes to reducing the costs within an organization. These techniques help in keeping the company organized and any deterioration in the costing plans are easily identifiable and addressed. 2. What problems did I encounter when completing the assignment? I had problems finding the correct sources initially but later I was able to get hold of several articles published by the Chartered Institute of Management Accountants. These articles helped me immensely in understanding the costing techniques more easily 3. What would I do differently next time and what would have enabled me to do a better job? The research data on throughput accounting was not large enough for me, though I tried to obtain as much data as possible but as throughput accounting is a developing topic, I would find out better articles for it the next time I work on the topic. 4. When completing the assignment, which learning outcomes did I find easiest / perform best at? The easiest learning outcome was to work autonomously and developing good awareness about performance management techniques. I think the structure of the paper was the best thing that I did with the paper along with the proper explanation of all the different costing techniques. 5. When completing the assignment, which learning outcomes did I find most difficult / perform worst at? The information was the difficult most learning outcome to achieve as it consumed a lot of time but I was able to find good information eventually. The worst area of my paper was probably the application of throughput accounting technique onto the Gwent Housing Association case. 6. Do I honestly believe that I have performed to the best of my ability? I believe that I have worked hard for the entire paper and have researched through a wide range of data that I was able to assess from different sources. This research took a lot of time but eventually it seems that the time spent was worthwhile as it produced good articles and a good paper in the end. Bibliography CIMA, 2005. Target costing in the NHS, Reforming the NHS from within, CIMA NHS Working Group. [online] Available at: [Assessed 19 October 2011] CIMA, 2006. Activity Based Costing, Topic Gateway Series No. 1. [online] Available at: [Assessed 20 October 2011] CIMA, 2007. Theory of constraints and throughput accounting, Topic Gateway Series No. 26. [online] Available at: [Assessed 20 October 2011] Garett, K., 2011. Target Costing and Lifecycle Costing, ACCA. [online] Available at: [Assessed 19 October 2011] Harvey, K.R. and Peter, L.M., 2003. Implementing Activity-Based Cost Accounting, Customer Profitability, and Product-Line Analysis In a Distribution Business, White Paper III. [online] Available at: < http://kczx.gzhu.edu.cn/course_center/files_upload/template/6C473DC0-9248-4A50-A2B2-04741AAD2F02/COLUMN_16/file3/IMPLEMENTING%20ACTIVITY-BASED%20COST%20ACCOUNTING.pdf> [Assessed 19 October 2011] Mtetwa, M., 2010. Absorption Costing: Full Cost Accounting. [online] Available at: [Assessed 19 October 2011] Mtetwa, M., 2010. Marginal Costing: Variable Cost Accounting. [online] Available at: < http://munya-mtetwa.suite101.com/marginal-costing-a192256> [Assessed 19 October 2011] Top of Form SRINIVASAN, P. (2008). Activity based costing: concepts and cases. Hyderabad, India, Icfai University Press. SMITH, J. A. (2007). Handbook of management accounting. Burlington, MA., CIMA. Bottom of Form Steven, G., 2005. Management Accounting – Decision Management. [online] Available at: < http://www.cimaglobal.com/Documents/ImportedDocuments/fm_julyaug05_p41.pdf> [Assessed 19 October 2011] Read More