Be Data Literate Know What to Know - Book Report/Review Example

1.1 Be Data Literate-Know What to Know This chapter talks about the need of computer literacy by executives in today’s world where computer literacy is on the upswing. Data literacy discusses the role of executives in the use of data. Managers need to view data not only as a tool for performing tasks but also should be able to interpret the data into relevant information. Challenges facing information users Deciding the information to use, who to use it and how to use it How to obtain data, test them and compile them together with existing information system to make them effective in company’s decision making process Grafting the accounting system and computer based data processing. Most companies do not have adequate data outside the business. Businesses need information from outside where there are threats, results, and opportunities in order to make strategic plans. Most businesses only have market info. Non-market information is important as it reveals the noncustomers traits. No company has more customers than its noncustomers and therefore there is need for nonmarket information to help the company expand. This information includes demographics, behavior, and plans of actual and potential competitors, technology, economic signals, and capital movements. 1.2 Cost /Management Accounting: The Twenty-First Century Paradigm Paradigm A The era of Industrial Revolution The most important or the base of this paradigm was standard cost or the total cost per unit of output. When analyzing the total cost per unit of output, almost all the costs including direct materials, direct labor, manufacturing overhead, and even marketing and administrative costs were accounted. As the final step of the process, to achieve the targeted or desired profit a target-selling price per unit was arrived. This is possible by adding the desired profit or markup, to the total cost per unit. The bottom line of paradigm A was to achieve the projected costs per unit, to achieve the price (target selling price per unit) that would yield desired profitability. Paradigm B The era of cost-volume-profit analysis and direct costing this introduces the distinction between fixed and variable costs, which ultimately leads to cost-volume-profit analysis and direct costing. The volume of activity issue relates mainly to fixed costs, because the variable costs per unit rely on engineering standards and analysis techniques and many variable costs have become more fixed over time. In essence, the issue of volume of activity to divide by has become a larger issue as the relative amount of variable costs has diminished and the relative amount of fixed costs has increased.  Paradigm C The era of activity- based costing. The activity-based costing (ABC) embodies two additional variable costs i.e. product complexity and product diversity, to develop a more accurate total cost per unit, which then improve the determination of selling prices and product mix decisions. There are three elements of variable manufacturing cost under ABC: a. Costs that vary with units of product. b. Costs that vary with product complexity, such as number of batches c. Costs that vary with product diversity, such as number of products Paradigm D The era of market driven standard costs as opposed to engineering-driven standard costs Paradigm D introduces using the selling price that the market will allow to help to determine the cost that the market will allow. Perter Drucker has referred to this concept as price-led costing opposed to cost-led pricing .In the cost-based pricing contracts, the market determines the price, and the role of cost is to help determine whether it is wise to enter the market or stay in the market. The target cost per unit is a market driven standard cost that has to be met to realize desired profits. This creates a series of new issues: a. the total cost per unit must not exceed the target cost if the desired profit is to be attained b. For continuous improvement, the allowable or target cost per unit must reduce over time c. The work process may have to change in order to reduce costs At the beginning of the century i.e. during paradigm A, a total cost per unit was derived by adding all the costs involved in the production process, and the selling price was determined by adding the desired profit to total cost per unit. The selling price was determined similarly as paradigm A. When considering the paradigm C, with the help of two additional variable costs i.e. product complexity and product diversity, which help to determine the activity of production, a total cost per unit, was derived. Ultimately using the said activity based total unit cost the selling price was determined. Hence, when considering the relationship so far between the cost and the selling price, firstly total cost per unit was determined and based on that the selling price was derived. Towards the end of the 20th century that is during paradigm D, we can clearly see that this trend has been changed. No longer was a total unit cost developed in order to determine the selling price, but instead a market driven selling price and a market driven standard cost was used. When elaborating on this it was believed that, the selling price was allowed or determined by the market, and based on that we determine the cost that the market will allow. Therefore, in order to attain desired profits a market driven standard cost has to be achieved. For the 1st century paradigm, Ferrara suggests a combination of paradigms C and D. When considering the present world market we have to accept the fact that it is intensely competitive. Therefore, the market driven selling price “which embodies by paradigm D cannot be ignored. In addition, he states continuous improvement is a necessity. I agree with afore said facts, because the present world market is an oligopoly and open market. Therefore, if you are to stay in the market and achieve desired profits, it is necessary you achieve the allowable cost permitted by our competitors.  Further, he says to use the ABC method introduced during paradigm C to determine the actual cost. With the help of activity based costing we can achieve the market allowable cost more organize and methodically. Thereby using product complexity and product diversity, we can analyses the production process and reduce production cost.  Ferrara recommends a combination of Paradigm C and D. Paradigm D is compelling as markets often determine prices and allowable costs to achieve the market price. Paradigm D alone is not sufficient; however, because there must be an ex ante and ex post assessment of costs. This is role for ABC from Paradigm C. With such determinations, there is not enough information and structure to know if a company can actually meet allowable costs. 