Average Costs and Variable Costs as Performance Measures - Essay Example

Accounting Average Costs and Variable Costs as Performance Measures According to Pride, Hughes and Kapoor , Cost Accounting involves such processes as the collection, analysis, summary, and evaluation of certain courses of action in order to offer invaluable advice to the management on the best way to act regarding cost efficiency versus capability. Through cost accounting, the management can understand the management needs and in this regard control the current operations as they plan. Normally, in every accounting environment be it within an organization or the government institutions, there are costs of production that include the fixed and the variable costs (Drury, 2008).

While fixed costs do not vary with the output like rent, insurance, and depreciation, variable costs as their name suggest, are under constant fluctuation depending on the output for example fuel cost, labor costs, and cost of materials. Average costs on the other hand are obtained by dividing the costs by the output (Pride, Hughes & Kapoor, 2012). Although the average costs and the variable costs may at times be unpredictable, managements can make use of the costs to measure the performance of the organization as well as the managers.

The manager of the manufacturing unit in a company is responsible for the costs of the manufacturing unit (Drury, 2008). In this regard, quality, timely delivery, and cost measures are used to reward the manager’s performance. However, there are problematic areas associated with the process of deciding whether to evaluate the manager of the manufacturing unit by average cost per unit or the variable cost per unit (Sharan, 2009). One of them is that the output has an indirect correlation to the costs and revenue therefore evaluating the manager of the manufacturing unit based on this may not be reliable as it may fluctuate depending on the total output.

Secondly, it would be inappropriate to judge a manager based on the costs of production, as they may not have any control or influence on such factors. For instance, such costs as labor costs and cost of materials may vary therefore the management can instead use the total average costs that would present a more non-variable performance index (Drury, 2008).  Just-In-Time and Stock-Out Costs Organizations are trying to cut costs either in order to stay in business or to move ahead of their competition.

Some organizations consider a shift to Just- In-Time inventory system (JIT). It is thought that considerable costs can be saved by reducing inventory. While Just in Time (JIT) strategy of production may enhance the return on investment of a business, through the reduction of associated carrying costs and in-process inventory, Stock-Out Costs normally derive from lost opportunities resulting from the depletion of the inventory. This exhaustion could result from poor shelf replenishment practices or an oversight on the part of the management (Crosson & Needles, 2011).

  There are a number of pros and cons of JIT in correlation to Stock-Out Costs. One of the benefits is the ability by companies to manage customer needs and change in interests while they balance between avoiding Stock-Out Costs while at the same time minimizing inventory costs. Another advantage is the reduction in inventory costs due to the reduction of JIT holding space, enabling the company to experience growth through more investments (Drury, 2008).  However, the major disadvantages associated with JIT include poor coordination and the high risks involves especially in correlation to the Stock-Out Costs.

Poor coordination comes in the sense that retailers and suppliers have a problem communicating and coordinating the activities within the distribution channel (Sharan, 2009). Besides, the risks associated with JIT are enormous especially if the suppliers have distribution challenges that may upset prospective customers. An organization can therefore measure Stock-Out Costs by performing a manual audit of the stock by searching for any available gaps in the shelves. However, this discrepancy can be managed effectively by avoiding incidences of stock outs and carrying out regular audits of the stock inventory.

This will considerably minimize both the Just in Time and Stock-Out Costs (Crosson & Needles, 2011).  Differences between Activity-Based Costs and Standard Costing Activity-based costs (ABC) and standard costs are not necessarily substitutes. However, very few firms use both activity-based costs and standard costs. In fact, some management consultants who advocate ABC argue that before adopting ABC, firms should abandon their standard cost systems (Sharan, 2009). Costing is essential to corporates as it enables them to determine the revenue they generate.

Two major costing techniques include the Activity-based costing (ABC) and the standard or traditional costing. In this regard, there exist notable differences between the two costs in that while the standard costs systems make use of one operating cost that includes the accumulation of non-directly identifiable costs like labor, activity based costs use many smaller cost buildups that are accumulated because of "activities" for example purchase orders (Drury, 2008).  The advantages of activity-based costing systems include its assistance in decision-making delegation and it promotes objective management whereby managers set attainable and realistic goals.

Additionally, it guides the evaluation of performance thereby helping determine a standard performance (Crosson & Needles, 2011). Overall, it helps improve business processes besides detecting wasteful products. However, the activity-based costing system has disadvantages ranging from extensive implementation procedures to the high possibility of misinterpreting data. Standard costing on the other hand helps in management by exception by promoting economy and efficiency, simplifying bookkeeping in addition to having a natural fit in a responsible accounting system.

The disadvantages of this system of costing include the possibility of releasing stale reports, inconsistencies in labor quantity standards, and the requirement of high technical skills in verifying the standards. Few firms use both ABC and standard costing together due to the technicality and cost implications involved (Crosson & Needles, 2011). References Crosson, S. V., & Needles, B. E. (2011). Managerial accounting. Mason, OH: Southwestern Cengage Learning. Drury, C. (2008). Management and cost accounting.

London: Thomson Learning. Pride, W. M., Hughes, R. J., & Kapoor, J. R. (2012). Business. Mason, OH: Southwestern Cengage Learning. Sharan, V. (2009). Fundamentals of financial management. Delhi: Pearson Education / Dorling Kindersley (India).