The Managerial Accounting Process in General Electric Inc - Term Paper Example

The Managerial Accounting Process in General Electric Inc. Section I Managerial accounting practices have undergone a drastic change over the last few decades. Previously, managerial accounting activity was only concerned with financially oriented decision analysis and budgetary control. However, over the last few years managerial accounting has taken a step forward towards a more strategic approach that focuses on the identification, management and measurement of the key financial and operational drivers of shareholder value (Ittner & Larcker, 2001). Managerial accounting process provides financial as well as non-financial information to the managers and other internal decision makers of an organization. In other words, it ensures effective planning and controlling of operations thereby supporting the decision making process. Planning of operations primarily involves the budgeting process. It is associated with the cost of producing a unit of product. Thereafter, the actual performance of the firm is compared along with the budgeted amounts and controlling occurs in those sectors where the difference seems to be significant (CSN, 2011). Simultaneously, along with the development of managerial accounting principles the traditional accounting system also witnessed a rapid development. However, there are good numbers of firms which are still following the traditional accounting system. But with the increasing global competition and evolution of technologies, production oriented operations are becoming more and more complex. Firms need to do an effective evaluation of the cost that they incur for producing goods, so that proper pricing of those goods can be done, which will generate sufficient revenues for the company. Precise cost information is very crucial for every aspect of business, be it pricing policies, product designs or performance reviews. These requirements saw the inception of activity based accounting over two decades ago and now is widely used in US, Europe and Pacific. Similar to managerial accounting, activity based costing not only includes the evaluation of a company from financial perspective, but also from the wholesome perspective as it includes both financial and non-financial data in its reporting (Gupta & Galloway, 2003). The following section will involve a thorough analysis of the managerial accounting process followed in General electric Inc thereby explaining the significance of Activity based costing towards the financial performance of the company. Moreover, comments will be made as to whether the usage of activity based costing system will add to the benefits of the company or not. Thereafter, emphasis will be laid on the usage of standard costing by General Electric (GE). Standard costing is basically used by companies for comparing standard cost set by the company with the actual cost that is incurred. Hence it draws attention to performance of the company with respect to the goal that is set by the company. The project seeks to find the benefits that are obtained from using the standard costing system as the part of the costing system if GE employs it. The fifth part of the project enlightens the benefits of the relevant cost for the future projects of the company. It helps the management of the company to take any crucial decision regarding the acceptance of the project or take make or buy decision. The data required for the purpose of analysis will be retrieved from the company website as well as from yahoo finance. In addition to that journal articles related to the topic of discussion will be used as the basis of ground work for the purpose of evaluation. Section II General Electric General Electric Company, headquartered in Fairfield, Connecticut, U.S, is widely known for its infrastructure and financial services across the globe. The company’s working segment includes power and water, oil and gas, energy management, aviation, healthcare, transportation, home and business solutions and GE Capital. Different working segment offers wide range of products to the consumers. The power and water segment offers gas, steam and aero derivative turbines, combined cycle systems, generators, controls, and other related services In addition to that; it also produces wind turbines and solar technology and provides water treatment services and equipment. Its oil and gas segment activity involves surface and sub-sea drilling and production systems, producing equipment for floating production platforms, compressors, turbines, turbo expanders, reactors, industrial power generation, and supplementary equipment. The energy management segments provides electrical distribution and control products, switchgears, and circuit breakers, lighting and power panels and other services related to engineering, inspection, mechanical. Moreover, this segment also produces motors, drives, and control technologies and also focuses in plant automation, hardware, software and embedded computing systems. General electric’s aviation department manufactures jet engines, turbo propellers and shaft engines, related replacement parts, and aerospace systems, equipment for military and commercial aircrafts. Its line of services includes maintenance, component repair, and overhaul services. The company’s healthcare segment develops technologies, such as medical imaging, medical diagnostics and patient monitoring systems. In addition to that, it also does drug innovation, disease research and remote diagnostic and repair services. Its transportation division involves the activity of manufacturing freight and passenger locomotives, diesel engines for rail, marine, and stationary power