CIMA Official Learning System - Performance Operations - Essay Example

?Running Head: Management Accounting Management Accounting [The of the will appear here] [The of the will appear here] [The name of the Professor] [Course] Question 1 Total Cost Approach In the Total or Full Cost Approach, the firm calculates all the costs that are to be incurred by the company and adds a profit margin to it. The Full Cost Approach takes into account both the direct and the indirect costs. The pricing of the goods under the total cost approach reflects the actual cost of the product and includes environmental costs, which is accounted as the indirect cost of the product (Schempf, n.d.). Indirect costs refer to costs that are not directly associated with the product and do not apparently increase the cost of the product. Indirect costs include overhead costs that are incurred by the organization to keep the organization running and are usually incurred under joint usage of more than one product. Examples of indirect cost include electricity, utility and telephone bills. Since all organization produce more than one product and the overhead costs are incurred together and thus the allocation, appropriation and absorption of these overhead costs have to be done most justly. Allocation allocates the overhead costs to the cost centres or units from where these costs are incurred. Appropriation is done on two levels. On the primary level, appropriation is done by dividing overhead costs to both product and service centres on an equal basis. On the secondary level, overhead costs are distributed on arbitrary bases, depending upon either time or usage. Absorption is the absorption of overhead costs to the production cost. To do this, absorption rate is determined using the following formula: Overhead Recovery Rate = Overhead Costs/ Unit Chose (Drury, 2007) The advantage of full cost approach is that it is relatively simple to use this approach if the firm can account for its costs easily. This approach also brings stability to the pricing system, thereby allowing the firm to justify their prices to the consumers. Full costs approach also makes it easier to understand the pricing strategy of their competitors. Under the full cost approach, the firm can expect a reasonable rate of recovery for its products. However, there are certain disadvantages of the full cost approach. The full cost approach does not allow for the adjustment of prices according to the changing demands and competition and thus may result in increased prices of the products against the competition. The full cost approach also does not allow the organization to adapt its pricing structure to prevent loss. This is because the volume of production of the products is not flexible and thus when demand goes down, the volume cannot be suitably adjusted. The treatment of costs in the full cost approach is also standardized and thus do not allow for the differentiation between relevant and irrelevant costs (Lal, 2008) Marginal Costing Approach Marginal Costing has been defined by I.C.M.A London as ‘the ascertainment of marginal costs and of the effect on profits of changes in the volume or the type of output by differentiating between fixed costs and variable costs’ (Murthy and Gurusamy, 2009). Marginal Costing allows the organization to write of its fixed costs in the profit or loss account while using the variable cost to determine the profit margin for the product. The Profit in marginal costing is determined by subtracting the variable and fixed costs from the selling price of the product. By differentiating between fixed and variable costs, marginal costing allows the organization to effectively decide the feasibility of the product by studying the current manufacturing costs. Since the costs are variable, the selling price of the product can also be adjusted to meet the pricing demands of the market. Marginal Costing Approach basically allows flexibility in the management decision, including the make-buy decision, the sales mix and the method of product to be used. Marginal Costing is more appropriate for short-term decisions by the management since it allows management to understand the current picture of costs and profits. Marginal Costing differs from the total costing approach on my points including profit determination; costs; determining the value of stocks; and application and calculation of overhead costs. In total costing approach, profit is measured by the profit figures and the expected relative profitability. In marginal costing approach, the profit is measured by the contribution made by the different products in the overall profit of the organization (Burke and Wilks, 2006). Activity Based Costing Activity Based Costing or ABC is a relatively modern approach towards accounting. It goes away with the traditional determination of costs as fixed or variable, rather Activity Based Costing assigns the cost of the product based on the activity or contribution of the product to the profit of the organization. The overhead costs of manufacturing are assigned to the products that are actually demanding the costs be incurred. For example, if a particular product is being advertised, activity based costing will only allocate the overhead head to