Management Accounting - Debenhams Plc - Assignment Example

Debenhams plc Introduction Debenhams plc was founded in 1778 and has since been in continuous operation (Debenhams, 2011). The company retails in clothing and other goods. The line product of the company includes women’s wear, menswear, children’s wear, home and, health and beauty products. The firm has over 150 stores located in England (Debenhams, 2011). International stores of the company are mainly franchised. The company was acquired by Burton Group in the late 1980s at a cost of about US $900 million. However, the firm regained its independence in 1998 when it “demerged” from the Burton group, which changed its name to Arcadia Group at a cost of £65 million. The group opened its largest store at the new Bull Ring shopping centre in Birmingham in 2003. The firm was again acquired by a private consortium in late 2003 (Debenhams, 2011). The consortium comprised of CVC Capital Partners, Merril Lynch Global Private Equity, Texas Pacific Group and management. The firm expanded rapidly in 1998 and 1999 by opening 17 new stores and modernizing 10 of its existing stores (Debenhams, 2011). By the end of 1998, which was the first year after demerging, the company saw its profits and revenues rise. The company was listed again on the London stock exchange in 2006. The firm has a unique mix of exclusive own brands, which includes Designers at Debenhams and a third party brands. These help the firm to differentiate itself from its competitors. The firm is primarily involved in the selling of fashion clothing and accessories in addition to cosmetics (Debenhams, 2011). The firm has both in store and in online stores for selling its products. The online retailing and departmental store serves over 3 million customers per month. Online shopping is so popular because thousands of products are available in every department, has great savings and is regularly updated, the customers are able to shop at the comfort of their own home, goods are delivered directly and customers are able to try on Debenhams Designer pieces at the comfort of their own home. The firm was awarded in 2010 for having the best website shopping at the Comfort Prima High Street Fashion Awards 2010. The firm as part of corporate responsibilities supports charitable causes such as breast cancer campaigns, National Society for the prevention of Cruelty to Children, Retail Trust, Children 1ST and the Marine Conservation Society. As part of marketing its products the firm holds accounts with social networks such as facebook, twitter, You Tube, foursquare, polyvore, and flickr (Debenhams, 2011). The top performing store of the firm is the debenhams.com. The firm earned £151.0 million in headline profit before tax in 2010, which was a 20.6% increase over the prior year. The firm gained market share in both menswear and children’s wear by 5.1% and 3.9% respectively in 2010. In the 2010, direct sales of the firm grew by 88.4% to £103.8 million (Debenhams, 2011). This was necessitated by the strategy of integrating the store business with the online business. Costing method and non costing management accounting techniques Marginal costing This is an accounting system where variable costs are charged to cost units and the fixed costs of the period are written off in full against the aggregate contribution. Contribution in this case refers to the difference between sales and marginal costs (Debenhams, 2011). The marginal cost is the sum totals of the variable cost direct labour, direct material, direct expense and variable overheads. It is used in decision-making process (Gazely and Lambert, 2006). Under the theory of marginal costing, an increase in volume of output is accompanied by reduction in cost per unit while reduction in output results in an increase in the cost per unit (Coombs, Hobbs, and Jenkins, 2005). In the case of the online shopping at Debenhams plc, the cost of hosting a website are relatively constant and therefore when a customers order several products at ago the cost per unit to the firm is reduced since the cost of delivery will remain constant and so is the cost of running the website. However, if online orders reduce drastically, then marginal costing will increase resulting in reduced returns. This is also true to other departmental stores. In case many customers are served by the employees of the Debenhams plc in a day, the marginal cost per unit reduce while the sales increase. This results in increased returns on investment as compared to when few customers are served by employees of the firm in a day. Under the theory of marginal costing when there is an increase in output more than one, marginal cost per unit is the total increase in cost divided by the total increase in output. Non-costing management accounting techniques a) Variance analysis This allows one to understand the differences between actual and expected costs. Thus, managers are