applications. It also works on railway signalling and communications systems, energy storage systems, motorized drive systems, underground mining equipment and information technology solutions. Lastly, the home and business solutions segment is concerned with the manufacturing of home appliances and lighting products. Its financial division which is known as GE Capital offers commercial loans and leases, financial programs, fleet management, home loans, personal loans, credit cards and other financial services (Yahoo finance, 2013a; General Electric, 2013). Its market capitalisation as of 15th October 2013 is 246.35 billion dollars (Yahoo finance, 2013b). Its market capitalisation has increased significantly over the last five years suggesting an increase in the number of shares outstanding. This explains its reputation in the market where more and more shares of General electric are being traded. The following figure depicts the market capitalisation of GE over the last five years: Fig. 1: Market capitalisation of General Electric (Source: ycharts, 2013) The Average market capitalisation of general electric for the last five years has been 189.74 billion dollars. It recorded a minimum market capitalisation of 70.33 billion dollars in Mar 5 2009 and the maximum market capitalisation of 253.17 billion dollars in Jul 22 2013 (ycharts, 2013). General Electric has a substantial presence all over the world. Apart from its operational division in US, it also has its divisions in Europe, Middle East and Africa, America and Pacific basin. Its main source of revenue comes from its operations in its country of origin that is the United States of America followed by revenue generated from its operations in Europe, Pacific basin and the Middle East and Africa. Total assets of General Electric’s global operations are the highest in United States followed by Europe and then the pacific basin. Its potential competitors include companies, such as Honeywell International, United Technologies and Boeing. Their manufacturing and production segment is similar to that of General electric. Section III Activity based costing The increase in competition and evolution in technologies and information systems is leading companies to adopt strategies, which ensure efficiency of operations in terms of cost thereby generating higher revenue for the company itself. As mentioned earlier correct cost information is a very critical factor, which contributes significantly towards the performance of an organization. This is primarily because pricing policies, product design and performance reviews are based upon those cost information available to the management of the company. In order to fulfil the above objective of providing precise and accurate cost related information, activity based costing system was introduced about two decades ago and now is being widely used by many companies all over the world. However, there are many companies who resort to the traditional costing system. The main drawback of the traditional costing system is that it distributes the overhead cost over the product thereby utilising the allocation bases, which are volume-related, such as direct material costs, labour hours, direct labour cost, and machine hours. It does not misrepresent the product costs in the traditional manufacturing environment where the overhead cost is a small part of the product cost. But when the manufactures will increase the level of automation and computerization, the overhead cost will also increase in accordance with that. This is where the drawback of traditional costing system lies as the cost distortion of the traditional cost systems will be significant. Traditional cost accounting methods employed by most of the companies only take into account a narrow range of products. However, if the wider range of products is taken into consideration in order to implement traditional costing system then it will lead to distortion. Thus, the importance of activity based costing lies in the fact that it has been developed to improve the accuracy and preciseness of product cost data derived from the traditional cost system. Accurate cost information, such as the production costs and value-added activities is a fundamental requirement as this information is utilized as a basis of decision for management and control purposes in case of production and marketing. Activity based costing not only aims to allocate overhead costs properly, but also identifies the areas of waste. Its primary consideration is the fact that purchasing, receiving, setting up and operating a machine consumes resources, and that products consume activities (Liu & Pan, 2007). These activities are at the source of resources consumption and that is why they are recorded as costs in the accounts. Thus this system caters to trace the cost of products according to the activities performed while producing them thereby providing more accurate cost related information, with reduced distortion. If General electric implements the activity based costing system then it will help their managers to base strategic decisions on more accurate information, which should improve the quality of their decisions. This is because with activity based costing system the managers get a wider and more realistic view of costs associated with production. It will help the management to get a more distinctive picture of how activities performed in the creation of a product or service impact its cost. In this way the company can address the underlying issues related to costs and can take strategic decisions directed towards generating value for their shareholders. Activity based costing system can be used by General Electric as by means of this the management can