Management Accounting and Traditional System Appraisal - Essay Example

Management Accounting Traditional System Appraisal Even though the traditional system that Balance Ltd uses is essential in coordinating the financial activities of an organization, it has shortcomings that make it undesirable. Traditional management accounting system that Balance Ltd utilizes in deriving the cost of the products is inadequate (Maher, Stickney, & Weil, 2012). This is due to the approach under which the method allocates overhead costs of the production process. Overhead costs are assigned using a single driver of machine hours. This has the potential of misleading the management in determining the cost of the product (Macintosh & Quattrone, 2009). In reality, different drivers of factory overheads such as machine setups, special storage, unique inspections and special handling drive the cost. Thus, it is difficult to allocate cost to the diverse activities undertaken in meeting the diverse customer demands using a single activity of machine hours consumed. Similarly, containing all the costs incurred in undertaking the diverse activities in a single cost to allocate the costs by dividing with machine hours used in the production process is erroneous under the traditional system applied by the firm (Gediehn, 2010). The approach gives an average rate to be employed in the different products despite of the complexity and number of activities performed. This is a misleading approach of allocating the costs since the diverse customer specifications do not correlate (Gediehn, 2010). The use of a general average rate in allocating the overhead costs under the traditional management system misleads the management in determining the cost of the product per customer demand. The response that is derived from the results given under the traditional system has high potential of been wrong due to the performance measures it generates (Bragg, 2013). Furthermore, the traditional system used by the firm has the potential of failing to motivate enviable behaviors. This is because it has the tendency of strengthening vertical controls and bureaucracy (Macintosh & Quattrone, 2009). The requirement for the staff to fill the time they spend in running the machine is a bureaucratic act that has the potential of attempting the staff members to inflate the hours to earn more salary. Thus, employees of the organization will not be motivated to act for the interest of the company. Similarly, the traditional system under use has the potential of causing the management to be disconnected from the strategic plan of the firm. This is because the managers will be obsessed in achieving the correct numbers that can cause the strategic purpose of the budgeting process to be missed. The use of the machine hours to determine the overhead cost has the potential of encouraging the management to reduce machine hours to expand profit and cut costs. Emphasize in reducing cost over value creation under the traditional system means the strategic initiatives are given lower priority under the traditional system (Gediehn, 2010). In addition, the traditional system currently been employed by Balance Ltd creates inefficiencies. The time that is consumed in detailing the machine hours and direct labor hours to compute the overhead cost is enormous and consumes significant management resources. Thus, the traditional system employed by the organization hinders efficient utilization of the management resources in enhancing the performance and value creation to attract more consumers. This implies that the management of Balance limited should devise a superior managerial accounting system to solve the enormous shortcomings of the current traditional managerial system. Activity Based Costing (ABC) System Owing to the limitations and inefficiency of the traditional system employed by Balance Ltd, activity based costing system should be embraced. This is due to the ability the system in allowing the management to allocate costs accurately to the products to give the optimal response in managing costs and determining the price (Bragg, 2013). The activity based costing system allocates overhead costs incurred to individual products in a logical approach compared to the traditional approach (Gediehn, 2010). Under the activity based costing approach, costs of the real activities involved in the manufacturing process are first assigned. The cost of the activities demanded by specific products is then assigned. This ensures that products not demanding certain activities are not assigned costs consumed by such activities. The ability of the system to ensure the production cost is more reliable and accurate makes it desirable for the organization since product cost will be overstated or understated (Macintosh & Quattrone, 2009). The management will be able to analyze the cost of the different products depending on the specifications of the customers compared to the traditional system that employs standard rate in determining the cost of the different products. The allocation of the product cost reliably and accurately under the activity based costing system will ensure selling price fixation for the diverse products is correct and fair. This is because the overhead costs allocated to the products will be determined by the cost drivers relevant to individual products. Thus, the system has the potential of enabling the firm to be more competitive since it will not over price