Managerial Accounting for Decision Making - Essay Example

? Managerial Accounting for Decision Making Managerial Accounting for Decision Making Part A. 1. Tanya does not explain very clearly what she means by a management accounting system. Outline what she ought to have said and explained. Tanya should have explained that management accounting systems are planning and control systems which are usually concerned with the planning and controlling activities of the organization. Management accounting can be defined as: ‘The process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information that assists executives in fulfilling organizational objectives… a formal mechanism of gathering and collecting data for the ends of aiding and coordinating collective decisions in light of the overall goals and objectives of an organization. Horngren and Sundem, 1990. P- 4’ (MACINTOSH & QUATTRONE. 2010) Management accounting system is a part of the larger control system in the organization used to measure, monitor and motivate the managers and employees in the organization and also to coordinate with the other components of the organization like machine, information, material and technologies etc. For a robust control system it is necessary for the entire control mechanism to support each other, management accounting system can play a great part in coordinating and controlling all the activities in the organization. (MACINTOSH & QUATTRONE. 2010) Management accounting system not only helps in planning and coordinating activities of the organization but also plays a vital role in performance measurement and decision making by providing information for managers to make timely decisions, to be effective and efficient in the execution of the business and to improve overall performance of the organization. Management accounting system also helps managers and provides assistance in financial reporting to control, formulate and implement strategies in a more efficient way. Both management and financial accounting systems are important for the organization, however in a rapid and growing business the organization cannot rely on the financial accounting system only. There are a few similarities between financial and management accounting for which one thinks that they both perform the same function like both are used in the reporting purpose and helps managers in analyzing the company’s performance and take action for control. But it’s important to mark the differences and benefits that management accounting can solely provide to the organization. Financial accounting is used at the end of the financial year when auditors come for the audit. They work on the historical data that how company performed during the year and prepare their report for the shareholders confirming company’s accounts give a true and fair view. Management accounting however is used to provide information for managers only on a continuous basis that is it doesn’t wait for the financial year to end. It is forward looking and focuses on information that managers can use to make decisions for the future. Therefore if company has issues and loopholes in the control and information systems it can be corrected right on time. Management accounting system in short makes the managers adopt a more forward looking approach for the business. (NEEDLES, POWERS & CROSSON .2010) Part A. 2. Identify from the case study the reasons why Tania thinks that Nosystem Limited should install a management accounting system Analyzing the case given it could be argued that Nosystem needs to install management accounting system. As Tania emphasized that Nosystem is a growing organization now there is a growing need for the planning, control and coordinating activities. By installing management accounting system Nosystem can plan its activities at all levels that is strategic, tactical and operational levels to achieve the ultimate goal and objective of the company mentioned in the mission statement. Further this can also fulfill the accountability towards shareholders and other stakeholders while ensuring them that company’s objectives will be met and all resources are employed for the purpose. (NEEDLES, POWERS & CROSSON .2010) Tony and the senior managers are now not able to take a very active part in the organization’s executing affairs and they are unaware of what exactly is going on the shop floors. Because of the scenario prevailing in Nosystem there can be many problems on the operational level like no coordination between employees and management, lack of direction for employees and chances of fraudulent activities can increase in such an atmosphere where no control and responsibility accounting are in place. Management accounting’s practices like budgeting, weekly and monthly reports and performance measurement can help reduce these problems to a remarkable extent. Tony and the senior managers in this way can very easily point out if something goes wrong on the shop floor level and a control action can be taken. (CHAPMAN. HOPWOOD & SHIELDS. 2008) Tony and the team wait for the financial audit to get done and rely on its results for the control action. As explained above this approach to control is a feedback control and takes into account only the past results. Even something goes wrong in the company it won’t be spotted immediately and may continue to affect the company adversely for long without anyone knowing about it. Further since the management relies on the audit to make decisions and measure performance it focuses on financial measures and indicators only. For successful execution of the business non-financial measures and indicators are equally important. Management accounting system provides a framework which deals with these problems too. (DRURY. 