identify activities that drive costs and thereafter they can allocate these costs to its particular services or products. Activity based costing system utilizes multiple cost drivers to provide a solid foundation for overhead allocation. The cost drivers taken into consideration are identified by reviewing the production process to find out the activities that caused those costs (Schulze, Seuring & Ewering, 2012). Thus if used properly, activity based system can be of significant benefit to a manufacturing giant like General Electric as their production is associated with lots of internal activities which accrue certain costs. Activity based system will help the management to identify the underlying costs of creating a product so that they can take effective steps to reduce the costs. However, unlike traditional cost accounting system activity based costing system is associated with a certain degree of complexity as it takes into account multiple variables (cost drivers) in order to produce accurate cost information. Section IV Standard Cost Standard cost can be defined as the planned cost for a unit of product or service that is rendered. It evaluates the target cost that is obtained in the process of calculation. It is the predetermined cost that is calculated by the management of firm by maintaining the standard of their effective operation and the necessary expenditure that are relevant in the process. It basically compares the standard cost with the actual cost (Warren, Reeve and Duchac, 2009). Standard Costing Standard costing can be defined as the technique that establishes a predetermined estimate of the costs of services and products. It then compares the predetermined cost with the actual cost as they are made. The predetermined cost is also known as the standard cost and the difference between the actual cost and the standard cost is known as the variance. For the success of standard costing, it demands reasonable stability and repetition of the works. Thus, it is applicable for manufacturing and service sectors (Rajasekaran, 2011). Establishments of Standard cost The establishment of standard cost for the direct labour, direct material, fixed overheads and variables is necessary. The determination of standard cost involves 1) quantity standards and 2) price standard of the items. The procedure for fixing the standard cost is as follows: 1) Direct material cost standard: The establishment of the standard cost for the direct material involves determination of standard quantity of raw material and standard price of the raw materials. 2) Direct wages standard: The standard cost for the direct labour is determined by the standard time and the standard rate that is paid to the labour. The standard time is fixed after the rate for the labour has been stated. The standard wage rates need the identification of the operation to be performed by the labour (Kimmel, Weygandt and Kiseo, 2011). 3) Direct expense standard: The determination of standard expense needs the identification of the standard quantity of the services and the rate. 4) Variable overhead standard: The variable per unit is kept constant irrespective of the volume of the production. 5) Fixed overhead standard: The determination of the standard fixed overhead involves identification of budgeted fixed overheads for a specific period (Hanif and Mukherjee, 2003). Benefits of Standard Costing in General Electric The company can use standard costing for evaluating the standard cost and comparing it with the actual cost and examine the financial position of the company. In the following points the benefits of using standard costing is elaborated: 1) It is an efficient process: The costing provides with positive contribution for the efficiency of the process. By fixing the standard cost a detailed study is required regarding the different features of business processes. As for General electric, it will help the company in determining the manufacturing and service expenses that are done through time and motion study. The determination of the standard inventory cost gives a mandate for the study of the control processes of the materials. In this study many inefficiency in the process are reflected, which provide the managers the chance to rectify the mistakes and promote efficiency in the process. The comparison of the actual cost and standard cost in this method of costing will enable GE to get a reliable evaluation of the performance of various cost centres. 2) The method helps in fixing the price: It helps in determining the prices of the products and devises policies for production in advance. It will help GE for estimating the prices at the initial stage of production. The method of costing allows simplifying the valuation of stocks by transferring difference between the actual cost and the standard cost to a different variable account. This will help the company in evaluating the stock. 3) Promoting management by exception: The costing method promotes management of exception, where the management set a fixed target and does not disturb the method until and unless the target is achieved. If there is deviation in the target achievement then only management interfere the process of evaluation. Thus, it relieves the management from performing routine jobs and helps in concentrating on the crucial issues. It will help the managers of GE to get relief from their routine job and will help them to focus on the crucial issues of the company. It helps in identifying the cost for the individual products or processes thereby making the approach scientific towards profit maximization or budget planning by various product mixes. It provides with readymade targets that sets the goal for the organisation. 