Accounting and Marketing: Step Sisters or Noisy Neighbours - Essay Example

? Accounting and Marketing: Step Sisters or Noisy Neighbors Accounting and Marketing are two integral functions of any enterprise – either for profitor not for profit. While Marketing ensures a continuous inflow of funds, Accounting ensures that it is wisely utilized for greater efficiency and higher profitability. Thus, any organization can survive and prosper only if these two vital management functions are properly synchronized and work in tandem with one another (Bases 2004). Accounting, however, has two major branches – financial accounting and management accounting. The basic difference between these two streams lies in the user groups of data generated from these functions. While financial accounting primarily caters to the requirements of external stakeholders of a business, i.e., shareholders, lenders, suppliers, customers, competitors and relevant government agencies; management accounting provides data that is exclusively used by the management of a business entity to take informed decisions about future course of action that may include among others, whether to develop a new product or drop an existing one, whether to enter a new territory or not, whether to produce a product in-house or outsource and similar other critical decisions. In the current context, the focus of discussion would be on management accounting instead of financial accounting as the former guides the management in deciding the course of action marketing should adopt with the objective of increasing the bottom-line of a business entity. It must also be mentioned in this connection that while financial accounting is governed by statutory considerations, management accounting is entirely an in-house concept that is implemented by the management to enable it to take rational decisions about the how the company is to be run. Therefore, management accounting has no statutorily predetermined reporting interval or format and is entirely determined by the management. Further, as the data involved in management accounting is sensitive in nature, the level of confidentiality is very high as any unauthorized leakage, especially to competitors might severely harm the company’s future marketing prospects and potential (Broadbent and Cullen 2003). As cost is the primary area of concern of any management it would be worthwhile to understand the basic nature of cost and how management accounting classifies total cost into fixed and variable, direct and indirect and how these elements affect managerial decision making. Cost of production can be primarily categorized into prime cost and manufacturing overheads. Prime cost consists of direct material cost and direct labor cost. While direct material cost is the cost of material that can be traced to the final product, direct labor cost pertains to cost of labor directly utilized in manufacturing the product, that is, remuneration of labor force working on machines and equipments present in the shop floor and producing the output. Overheads, on the other hand, consist of all production related costs except prime costs. Therefore, the total cost of manufacturing a product is the sum of prime cost and overheads. Hence, the total cost incurred by a business entity is the sum of manufacturing cost and non-manufacturing overheads. While financial accounting is primarily interested in total cost, management accounting is more focused on the individual components that make up the total cost as in more instances than one management decisions are based on the behavior of these individual constituents under differing situations (Drury 2009). There is a further classification of costs that management accountants often make and that is fixed cost and variable cost. While fixed cost is unrelated to the volume of production, such as rent for factory shed, depreciation or the minimum charges to be paid to maintain a telephone connection, variable costs such as prime cost and manufacturing overheads vary with levels of output. Therefore, if a decision for increasing the output needs to be taken it becomes essential to calculate the behavior of variable costs as these would change as a consequence of such a decision (Chadwick 2000). The best example of such a scenario would be when a company has unutilized production capacity and the management needs to take a decision whether it would be more economical to make a component or a product in-house and then sell it or whether it would result in higher profit if the component or product is outsourced and sold under the company brand name (Atrill and McLaney 2006). Management Accountant uses the Marginal Costing technique (Globusz Publishing 2001) to provide an effective and convincing answer to this issue. Let us consider a hypothetical situation to understand the technique in greater detail. XYZ Ltd. is producing a component at a cost of $12 per unit and the breakup of cost is: Material $4.00 Labor $4.00 Overheads – Variable $2.50 Fixed $1.50 Total $12.00 An outside vendor offers to supply an identical component at a price of $11. Apparently it seems it would be profitable for the company to outsource as that would lead to a reduction of $1 cost per unit of the component. But a management accountant does a more in-depth to study before coming to a conclusion as they are aware that if the component is outsourced, the machine manufacturing it would become idle but the fixed costs related to it (i.e. the fixed overheads) would continue to be incurred. Hence without comparing total cost to total outsourcing cost the management accountant would recast the figures as under: Material $4.00 Labor $4.00 Overheads – Variable $2.50 Total Variable Cost $10.50 As the fixed overheads are to be incurred irrespective of whether the component is produced in-house or not, the relevant costs in this instance are the variable costs only. It is observed that the additional cost of manufacturing