Accounting for Managerial Decision Making - Research Paper Example

In its basic form, cost volume analysis allows the company to understand how the changes in the costs and volumes actually have an impact on the operating as well as net income of the firm. This sort of approach therefore can allow a firm to estimate the level of sales required to generate a specific and targeted level of income. Traditionally, there are two things which are calculated while performing the cost volume profit analysis. These are calculating the contribution margin and contribution margin ratio. (Navaro, 2005) Contribution Margin = Sales – Variable costs Contribution Margin Ratio = Contribution / Sales The above calculations therefore focus on the overall fixed and variable costs of the firm while at the same time providing insight into how the costs vary with the output. However, when this technique was developed, firms were more labor intensive and had different manufacturing costs break up. The new firms have more constant costs which normally do not wary because most of the modern organizations are now capital intensive organizations with fixed labor costs. For example, a supervisor may be paid the same wages regardless of the fact that whether the machine works at its full capacity or not. As such many argue that the maximization of the contribution margin may no longer be relevant for the modern organizations. (Luther, and O’Donovan., 1998) It is also important to understand that the CVP analysis is made under certain assumptions and as such it may be difficult for the firms with capital intensive nature to follow these assumptions in their letter and spirit. One of the assumptions of CVP analysis focuses upon separating the costs into the variable as well as fixed costs however, when the overall ratio of fixed costs in the total cost structure of the firm is higher, it may be difficult for the capital intensive firms to actually realize the full benefits of the CVP Analysis. Since CVP analysis focuses on the variable costs to calculate the contribution margin and how it can have an impact on the profitability of the firm therefore in the presence of higher fixed costs, it may be difficult to assess the correct impact on the firm’s profitability. (Horngren, 2005) The capital intensive nature of the firms therefore makes it more difficult for the firms to understand the overall nature of the costs therefore the use of CVP analysis may not be relevant. Further, since the capital intensive firms have higher fixed cost ratio in their total cost structure therefore capital intensive firms may not be able to clearly identity their breakeven point based on the CVP analysis as this may be misleading. In a capital intensive firm, more costs goes to the management and operations of the capital intensive equipment with little costs going towards the labor and other overheads. The excessive contribution by the manufacturing overheads therefore makes it irrelevant for the capital intensive firms to actually use the CVP analysis. 2) The traditional theory on corporate finance and accounting suggests that the major task of the managers is to ensure that their actions result into the generation of value for the shareholders. Thus the common objective of the firm or the business has been focused upon the profit maximization and the maximization of the shareholders’ value. Any business activity which does not result into the above two therefore may not be considered as the real objectives of the firm. The traditional accounting therefore seems to portray only the above basic aims of the firm i.e. capturing how value and profitability can be maximized and based on these principles different accounting estimates and procedures are made. The latest trends however suggest that the firm’s only objective cannot be limited to just the maximization of the profits or the shareholders’ value. Now firms also being viewed as larger part of the society with different other objectives too including sustainability of the environment as well as corporate social responsibility.( Islam, and Dellaportas, 2011) One of the key issues which accounting is facing today is the lack of quantification of firm’s objective such as conservation of the environment. Since accounting estimates are based upon the principles of quantification and having monetary value assigned to the transactions therefore it is important that the resulting accounting treatment of the issues like sustainability also follow the normal accounting procedures.( Vurro, and Perrini, 2011) The current debate on the relationship between accounting as well as the corporate social responsibility is based upon the notion that this relationship is not just limited to the financial accounting aspects. Increasingly, there has been an emphasis on providing social justice and contribution of accountants in generating the social and environmental benefits for the society. This therefore put the role of financial accountants in a relatively larger context which traditional accounting principles failed to achieve. This is also due to the fact that traditional accounting is based upon historical cost concepts therefore it does not record how to fully capture all the economic actions. The externalities and their impact on the organization therefore are not completely measured and recorded under the traditional accounting concepts. Traditional accounting often focus upon the measurability of an event which than can be transformed into accounting entries to take care of how the transaction can be recorded. However, this may not be the case with the issues like corporate social responsibility as well as the sustainability due to the fact that they may not be easily measured. For this purpose, new techniques like sustainability accounting can be used to measure the impact of sustainability on the financial strength of the firm. (Aras and Crowther, 2008) It is also important to understand that traditional accounting concepts actually focus upon the actual costs and benefits whereas the corporate social responsibility and sustainability is often based upon potential costs and benefits. Traditional accounting therefore fails to capture the impact of potential costs and benefits into the financial aspects of the organization. It may therefore be concluded that traditional accounting may not be sufficient to record and portray aspects other than increasing shareholders value and profit maximization. References 1. Abdel-Kader, M and Luther, R (2006) Management accounting practices in the British food and drinks industry, British Food Journal, 108 (5), p.336 - 357 2. Aras, G. and Crowther,, D. (2008) Developing sustainable reporting standards, Journal of Applied Accounting Research, 9(1), p.4 - 16. 3. Horngren. (2005) Cost Accounting, New York: Pearson Education, p.65-67. 4. Islam, M and Dellaportas, S (2011) Perceptions of corporate social and environmental accounting and reporting practices from accountants in Bangladesh, Social Responsibility Journal, 7 ( 4), p.649 – 664 5. Luther, R. and O’Donovan., B. (1998) Cost-volume-profit analysis and the theory of constraints., Journal of Cost Management, 1(1), p.16-21. 6. Navaro. (2005) What The Best Mbas Know, New York: McGraw-Hill , p.180. 7. Vurro, C and Perrini, F (2011) Making the most of corporate social responsibility reporting: disclosure structure and its impact on performance, Corporate Governance, 11 (4), 459 – 474 Read More