2.1 Strategic Cost Management and the Value Chain Strategic cost management concept centers on value chain concept. Value chain is the linked set of value creating activities. On the other hand traditional management accounting uses the value added perspective. Value-added Concept The two disadvantages of Value-added concept are that it starts too late and it stops too soon. The aim of this concept is to maximize the difference between purchases and sales. As a result, it misses the opportunity to explore linkages with suppliers. Value Chain Concept Multiple cost drivers are used based on various types of activities throughout the value chain. Cost drivers are divided into executional and structural cost drivers Structural cost drivers Executional cost drivers Scale- the size of investment in manufacturing, R&D and marketing Workforce involvement-is the workforce committed to continuous improvement? Total quality management- commitment to total product quality Scope- the degree of vertical integration Capacity utilization – scale choices on maximum plant construction Experience-number of times in the past the firm has done what it is doing Plant Layout- efficiency against current norms Technology- the process technologies used in each step of value chain Product configuration – effectiveness of product design Complexity- width of line of product or service offered Linkages with customers or suppliers- are the lineage exploited according to the value chain. Questions; What is the difference between value –chain and value-added concepts? What are the structural and executional cost drivers and how are they distinguished in shank and Govindarajan’s article? 3.1 How Cost Accounting Distorts Product Costs Full Vs. Variable Costs Full cost system – production costs allocated so that reported product costs measure total manufacturing costs. Variable cost system - fixed costs are not allocated and product costs reflect only the marginal cost of manufacturing. Two stage cost allocation system – costs are assigned into cost pools in the first stage. They are then allocated from cost pools to the products. Firms used different bases to allocate in the first stage but all used direct labor costs in the second stage. Failure of Marginal Costing Marginal costing is identified by product costing systems that explicitly report variable-cost information. This system is relevant only when variable costs are a relatively high proportion of total manufactured cost and when there is minimal product differentiation. These conditions are not typical of today’s firms. The Failure of fixed-cost allocation Introduction of machines mean direct labor is no longer a principal value adding activity. Therefore, the procedure of use of direct labor hours in the second stage to allocate costs from centers to products has become irrelevant. It is also difficult to assign labor hours to products as it works on different products at the same time. The cost of complexity Firms with complex production incur additional support department costs to handle the complexity. However, traditional accounting system classifies the additional costs when the costs actually vary systematically. The volume related allocation also makes it hard to recognize how support department costs vary. Transaction Costing Low-volume products create more transactions per unit manufactured than high-volume .products. However, when volume related bases are used to allocate support department costs, both high and low volume products receive similar transaction-related costs. 3.3 Distinguishing Between Direct and Indirect Costs Is Crucial for Internet Companies Direct Vs. Indirect Cost Traditional View Direct cost is traceable to the objective function. Indirect costs cannot be easily traced to the cost objective. A cost objective is critical in determining whether to consider a cost as direct or indirect. Cost objective is the purpose for which cost is being measured. Products, services, and departments serve as key objectives in managing operations of a firm. The primary objective is the product being manufactured. Direct vs. Indirect costs in Internet-Based In e-commerce environment, processing of transactions is through electronic means. For a firm to be eligible for Dow Jones Internet composite Index, it must generate at least half of its sales on the internet. Pricing on the internet has pushed firms to performing in highly competitive markets. Firms are moving towards customer centric in competing in customer service. As a result, customers are becoming primary cost objective. Business Models for Internet-based Firms B2B-Business to business model where firms use internet to generate sales of products and services to other business B2C- Firms use the internet to generate sales directly to consumers. B2G- Firm sells its products primarily to government agencies C2C- Firms facilitate trade by providing a platform for trade on the internet. Internet based sales gives room for firms to modify products to customer needs, as there is an instantaneous and direct contact with customers. Tracing costs to customers is an essential competitive strategy for internet-based firms. Customers are a primary cost objective. Tracing costs to customers is continuous through real time cost systems. Firms can determine advertising costs that routes customers to its e-store. Treating of customers as primary cost objective enhances effective resource allocation decisions. 4.1 What are the costs of Variability? An important measure in any quality philosophy is the cost of product variability. The cost of variations depends on whether the remake of a product is possible, if there are constraints on production, and the distance between product specification limits. Two Philosophies The role of product variability in evaluating quality depends on whether the company has adopted a zero defects or robust quality philosophy. Zero defects philosophy- Specification limits and any variation within those limits is acceptable define the allowable variations. Robust Quality Philosophy- any variation from a target value represents a condition that is less than ideal, with potential economic consequences. Robustness is the result of meeting exact targets consistently. Cost Variation Companies that adopt zero defects philosophy will not attribute any cost to variability if product is within specification limits. On the other hand, robust quality proponent will assign a cost to variability whenever a product varies from a target. Cost of Variability Many costs are associated with variability in product attributes. For instance, raw materials cost will be higher if the product uses more materials than specified by