the component in-house is $10.50 per unit while the cost of outsourcing it is $11 per unit. Hence, the company should manufacture the component in-house. Management accounting also helps management in taking informed decisions about whether to drop an existing product and introduce a new product. Let us again consider another hypothetical situation. Suppose the cost breakup of product X and the market price it fetches are: Material $400 Labor $400 Prime Costs $800 Overheads – Variable $250 Fixed $250 Total Cost $1300 Market price $1200 Apparently it seems it would be unprofitable to produce X. However, a management accountant will view the entire situation from a different perspective. As the machine manufacturing X would remain idle, the fixed overhead associated with it will in any case have to borne by the company. So, the company will have to bear the fixed cost of $250 even if it decides to stop producing X. If, on the other hand, it continues producing X, it would generate a Contribution of $150 where Contribution is calculated as the difference between total variable cost per unit and market price. This Contribution will go towards partially recovering the fixed cost and the loss borne by the company would be reduced to $100 ($250 - $150). Therefore it would be a prudent decision to continue producing X even though it fetches a market price that is less than the cost of production. Let us consider another hypothetical scenario where the company is faced with the dilemma of whether to make or buy and what would be the minimum volume of output necessary to break even. Suppose XYZ Company outsources a component at a price of $12. The alternative proposal is to utilize the idle space within the factory shed for manufacturing this component in-house. The cost of procurement of the machine required for manufacturing this component is $85000. The machine will have an annual production capacity of 20,000 units and a productive life of 10 years. A supervisor has to be appointed specially for this machine at a monthly salary of $750. Direct material cost per unit would be $3 and direct labor would be $3. Variable overheads are estimated at 150% of direct labor cost. Financing the new machine can be done at 10% and there is guaranteed requirement of the component for the next 12 years. The company would like to ascertain the minimum number of units that need to be produced to make in-house manufacturing a profitable decision. Additional Fixed Cost: Annual salary of supervisor $ 9000 Interest on funds borrowed to purchase the machine (@10%) $ 8500 Depreciation of the machine (as per straight line method) $ 8500 Total $26000 Calculation of per unit Contribution: Purchase price of component $12.00 Less: Variable Cost: Material $3.00 Labor $3.00 Variable O.H. (150% of Labor) $4.50 $10.50 Contribution $ 1.50 Therefore, the minimum volume of output that would make this endeavor break even is: 26000/1.50 = 17,333 units per year. The machine has a capacity of 20,000 units per year so that would not be a constraint. If the management is assured that it would require at least 17,333 units per annum it would be a profitable decision to opt for in-house manufacturing else not. These are only a few examples of how accounting and marketing can function as step sisters. These are just representative examples and such decisions can be taken with respect to any expenditure incurred by a company where there are more than one alternatives to consider. Good examples of such situations would be when management has to choose between increasing advertising outlay and increasing sales force or whether or not to enter a new sales territory (Dyson 2003). However, it would be rather misplaced to assume that accounting and marketing always function as step sisters. Oftentimes they behave as if they are the noisiest neighbors possible. It should be mentioned that these two vital pillars of any business organization cross each other paths not due to any kind of turf war but mainly because of misplaced intentions and diverse priorities. Both the departments feel that they are working towards the best interests of the organization but somehow fail to agree on certain issues (Porter and Akers 1987). The first such instance occurs in deciding the optimum level of inventory, especially that of finished goods. Marketing department would quite obviously want to maintain enough stocks of all types of finished goods as they would never like to lose any opportunity of sales. If enough levels of inventory are not maintained then there might be a situation where the company might not be able to service a potential customer and thereby lose the all important revenue. Moreover, the customer might be lost forever as chances are rather slim that they would come back next time they require that particular product to a company that had failed to supply in the first instance (Anthony, Dearden and Vancil 1976). So, marketing department would like to keep the finished goods store full to the brim all the time. They are right from their perspective and while they demand such overstocked condition they feel that they are indeed doing a great service to the company by demanding so. However, there is a vital ingredient of cost called inventory carrying cost which increases as the volume of inventory rises. Accounts department which keeps a tab on all forms of cost would quite rightly like to put a limit to inventory carrying cost and would like to limit inventory to optimum levels. In this way, the department feels that is doing a great service to the organization as it would not have to bear unnecessary and avoidable inventory cost (Howell and Soucy, Operating controls in the new manufacturing environment 1987). The accounts department would surely not wish to put a blanket limit on all types of inventory as it also realizes fully well the importance of sales revenue. It would rather embark on an ABC analysis of available stock on the basis of