2008) Another problem in Nosystem relates to pricing of the product. Tanya at a point said that Tony merely ‘guess’ when he asked to quote a price. In a competitive and growing business no one can rely on ‘guessing’ while quoting a price. Now when Tony doesn’t look into the business very frequently at the operational level, this problem seems to grow stronger as his employees don’t know how to quote a price. Systems that can give provide a breakup for costs and pricing is required in Nosystem. Management accounting system can help in quoting prices as well as provide timely information for better decision making. Part A. 3. Respond more adequately than Tanya did to Tony Tonka’s query about the benefits that a management accounting system could provide against what it would cost to operate it. Management accounting system can greatly benefit growing companies like Nosystem. It can help in planning for a future period through many management accounting techniques, in coordinating with various levels in the organization by forward and backward reporting and in controlling by taking corrective action if any problem is found. The need for management accounting system and information grow as the company grows and the employees grow along with it. In the early stages of the company informal interactions are enough for information exchange in the company. However when the operations, processes and people in the organization grow the information exchange needs also increase which is essential for coordination purpose. By the installation of management accounting system in Nosystem the employees can report about the performance on the daily, weekly or monthly basis which will make Tony aware of the circumstances prevailing on the shop floor. It will also increase the responsibility and accountability in the staff. (DAVILA & FOSTER. 2005) Management accounting system will make Tony take better and informed decisions about the business as the main function of MAS is to support manager’s decision making process by providing relevant and timely information. By implementing techniques like activity based costing, target costing etc. Tony will be able to make a better analysis of the cost components of the products. This will not only help in making the pricing decisions but also will highlight the areas of cost reduction. Right now Tony keeps no trace of costs incurred and quotes the prices by guessing. MA techniques will make Tony focus more on the costs, prices and profits which are all greatly beneficial for Nosystem. With management accounting techniques like budgeting and forecasting Nosystem will be able to give a more forward looking approach to the business and will immediately be informed about anything wrong that will take place in the organization and a corrective action will be taken. With MAS implementation Nosystem doesn’t have to wait for the financial year audit to analyze its performance. It will be done on the continuous basis to identify the areas of improvements continuously. Further MAS implementation will make the company focus on the non-financial indicators of performance too by which company will be able to make better decisions and would know their customers better. The company needs to incur costs on its initial implementation, hiring of relevant staff and training of existing ones which seems to be quite costly. However with the above detailed benefits identified the benefits of implementing MAS, financially and non-financially both, is way more than the costs that will incurred. Word Count: 1,444 Part B. Jean Jumper did not have an opportunity to explain in detail to colleagues the various factors to be taken into account and the range of costing methods that can be used in quoting for a special order. Prepare such a report in as much detail as possible using the circumstances outlined in the case study. To: Rupert Russ- Managing Director From: Jean Jumper- Chief Accountant Date: March 12, 2012 Subject: Accounting for Special order As we discussed in yesterday’s meeting, I was asked to prepare a report regarding the range of costing methods that can be used in quoting for a special order that we have been asked to bit for. Introduction: A special job order can not be accounted for and can not be accepted in the normal way. There are various factors that need to be considered while accepting the special job order. Special orders are usually accepted if they cover the fixed cost of operation, if there is spare capacity of production and if the order doesn’t affect the production of its regular products. A special order should be accepted if it maximizes the operating income. Special considerations are to be given to fixed costs in such a decision as existing facilities do not change in the acceptance of the order therefore fixed costs should be considered irrelevant to such decisions. However any fixed cost that will be incurred because of the acceptance of the order and is directly attributable to the order should be taken into account. Usually the accounting for a special order is done by taking into account the incremental costs of production. (NEEDLES, POWERS & CROSSON .2010) Costs Analysis: It is important to analyze the different components of costs while accepting a special order because the company usually has to bid for such an order along with many companies. If the correct components are not taken into account the cost and price of the bid might be overstated which can result in losing an order which could have been beneficial to the company. If we analyze the costs of Cleanalot Limited we can see that the costs incurred by our company consist of a very high proportion of fixed costs. Out of the total overheads incurred over 50% in each category are made up of fixed costs. This means that we have to incur these large costs whether we have business or not. Spare Capacity: Cleanalot Limited has spare capacity and our production facility is under utilized due to reduction in consumer spending. Further there are no chances of business to revive in the next two years. That means we have to operate under utilized for a significant period. This also means that we have to incur all his fixed costs for the time period without any rise in income. Labour Issues: Further the production manager Rash Rew told in the meeting that we do have the spare capacity as the workload is comparatively less, however he had identified that we might have to take on more staff to complete this job. This job would cost ?200,000 of direct labour. This will be an additional cost associated with acceptance of the job and should be taken into account for its pricing. Another issue related to accounting for labour will be opportunity costs associated with the use of labour. Opportunity costs are benefits that are forgone because of taking a decision, which is the loss of benefits of second best option. If we chose to take up the special job the price we get from our products that we produce in the normal capacity will be opportunity cost because by choosing one option we will lose the benefits of others. Hence the opportunity cost associated with labour will also be accounted for. (POLIMENI, HANDY & CASHIN. 