that product rather dividing it between all the products. The need for ABC was felt in the early 1980s, when organizations became aware of the fact that the traditional accounting approach does not provide accurate or useful information to the management (Scarlett, 2009). When ABC approach was introduced in organizations, it was quickly adopted by most organization as it allowed management to make timely decisions based on the clear picture provided by this approach. Probably the biggest advantage of ABC costing and the reason it became quickly popular was the improved management decisions made by the organization. This approach provides a more accurate picture of the cost data and thereby the profit data. Based on this cost and profit data, the management can easily decide where to focus on and which product to discontinue. ABC also allows organization a better control over their overhead costs. Overhead costs in ABC approach is easily identified with the product for which they had been incurred and allows the organization to decide which costs they can control in order to bring down the manufacturing cost of that product. Also ABC approach allows for a more flexible allocation of cost based on the cost drivers that led to the production of each product. However, even as organizations are increasingly adapting the ABC approach, the limitations of this approach are also becoming apparent. The ABC approach is relatively much expensive than other traditional approaches, therefore it is more feasible for large organizations. Since the ABC approach is more complex and rewarding than other traditional approaches, it demands more costs from the organization. Also even though ABC costing has allowed organization to allocate their overhead costs more accurately, there are still costs that are still allocated on the basis of production of the product. These costs include machine and labour costs (Weygandt, Kimmel and Kieso, 2009). Organizations that have adopted the ABC approach have not felt any remarkable increase in profits as a result of better managerial decision making. Question 2 Schedule Material Alpha 20?1700= ? 34000 Beta 30?1600= ? 48000 Labour Skilled 4?17800= ? 71200 Unskilled ? 38400 Supervisor ? 20800 Total Labour (Labour Cost- Labour cost saving) 71200+38400+20800-9,600= ? 120800 Machinery ? 37600 Overheads Materials (34000+48000) ?50%= ? 41000 Labour (71200+38400) ?50%= ? 54800 Total ? 336,200 Since the maximum that Coates could pay for the contract is ? 237,600, the contract is not acceptable to Seashell Ltd. Discussion The Materials required for the construction of the cabin cruiser hulls are Alpha and Beta. Alpha is available to Seashell through a fixed and binding contract at ?1,700 per tonne. Even though the price has dropped to ?1,600, the contract is binding and thus Seashell will have to purchase its 20 tonnes at ? 1,700 which will amount to ? 34,000. For the second material which is Beta, Seashell already has a stock of 30 tonnes. The Company is willing to sell its stock for ?1,600 per tonne which will cost ?48,000 for the 30 tonnes that Seashell needs for the contract. Additionally Seashell has a policy of adding 50% to its material cost as an overhead contract. This will amount to ?41,000. For the Coates contract, Seashell will have to hire skilled and unskilled labour along with a supervisor. The four skilled labour cost ? 71,200 for this contract, with one skilled labour being paid ? 17,800. For the unskilled labour, Seashell will have to shift its routine labour form the dinghy contract to the Coates contract which will incur Seashell ?38,400 for the overtime paid to the routine unskilled labour. The salary of the supervisor will be counted as a fixed cost since the organization will have to pay a salary of ?20,800 in any condition. However, Seashell will be able to save ?9,600 on labour costs by using rented machinery on its rented dinghy work and thus it would be deducted from the total labour cost. Seashell has a policy of adding 50 percent as overhead cost for its labour costs. This will be calculated by adding the salary of skilled and unskilled labour, and ignoring the salary of supervisor since it is a fixed cost, and then taking 50 percent of the total calculated. The machinery that would be employed for the Coates contract will be rented by the organization at ? 28,000 and thus will be added to the contract. References Burke, L. and Wilks, C., (2006) CIMA Learning System 2007 Management Accounting Decision Management, Massachussets Butterworth-Heinemann, 2006 - 608 pages Drury, C. (2007) Management and Cost Accounting, Ohio: Cengage Learning Lal, J and Srivastava, S. (2008), Cost Accounting, New Delhi: Tata McGraw-Hill Education, 2008  Murthy, A. and Gurusamy, S. (2009), Cost Accounting, New Delhi: Tata McGraw-Hill Education, 2008  Scarlett, R., (2009) CIMA Official Learning System - Performance Operations, Massachusetts: Butterworth-Heinemann, 2009  Schempf, C. (n.d), Full Cost Accounting, Pennsylvania: Carnegie Mellon University Retrieved from http://www.ce.cmu.edu/GreenDesign/gd/education/FCA_Module_98.pdf Weygandt, J. J., Kimmel, P. D., and Kieso, D. E. (2009) Managerial Accounting: Tools for Business Decision Making, New Jersey: John Wiley and Sons Read More