unit cost and turnover and would come to a decision as to what would be the optimum levels of stock that the company should carry in its inventory (Egan 1994). The accounts department would surely like to reduce inventory levels of slow moving stocks while agreeing to optimum levels of fast moving stocks as it feels that would be the best possible way to reduce unnecessary inventory cost while not impeding possible increases in revenue. Thus, the whole situation is a matter of conflict of perspectives and we really cannot say with any degree of certainty which department is right in this instance. The top management has to intervene in such situations to restore some semblance of peace among the warring departments (Cooper and Kaplan 1998). The other area of potential conflict is in offering credit limits to buyers. Credit is the lifeline of any form of business and commerce. Any company, if it wishes to survive, has to forward credit to its customers, with the exception of a possible few that have patent rights over certain products, as much as it expects credit from its suppliers. This mutual giving and offering credit is a vital source of short term finance in the world of commerce (Hofer and Schendel 1979). There is, quite naturally, a severe competition among rival marketers to bag as large a market share as possible and in situations where there are not much qualitative differences in products that each competing marketer has on offer, duration of credit offered is a potential differentiator between them. Customers will obviously flock to the marketer that offers the longest credit period and marketing department of each company would like to beat other market operators in this regard. Thus, marketing department would fight to offer longer credit period than their competitors and increase sales revenue to the maximum extent possible but accounting department has other ideas about the whole issue. Any form of credit has an associated cost. From strict accounting sense, offering credit is nothing but financing the operations of the customers through the credit period. Funds cost money as every dollar invested in business attract interest cost and the accounting department would, again quite rightly from their perspective, try to restrict credit limits and periods offered to the customers to the extent possible. It is another matter of course that this same accounting department would pressurize the Purchase department to negotiate with suppliers for the maximum extent of credit possible (Howell and Soucy 1987). The accounting department feels it would of great benefit to the company financially if it is able to negotiate long periods of credit from suppliers while offering minimum credit to customers as in that way the working capital requirement of the company would be substantially lowered. There is also the additional risk of forwarding credit to not so creditworthy customers and incurring bad debts that would finally harm the company’s financial position. To an unbiased and dispassionate observer it seems that both the warring departments are right from their individual perspectives. While the marketing department feels that in its desire to reduce working capital requirement the accounting department is in effect stunting the possibilities of increased revenue and a larger share of the market, the accounting department feels that marketing department in its one point agenda of increasing sales is in effect weakening the financial health of the company (Howell and Soucy, Management reporting in the new manufacturing environment 1988). As in the previous instance the top management has to step in and strike a balance somewhere in between. Thus, it can never be said with any degree of certainty whether marketing and accounting departments are step sisters or noisy neighbors. There are many areas where one complements the activities of the other while in many other areas they seem to be having different agendas and consider each as an impediment to the smooth functioning of the other. The reality obviously lies somewhere in between. Both departments are equally vital for any business enterprise and as they have different perspectives they ensure that parity and balance in the company’s overall actions are maintained all the time. So, in a sense it might be concluded that while it is absolutely necessary for these two departments to assist each other in decision making as that helps the top management in getting an all-round perspective about an issue and act accordingly, it is also equally vital for the health of the company that these two departments present diverse opinions about certain issues under consideration. That acts as a natural safeguard for the management as it would never take a decision that would blind to either of the department’s concern. This automatically creates an environment where balanced and measured decisions, instead of impulsive actions, are taken. This is possibly the best arrangement that any business enterprise can hope to achieve. References Anthony, N. R., J. Dearden, and R. F. Vancil. Management Control Systems: Text and Cases. Homewood, IL: Irwin, 1976. Atrill, P., and E. McLaney. Accounting and Finance for non-specialists. FT Prentice Hall, 2006. Bases, Gary J. "Understanding the bidding process--from both sides: a foundry executive needs to have bidding expertise whether he is receiving bids or submitting them. An accounting-driven firm may be more interested in financial percentages and rates of return, but ..." Foundry Management & Technology , 2004. Broadbent, M., and J. Cullen. Managing Financial Resources. Oxford: Butterworth-Heinemann, 2003. 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Howell, R. A., and S. R. Soucy. "Operating controls in the new manufacturing environment." Management Accounting, October, 1987: 25-31. Porter, G. L., and M. D. Akers. "In Defense of Management Accounting." Management Accounting , 1987: 58-62. Read More