1994) Differentiation between variable and fixed costs: Our company uses absorption costing for the allocation of overheads. Right now there are no details given to analyze what amount of fixed overheads will be incurred to execute this special job that is the fixed overheads directly attributable to this job. However we have large amount of fixed and variable overheads associated with administration, selling and distribution of the products. The point to be made here is that we have to incur the fixed costs that is 90% of the administration costs and 60% of the S&D costs whether we accept the order or not. These costs are unavoidable and should be irrelevant to the decision. The only overheads that should be considered are variable which will be 10% of administration costs and 40% of selling and distribution costs. The breakup of overheads that will be incurred because of the job isn’t available at this stage. Overheads Allocation: A problem that I foresee in the future if we accept this project will be of the allocation of overheads. Since overheads built up such large portion of the total costs its fair allocation is extremely important. Right now we use the absorption costing system in which we allocate manufacturing overheads on the machine hours basis and non manufacturing overheads by loading 20% of overheads on the total cost basis. This doesn’t seem to be a very fair method of distribution of overheads. If we continued it the same way we will be allocating ?25,000 as variable factory overheads as those will be specifically incurred for the order. However the fixed factory over head will remain unchanged because of the acceptance of this order. If we use the data given right now the total factory overheads are ?400,000 out of which 25% are variable and 80% are fixed. Using the data given ?320,000 factory overheads are going to be fixed, while the other ?25,000 are directly attributable to the project. While the total number of machine hours incurred can be calculated as 160,000 hours (?320,000/2). If we use the traditional overhead absorption technique the fixed overheads will be absorbed on the basis of machine hours which will be ?320,000/ (40,000+160,000)*40,000=?64,000. This method could be inappropriate for the reason that company has less business these days and the usage of its machine is less for the normal production, if the overheads will be allocated on the machine hours basis its highly likely that the burden of the overheads will be transferred to special order and will increase the cost unnecessarily. For this project I think we can try a new overhead absorption technique of Activity based costing by which we will allocate overheads on the basis of cost drivers, that is whatever drives the cost the overheads will be allocated to it for example the overheads can be absorbed on the basis of number of production runs taken by the special order, number of items packed for the special order etc. In this way we will be able to analyze our costs better, will be able to quote a competitive price for the order and identify areas of cost reduction too. Other Considerations: Further as this just a one-off order and there is no guarantee it would be continued in the future, I would recommend that it shouldn’t disturb our normal production capacity and orders. But we do have spare capacity and the boom in the business doesn’t seem to come in the near future. The only constraint I see is the short off staff in the production department and excess of staff in selling and distribution department, which gives the answer itself that we can loan distribution staff to the production department. However if we do so, the costs that we will incur to train the staff and any other costs like purchasing vehicle to fulfill this order only should also be included in the price of special order as it would be done especially for the order. Conclusion: With the available information that I have right now about the special order the variable costs should only be considered for the decision making purposes, that is direct material, direct labour and variable factory overheads which totals ?300,000 should be taken to account for costing for the order. Since we have spare production capacity all the fixed costs will be irrelevant to the decision of acceptance or rejecting the order. Though if we incur any incremental costs because of the order that should be included in the cost of the order too. Further absorption costing isn’t a very appropriate method of overhead allocation so we might have to look into other methods of accounting for overheads which I discussed above in the report too. Word Count: 1,423 Bibliography POLIMENI, R. S., HANDY, S. A., & CASHIN, J. A. (1994). Schaum's outline of theory and problems of cost accounting. New York, McGraw-Hill. DAVILA, A., & FOSTER, G. (2005). Management Accounting Systems Adoption Decisions: Evidence and Performance Implications from Early-Stage/Startup Companies. The Accounting Review. 80, 1039. DRURY, C. (2008). Management and cost accounting: student's manual. Australia, South Western Cengage learnig. CHAPMAN, C. S., HOPWOOD, A. G., & SHIELDS, M. D. (2008). Handbooks of management accounting research. Oxford, Elsevier Science. NEEDLES, B. E., POWERS, M., & CROSSON, S. V. (2010). Financial and managerial accounting. Mason, OH, South-Western Cengage Learning. MACINTOSH, N. B., & QUATTRONE, P. (2010). Management accounting and control systems: an organizational and sociological approach. Hoboken, NJ, John Wiley & Sons. Read More