some products that causes customers to decline demanding their products. Embracing the activity based costing system will allow monitoring and controlling of variable and fixed overheads (Bragg, 2013). The linkage between activities and costs under the activity based costing approach is identifiable (Maher, Stickney, & Weil, 2012). This gives the management the chance to manage the overhead costs incurred by the organization. Consequently, activity based costing system enables adequate information to be achieved by the management in making decisions on the profitability of various products. ABC Implementation Recommendation and Potential Challenges Owing to the ability of activity based costing in enabling the management to assign costs reliably and accurately on diverse products, the management of Balance Ltd should adopt the system. This is because the system will enable the management to price the products correctly and fairly to the customers. Thus, consumers will not be demanding some products and avoiding others due arbitrarily cost allocation that makes the price to be biased. Furthermore, the management allows a clear understanding of the cost drivers and overheads that is essential in making reduction or elimination of some activities that increase the cost of production without adding value logical (Maher, Stickney, & Weil, 2012). Similarly, an analysis on the customer and product profitability will be easier for the firm if it adopts the system. Moreover, embracement of the activity based costing will enable performance management practices like scorecard and continuous improvements to be undertaken. The implementation of the activity based costing has the potential of posing a number of challenges for the organization. ABC implementation is a huge scheme that is likely to consume enormous resources. Furthermore, the system will consume huge resources for maintenance once it is implemented. This is because numerous activities data has to be collected, authenticated and entered. Consequently, the organization will incur huge costs implementing and maintaining the system. Similarly, ABC system generates reports that are incompatible with generally accepted accounting principles (GAAP) (Bragg, 2013). Thus, the firm will be forced to prepare two costing systems for external and internal report. This will increase the cost and time of preparing financial reports for the firm. ABC system makes it difficult for the managers in identifying the general activities that manipulate costs (Macintosh & Quattrone, 2009). This is due to the allocation of the costs to individual customers and products. Thus, the data generated through ABC system should be handled by managers in making decisions. The costing allocated to products and customers can only be applied in solving the problem under consideration. Thus, the costing data under ABC system is limited to it application. Another major challenge that Balance limited is likely to face is odd numbers that will be faced by the managers. ABC system generates numbers like product margin that are not generated under the current traditional system been used by the organization (Maher, Stickney, & Weil, 2012). Thus, managers will be faced with difficulty in evaluating performance since they are used to traditional costing method. Viability of ABC Even though implementation of the ABC system at Balance Limited will pose challenges, it is viable for the finance director to adopt the system. The embracement of the system will help the organization to reduce the cost of the costing system in the long-run. In addition, decision making will be clear and understandable compared to the current situation. The ability of the system in allowing the costs to be allocated to the customers and products accurately makes the system easier for the management in making optimal decisions (Macintosh & Quattrone, 2009). This is because the managers will be able to price their products fairly in accordance with the demands of the diverse customers it serves. Furthermore, managers will be able to identify activities that do not add value to the product for elimination (Bragg, 2013). Consequently, it will allow the managers of the organization to come up with optimal managerial reports in running the firm. This is crucial for an organization in future since it will be able to allocate resources efficiently to realize the optimal benefit. In addition, the bureaucratic tendency of the traditional system that is time consuming will be eliminated allowing the managers to make timely decisions due to timely availability of the costing reports (Gediehn, 2010). Consequently, it is viable for the organization to embrace the system due to its long-run benefits over the current costing system that hinders accurate and reliable decision making environment. References Bragg, S. M. (2013). Management accounting best practices: A guide for the professional accountant. Hoboken, N.J: Wiley. Gediehn, O. (2010). Management accounting practice and strategic behavior: On the dysfunctional effect of short-term budgetary goals on managerial long-term growth orientation. Wiesbaden: Gabler. Macintosh, N. B., & Quattrone, P. (2009). Management accounting and control systems: An organizational and sociological approach. Hoboken, N.J: Wiley. Maher, M., Stickney, C. P., & Weil, R. L. (2012). Managerial accounting: An introduction to concepts, methods and uses. Mason, OH: South-Western Cengage Learning. Read More