engineering standards. Additionally, products that use more material may have higher delivery costs due to more weight than target weight. These costs do not relate to variability with the zero defects philosophy. Costs incurred when product falls outside specification limits depend on; whether the remake of the product is possible, production constraints and the specification limits. Calculating the Costs If a product sells as a first-quality unit after re-work, costs of rework are the total costs of variability. If the product cannot sell as a first-quality unit, then the cost of variability may include opportunity cost. The opportunity cost is the difference between the contribution margin of first-quality product and the actual contribution margin. Quality Loss Function This function is centers on the idea that any variability from the target value causes a loss to society. Any variability is a cost even if it falls within the specification range. The quality loss function is a quadratic function where costs increase as the actual product features deviate from target value. Measuring Quality Loss Unit Loss L = k(Y-T) 2 Where L- unit loss, Y- actual value of feature, T- Target value of feature and k- proportionality constant calculated by dividing loss of a product by the squared distance from target value i.e. k=c/d2 Average Loss per unit Average Loss = k (s2 + (Y-T) 2 ) Where s- standard deviation, Y- mean, T – target value and k – proportionality constant Importance of Measuring Variability It provides managers with information that can help improve operations. The efforts may also involve educating and retaining employees, redesigning production processes, investing in equipment, and even redesigning products. Measuring variability also helps managers in their quest for quality. 4.2 Effective Long-Term Cost Reduction: A strategic Perspective Traditional Cost Reduction Programs Firms use traditional cost programs due to immediate threat to the organization such as loss of contracts, poor performance, or price reductions. The Technology Approach This approach focuses on replacing direct labor with technology to increase operating efficiency and to reduce influence of unions. The approach is most effective when performance of firm is below par. Lean and Mean This approach emphasizes on reducing the number of workers. However, it is not effective in the long-term as it focuses on reducing workers to reduce costs without reducing the workload. Offshore Retreat This approach relies on reducing costs by moving to regions where the cost of labor is low such as Asia. However, there are economic implications of the movement such as exchange rates, currency fluctuations, and employee lay off when the firm moves. Mergers Mergers purport to create economies of scale by eliminating overlapping employees, products, plant, and overhead. However, merging firms may experience challenges in corporate culture, type of products and technologies. Employees may also suffer demotivation and morale loss. Diversification Firms diversify into new industries in search of a less expensive operating environment. However, a firm may experience challenges in developing and implementing new products. Strategic Cost Reduction This approach involves implementing a long-term plan that integrates competitive strategy, human resource strategy, organizational design considerations, and technological strategies to provide a coordinated basis for sustaining competitive advantage. 4.4 Is ABC suitable for your company? For ABC to be effective, analysis of costs should be systematic. Implementation of ABC requires complex, comprehensive process is costly and time consuming. As a result, managers need to be sure of the advantages before implementing it. A contingency approach to Implementing ABC This method centers on a company analysis of itself. It entails weighting and combining weights in order to evaluate the probability of success in implementing ABC. One then plot the combined weighted scores as a point on one of the four quadrants of a graph. The quadrants have a meaning and the location of the final score in that quadrant. Analyzing nature of a company Product Diversity – Refers to the range of products offered. Support diversity – Refers to the range of variations of support overheads given to products. Common Process – Refers to the degree of commonality of processes among the different product offerings. Period Cost Allocation- Refers to the existing costing system’s conceptual ability to allocate period costs properly. Rate of Growth of Period Costs – Refers to the growth in period costs as an indicator of the dynamism required by the costing system. How Management use cost Information in Decisions The following factors influence management’s desire to use cost information in its deliberations: Pricing freedom – this is the company’s degree of power and freedom to set prices and therefore establish product profitability. The more freedom a firm has, the less important product costs become. Period Expense Ratio- it addresses the possible materiality of product cost distortions directly. Strategic considerations- Refers to the constraints imposed upon management’s decisions by its strategies. Cost Reduction- it involves the corporate culture as it affects the relationship between internal cost-related decisions and the direct component of the total cost of products. Analysis Frequency- Refers to the frequency of product cost analyses, incorporates both current, and desires frequencies. Contingency Grid The figure above shows a grid where one can plot situational factors in an evaluation of the potential of ABC for a particular situation. Interpreting Results Quadrant One Results that are plotted in quadrant one initially suggest because product cost distortions are likely and management is free to act upon corrected product costs, an ABC system should be implemented. Quadrant Two If results are in this quadrant, it indicates that even though management is free to utilize product cost information, it is unlikely that those costs contain material distortions. Quadrant Three Results plotted in this quadrant indicate that ABC is not a recommendation. It is unlikely that material product cost distortions are present, and management has limited ability to react to modified costs. Quadrant Four Results in this quadrant suggest that although product cost distortions are likely, management has little ability to modify its decisions that are cost dependent. The final Decision The factors presented in the discussions are neither mutually exclusive nor collectively exhaustive. The scoring system centers on factors cited in ABC literature as being causal in determining superiority of ABC over traditional costing. Read More