able to manage costs through variance analysis (Gazely and Lambert, 2006). By establishing well-developed process and standards, the Debenhams plc can determine cost and volume variances (Coombs, Hobbs, and Jenkins, 2005). Thus for Debenhams plc to develop a useful variance analysis it will have to build good standards which will be able to identify the expected volume and cost for each service such as running a website for selling its products and delivery of such products ordered online to customers (Debenhams, 2011). Cost variance at Debenhams plc may arise from increases of salaries, cost of delivery of goods ordered online and changes in the cost material required for making clothes at the firm. This implies that the firm needs to carry out cost analysis variance for it to be able to remain profitable. Volume variance may result from changes in sales volume either at the firm, which may influence positively or negatively on the revenue of the firm. Fall in volumes may result in decreased revenue. Thus, the firm will also have to carry out volume variance analysis. b) CVP analysis Under cost volume profit (CVP) analysis, cost equations are combined with revenue equations to determine profitability at different levels of output (Gazely and Lambert, 2006). Thus, the net income is the total revenue minus total cost. In the case of Debenhams plc net income from online shopping = total revenue from online sales - (average variable cost x quantity of output) + fixed cost. In this case average variable cost will be sum total of say the cost of delivery of the item divided by the number of items delivered. Total revenue will be the price times the quantity of output sold. The fixed cost in this case will include the cost of hosting the website and the cost of salary to employees involved in delivery and servicing the website. c) The Make or Buy Decision This refers to a decision made by the firm on whether to produce an item internally or purchase from outside supplier (Coombs, Hobbs, and Jenkins, 2005). Since Debenhams plc is involved in fashion industry, either it can decide to outsource some of fashions from other companies or it can decide to make them internally (Debenhams, 2011). In order for Debenhams plc to make this decision its has to evaluate the advantages and disadvantages of making the fashion within the firm as opposed to its outsourcing prior to making a decision on whether to make or buy the item (Langfield & Thorne, 2005). Both qualitative (such as quality control) and quantitative (such as the relative cost) factors will be considered by the firm management when making this decision. Advantages of the marginal costing method and the non-costing management accounting techniques The marginal costing method is simple to understand and hence the Debenhams plc management will be able to easily and quickly make decision based on this method on how to reduce costs of running the stores and at the same time increase returns on investment. This method does not charge fixed overhead to cost of production and thus the Debenhams plc will avoid the effect of varying charges per unit (Coombs, Hobbs, and Jenkins, 2005). The Debenhams plc will also be able to prevent the illogical carry forward in stock valuation of some proportion of current year fixed overhead. Debenhams plc will also be able to access and easily asses the effects of alternative sales such as online sales to help in making decisions that can yield maximum returns to its business (Debenhams, 2011). Furthermore, the use of marginal costing method by Debenhams plc will enable it to eliminate large balances left in overhead control accounts, which are an indication of the difficulty of ascertaining an accurate overhead recovery rate (Langfield & Thorne, 2005). The method will also greatly facilitate practical cost control (Coombs, Hobbs, and Jenkins, 2005). This is because Debenhams plc will be able to avoid arbitrary allocation of fixed overhead and hence its efforts will be concentrated on the maintenance of a consistent and uniform marginal cost, which is useful to various levels of management. Finally, marginal costing method will help Debenhams plc in short term profit planning by profitability and breakeven analysis both ion terms of graphs and quantity (Gazely and Lambert, 2006). This will enable Debenhams plc to compare performance and profitability between two or more products (say menswear and women’s wear) and different stores to help the Debenhams plc management in making informed decisions. CVP will be advantageous to Debenhams plc in that it will allow determination of profitability of the firm at different levels. Furthermore, it will allow Debenhams plc to determine its breakeven point, which is the level of output at which the total revenue equals the total cost (Debenhams, 2011). The technique will also enable Debenhams plc to determine whether the projected sales are sufficiently beyond the