Influence of Product Costing Variances on Operational and Business Decisions - Research Paper Example

?Week 8 Assignment Table of Contents Table of Contents 2 Introduction 3 Thesis ment 3 Allocation of Costs 4 Benefits of Activity Based Accounting and Activity Based Management 5 Impact of Standardized Costing and Inventory Costing Methods on the Financial Reporting 7 Influence of Product Costing Variances on Operational and Business Decisions 9 Conclusion 10 Works Cited 11 Introduction One of the leaders in global automotive industry, Ford Motor Company manufactures and distributes automobiles across six continents. The company operates with a workforce of 164,000 employees in more than 70 manufacturing units established worldwide. It is worth mentioning in this regard that recent global economic turmoil has affected various manufacturing companies across the globe, including Ford. Irrespective of such disruptions, in the year 2011, Ford completed its consecutive three years of earning profit in relation to its operating costs and, therefore, announced the payment of dividends to its valued shareholders in five years, which, in turn, has significantly motivated the company to preserve its financial efficiencies in the long run (Ford Motor Company). Thesis Statement The report will analyze various divisions and departments of Ford where costs are allocated currently. Furthermore, it will provide recommendations based on the importance of divisions and departments about effective allocation of costs. Allocation of Costs The automobile industry is facing continuous challenges due to the increasing fuel prices, uncertain economic conditions prevailing in the international arena, rising commodity prices and the growing need to reduce CO2 emissions in order to protect the environment. Thus, Ford has been allocating huge amount of revenues to the Research and Development (R&D) department in order to develop best-in-class vehicles that will provide superior quality, efficient fuel economy, safety, value for money and attractive design which best satisfies the consumer preferences. Furthermore, the company has been doubling its investment in innovating advanced technologies in order to maintain a high degree of competitive edge over its global competitors (Ford Motor Company). Although the automobile industry is facing fierce competition due to the presence of large number of competitors, Ford can utilize its brand recognition and strong financial resources to expand its global presence and increase the volume of sales. Sudden shifts in demand have also been identified, from hybrid cars to small cars due to the non-availability of parking spaces and traffic congestions. Thus, the sudden increase in demands disrupted the process of production as the company had to make major changes in order to shift its manufacturing concentration solely to small cars segment. Furthermore, the introduction of advanced technologies has emerged as a growing trend among the car manufacturing companies across the globe. Thus, Ford should emphasize more on its technology development department in order to introduce unique technologies integrated with modern vehicles: parking assistance, car tracking device and GPRS among others (Ford Motor Company). Moreover, the company can invest its capital for expanding its production facilities in countries where Ford’s market share is considerably lower than that of other car companies even though the markets are promising. Hence, the establishment of manufacturing units will lower the logistics costs and enable the company to have greater profit margins. Furthermore, the company may allocate additional funds to the marketing segment in order to promote the uniqueness of its technologies. Notably, the recovery of the global economy from the financial downturn has provided consumers around the world with an increasing purchase power, which has been reflected through the increased demand across the globe. People are comfortable in spending money for luxurious products, especially those with integrated technologies which have not been introduced earlier (Humphrey and Memedovic). Benefits of Activity Based Accounting and Activity Based Management Activity-Based Costing (ABC) is an effective process of accounting and thus determines the actual costs of manufacturing. Although the process is relatively new, it is being increasingly utilized by companies across various industries involved in manufacturing. In other words, ABC is an accounting method that determines the actual costs assigned to each of the resources such as services, products and customer related activities. Notably, ABC has been adopted to reduce alterations of products which are common in Value-Based Costing (VBC). For instance, one of the major lacunas of VBC can be identified as its determination of the cost of products rendering meager emphasis on relationship between the activities and resources utilized during the operations. Based on these aspects, the ABC method may assist Ford in analyzing the costs allocated to different resources and the outcomes of such allocation. Therefore, the benefits Ford can earn through ABC method are listed below: Better profitability measures – The ABC method can help Ford to determine accurately the production costs which can lead to effective development of products according to the preferences of the customers. It can further enable Ford to develop strategies distinctly related to pricing, promotional activities, costs allocation and product lines. Better decision-making – The ABC method can enable Ford to measure accurately the activity-driving costs, assisting the management in improving the products and value of the processes in order to make effective decisions for enhanced designs, better customer support decisions and promoting value enhancement projects. Process improvement – The ABC method can also help the management to evaluate and identify the areas where the process of operations can be improved. Cost estimation – The ABC approach can also be expected to assist Ford in improving its production costs, which may lead to the enhancement of efficiency in relation