4) It helps in estimating the profit of the company: The benefit of the method extends to the efficiency and profitability in “rank-and-file activity” (Patra and Panda, 2006). It identifies the responsibility of the line managers and hence integrates processes or products efficiency interference as their routine line of activity rather than making it as a specialized intervention for the staff management. 5) The methods help in controlling the cost: This is one of the most important benefits of standard costing. The costing principles have depicted the fact that standard costing have provided lesser information in comparison to actual costing as it tracks inventory that are used in budgeted amounts. But this reasoning is not right as the actual cost is tracked in the accounting system in the journal entries to accumulate the liabilities for purchase of the materials and payment of labour. Thus, the costing system can record both the budgeted amounts and also the actual cost that is incurred. The difference between the actual amount and budgeted amounts gives important information regarding the cost control. This information is to a firm who has employed actual costing system. The analysis is an integral part of general ledger system. This general ledger helps in tracking the necessary information regarding the performance of the company. Thus, GE can implement this costing system in order to evaluate the financial position of the firm. 6) The method helps in determining the fluctuations in the direct costs: The methods helps in identifying the fluctuations in the direct cost that are affected by the cost of the related products. GE will have the opportunity to evaluate the fluctuations in the direct costs. There are few disadvantages of standard costing, which are as follows that will be barrier for the GE to use the standard costing system: 1) The costing system will not be applicable when the time principle is adopted. 2) The standard costing ignores the quality of the products and concentrates on the operation of the organisation. 3) The costing system is not applicable in case of non-standardized products and services. Section V Benefits of Relevant cost The relevant cost can be defined as the costs that help in decision making. The decision changes along with the relevant cost and necessary course of action are taken. They are also termed as the differential cost. If GE employs relevant costing, it can obtain the following benefits: 1) It helps the management in identifying the right decision whether to buy or make. It also helps the company to make decision during the time of expansion. It evaluates whether the expansion will profitable or not and thus directs the management in taking necessary steps. 2) The relevant cost helps in determining the cost benefit analysis. 3) The relevant costing helps in identifying whether the company need downsizing, so as to run a successful business (Eisen, 2007). Section VI Conclusion Traditional cost accounting methods are inaccurate and misleading as it provides distorted information. This is primarily because this system distributes overhead costs on the basis of just one driver. For example, direct cost or machine hours. The major shortcoming of this system is that it allocates too much cost to one product neglecting the others. In order to address this issue, activity-based accounting system was developed by means of which more accurate representation of activities concerned towards creation of a product or service and its impact its cost can be done. Although, it involves a certain degree of complexity, yet it is a robust system that companies can implement by means of which effective managerial accounting can be followed thereby ensuring a good financial performance of the company. It can also be concluded that if GE employs standard costing in their costing system, then the company will be have the opportunity to create a new outlook for evaluating the performance of the company. The relevant cost will also help the company take decisions in the crucial areas of management. References CSN. (2011). Managerial accounting concepts and principles. Retrieved from http://sites.csn.edu/bgutschick/MGR_ch01.pdf Eisen, P. (2007). Accounting. New York: Baron Educational Series. General Electric. (2013). For business. Retrieved from http://www.ge.com/b2b Gupta, M. & Galloway, K. (2003). Activity-based costing/management and its implications for operations management. Technovation, 23, 131-138. Hanif, M. and Mukherjee, A. (2003). Financial accounting. New Delhi: Tata Mc Graw-Hill. Ittner, C. D. & Larcker, D. F. (2001). Assessing empirical research in managerial accounting: a value-based management perspective. Journal of Accounting and Economics, 32, 349-410. Kimmel, P., Weygandt, J. and Kiseo, D. (2011). Accounting. New Jersey: John Wiley & Sons Inc. Liu, L. Y. J. & Pan, F. 2007. The implementation of Activity-Based Costing in China: An innovation action research approach. The British Accounting Review, 39, 249-264. Patra, K. and Panda, J. (2006). Accounting and finance for managers. New Delhi: Swarup and Sons. Rajasekaran, V. (2011). Financial accounting. Noida: Dorling Kindersley Pvt. Ltd. Schulze, M., Seuring, S. & Ewering, C. 2012. Applying activity based costing in a supply chain environment. Int. J.ProductionEconomics, 135, 716-725. Warren, C., Reeve, J. and Duchac, J. (2009). Accounting. Connecticut: Cengage Learning Yahoo finance. (2013a). Business Summary. Retrieved from http://finance.yahoo.com/q/pr?s=GE Yahoo finance. (2013b). General Electric Company (GE). Retrieved from http://finance.yahoo.com/q?s=GE&ql=1 Ycharts. (2013). General Electric Market Cap. Retrieved from http://ycharts.com/companies/GE/market_cap Read More