breakeven point to justify continued engagement in trading of that particular fashion (Langfield & Thorne, 2005). Just like marginal costing method, variance analysis technique will help the Debenhams plc management in making informed decisions. In addition, the technique will help Debenhams plc management in controlling costs (Coombs, Hobbs, and Jenkins, 2005). The technique will also act as a warning mechanism to Debenhams plc management on any corrective action that ought to be undertaken by the firm. The technique will also provide the basis for accountability among the management of Debenhams plc (Debenhams, 2011). The make or buy technique will enable the firm to make thorough analysis of making as opposed to buying and buying as opposed to making and make an informed decision. Based on this the Debenhams plc will be able to make products internally, which are cheaper to make than to buy and buy those which are cheaper to buy than to make internally (Gazely and Lambert, 2006). To make these decisions the management will have to compare the relevant cost of making or buying (Coombs, Hobbs, and Jenkins, 2005). The relevant costs of making is the sum of the variable cost of manufacturing (like direct materials, direct labours and variable production overheads), any increase in specific fixed costs and any opportunity cost involved (Langfield & Thorne, 2005). Debenhams plc will be able to evaluate the quality of products bought externally and whether delivery time can be met in addition to the effect on customer loyalty when sales are foregone due to cases of full capacity (Seal, Garrison, and Noreen, 2006). By deciding to buy some item from outside sources, Debenhams plc will be able to flexibly meet urgent demand of its customers, overcome limiting factor problem, concentrate on its own core competencies and overcome seasonal demand problem (Debenhams, 2011). In addition, Debenhams plc will also be able to take advantage of the specialist skill and expertise of the outsiders and overcome production bottleneck (Langfield & Thorne, 2005). Limitation of the marginal costing method and the non-costing management accounting techniques By employing marginal costing, Debenhams plc will find it difficult to separate costs into fixed and variable and this may give rise to misleading results. Since normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing for Debenhams plc (Debenhams, 2011). Furthermore, marginal costing at Debenhams plc will lead to understating of stocks and work in progress. Since the exclusion of fixed costs from inventories affect profit, and true and fair view of financial affairs of the Debenhams plc may not be clearly transparent (Coombs, Hobbs, and Jenkins, 2005). Marginal cost data may become unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal fashions at Debenhams plc (Debenhams, 2011). Application of fixed overhead depends on estimates and not on the actual and as such, there may be under or over absorption of the same at Debenhams plc. Marginal costing system ignores fixed costs and hence is less effective. In practice, sales price, fixed cost and variable cost per unit may vary (Seal, Garrison, and Noreen, 2006). Thus, the assumptions underlying the theory of marginal costing may be unrealistic to Debenhams plc. Adoption of variance analysis by Debenhams plc may fail to tell its management the cause of discrepancy of say between material price variance and material usage variance (Debenhams, 2011). This may lead to reprimanding of the manager who is responsible for using the material. Thus, use of variance analysis in decision-making is not effective unless the cause of variance is investigated further. Cost volume profit (CVP) is a short run, marginal analysis: it assumes that unit variable costs and unit revenues are constant, which is appropriate for small deviations from current production and sales, and assumes a neat division between fixed costs and variable costs, though in the end all costs are variable. Therefore, Debenhams plc cannot use this technique for its long-term decision making process (Debenhams, 2011). By adopting the make or buy technique Debenhams plc may resort to buying most of its product lines which may result in reduced product innovation and compromised quality in case a firm is contracted to supply certain items for a prolonged period. Reference Coombs, H., Hobbs, D., and Jenkins, E. 2005. Management accounting: principles and applications. New York: SAGE. Debenhams. (2011). Home. Available at http://www.debenhamsplc.com/phoenix.zhtml?c=196805&p=index [Accessed 18 Feb. 2011] Gazely, A., and Lambert, M. 2006. Management accounting. New York: SAGE Publishers. Langfield, K., & Thorne, H. 2005. Management accounting: information for managing and creating value, 4th Ed. Sydney: McGraw-Hill Australia. Seal, W., Garrison, R., and Noreen, E. 2006. Management accounting, 2nd Ed. New York: McGraw-Hill Publishers. Read More