to the estimates of job costs for planning, budgeting and pricing. Cost of unused capacity – During financial downturn of the global company, the demand for luxurious products decreased, as a result of which the capacity of the plant has not been fully utilized. However, the costs related to raw materials, facility-level activities and consignments remain unused. Thus, from an in-depth perspective, the ABC method can be expected to assist Ford in identifying the cost of unused capacities and ensure a separate accounting for these costs. Additionally, by adopting Activity-Based Management (ABM), Ford will be able to manage its activities effectively in order to develop the value of the products and provide efficient services to its customers, thereby increasing the company’s competitiveness and profitability. It is worth mentioning in this context that the concepts of ABC and ABM are interdependent as regards collecting information and focusing on the competencies and effectiveness of the major business processes and activities. Moreover, ABM will help the management of Ford to enhance its operations, thereby decreasing costs of production and increasing the value of the products amid the targeted customers. Impact of Standardized Costing and Inventory Costing Methods on the Financial Reporting Standard costing is defined as a method of cost accounting which attempts to compare the actual cost of the product with the standard cost in order to determine the competencies of the operation for evaluating any remedial areas. In this highly competitive world, where customers require value for their money, the companies have very little scope to earn higher profits. Therefore, revenue is generated through maximization of sales in general terms (Sivakumar). Thus, the standardized costing method will evaluate the actual costs required for Ford to manufacture a product and determine the prices which will help the company to earn minimum profit, thereby, offering customers an appropriate value for their money. The standard costing method can be expected to further assist Ford in controlling fixed costs in production as employees will have targets assigned, which needs to be performed efficiently. Therefore, the overall costs incurred shall be reduced considerably, and any misuse of resources can be identified which can ultimately reflect on the financial statements of the company. Inventory costing method is an effective tool that helps save substantial amount of money spent on taxes. While calculating the taxes of the company, the inventory remaining at the end of a financial year is deducted from the purchases which were accounted in the beginning of the year. Therefore, the remaining inventory cost reduces the income of the company, and due to this lesser amount of taxes must be paid. The law pertaining to taxation allows two methods of inventory valuations, namely, the First-in First-Out (FIFO) and Last-in First-Out (LIFO) methods. While FIFO values the outstanding inventory at the most recent cost, LIFO values it at the earliest cost paid that year (Epstein 80-85). It is in this context that the current markets are charging higher costs for the raw materials in the automobile industry. Thus, LIFO can be a profitable method for Ford as the value of the inventory is quite likely to cost less, while higher value can be expected for the cost of finished products. This method will not increase the income, thereby allowing the company to spend a lesser sum of money on taxes. Influence of Product Costing Variances on Operational and Business Decisions ‘Variances’ is the term identifying the differences between a budgeted amount and the actual amount generated during a specified period. Variances are generally calculated based on various components of labor, materials and other overhead costs. Therefore, budgetary planning is required in order to forecast efficiency levels of all components involved in manufacturing. Furthermore, budgetary control classifies areas of responsibility for the management and compares the actual results with the budget or standards planned (Sivakumar). In this context, it can be stated that Ford should prepare a flexible budget, which will help analyze and compare the actual costs spent along with the revenue generated. Moreover, the variance analysis will help Ford to identify the areas of manufacturing where special concern is required in order to minimize the production costs and thereby gain better profitability. Conclusion Due to the effective strategic financial planning, Ford has maintained profitability for three consecutive years following the global economic crisis. However, as the automobile industry is one of the booming industries of recent times, in order to maintain a competitive edge over the rivals and to retain its customers, the company should introduce unique features. Furthermore, the recent shifts in demand from hybrid cars to small segment cars have forced the company to change its line of production in order to survive in the global market. Accounting is considered as an important aspect of the company’s operations. Thus, effective management and implementation of modern accounting methods is likely to ensure that company sustains its profitability during this transformational phase. Furthermore, effective control over inventories has also been identified as beneficial for huge tax savings. In recent times, car-manufacturing companies have had to pay higher costs for the goods required for production. Therefore, budgetary planning and controlling has become essential in order to minimize the cost variances from the actual revenue generated. Works Cited Epstein, Lita. Reading Financial Reports for Dummies. United States: John Wiley & Sons, 2009. Print. Ford Motor Company. “2011 Annual Report”. editiondigital.net. 2012. Web. 24 Aug. 2012. Sivakumar, R. “Standard Costing & Variance Analysis”. Prime Academy. n.d. Web. 24 Aug. 2012. Humphrey, John, and Olga Memedovic. “The Global Automotive Industry Value Chain: What Prospects by Upgrading by Developing Countries?” United Nations Industrial Development Organization, 2003. PDF file. Read More