Advanced Management Accounting Systems - Coursework Example

Contents 1.0 Introduction 2 2.0 Traditional Costing 3 2.1 Decision Making 4 2.2 Limitations 4 3.0 Activity Based Costing 5 3.1 Decision making in ABC 7 3.2 Limitations of ABC 8 4.0 Recommendation 8 5.0 Conclusion 9 Reference List 10 APPENDIX 14 1.0 Introduction Since the inception of the new movement in managerial accounting, a gap has emerged regarding the viability of traditional managerial accounting techniques. Although many practitioners prefer traditional managerial accounting techniques, it has faced considerable criticism given that they are obsolete and not effective during decision-making. Evidently, most information in traditional management accounting information are essentially too distorted and too aggregated to be relevant for practice in the present business environment. The preference of ABC to traditional approaches, this paper confronts, is well placed in addressing issues in today’s field of management. This retrospect paper seeks to present the differences between these two approaches and their subsequent limitation for practice. Simply put, management accounting is the preparation of management reports and accounting reports which give accurate and timely information on finance and statistics essential managers in decision-making (Weetman, 2010). They present revenue from sales, orders at hand, account payables and receivable’s status, available inventory, unpaid debts, amount of raw materials and many other statistics. It is important to consolidate a viable accounting approach since management accounting is concerned with the planning of the company’s future needs, control of activities, analyzing information and reporting of findings (Weetman, 2010). Costing systems enable organizations to determine production costs related to revenue generation, provision of cost estimation frameworks, valuation of inventory and control of costs. A firm needs to understand the profitability of each product and in doing so an accurate measure of cost production is needed (Drury, 2008). Traditional costing and the Activity Based costing are the two most widely knownaccounting approach. 2.0 Traditional Costing Traditional costing method is used by a great number of manufacturers to assign manufacturing overhead to their products. Many manufacturers employing this methodology assume that the underlying driver in manufacturing overhead cost is the volume metric. In this respect,allocate the manufacturing costs to the products only (Anvari and Rezayat, 2007).The non-manufacturing costs are not allocatedtothe production cost of an item. An example of such a cost is a firm’s administrative expense. This method brings together all the indirect costs of production and dispenses them equally on all the manufactured products using a single cost driver, for instance, the machine hours (Popesko and Novák, 2008).As such, the cost allocation approach focuses on three steps, which includes the accumulation of costs in production or non-production departments, allocating of costs from non-production departments to the production departments. Lastly,it allocates the costs from various departments of different customers, services, and products. Traditional costing is at optimal when the indirect cost is lower in comparison to direct cost. This is achievable when an estimate is done for indirect costs for a specific duration of time while choosing the cost-driver with a causal link between the cost. An estimate of cost-driver is done. The overhead rate is then computed with the below formula Predetermined Overhead Rate = Estimated Overhead Costs / Estimated Cost-Driver Amount The effectiveness and accurate comes because of similar items being produced at the same time. For external use, the approach is appropriate since outsiders will determine the price of thecommodity.On allocation basis, direct labor, is thought to distort product cost computation (Naidoo, 2010). 2.1 Decision Making Traditional Costing approach is efficient in provisioning consistent and simplicity in financial statements. The method was used in past to compute direct labour and overhead costs to make charges on manufactured products (Potkány, 2008). Itsdecision-making approach is based on the computation of overhead cost that is charged for the manufactured product (Hassini ,Surti and Searcy, 2012). In the present dynamic business environment, its usefulness in decision-making is misinformed. 2.2 Limitations Specific estimations levels are imperative during cost allocation (Potkány, 2008). Hence, the cost systems are not centered on specific estimation in cost allocation. This approach presupposes that the systems are not focussed on the reasons that pertain to incurred cost. It presents insufficient insights into the causes of the variance (Kallunki and Silvola 2008). Therefore, its reporting approach assumes an accounting oriented approach that is inaccurate, and inefficient. In this respect the manager cannot conceptualize what is needed, hence does not relate to the cost of the services or products used. With the exclusion of certain non-manufacturing costs, the approach might contribute to uninformed decision-making concerning the management. Most manufacturing companies use various technological equipments like computer machines for lean manufacturing. The computer machines make the system useless since it uses direct labour hours in calculating the cost. The cost faces the limitation because the direct labour hours are not the best driver positioned. Traditional cost negates other cost drivers that may contribute to the product’s cost. As such, this method is that it can lead to unsound management decisions as it excludes certain non-manufacturing costs.In the calculation 1 (Appendix) the overhead charged for the shovels using ABC is £0.52 which is higher than £0.35 obtained from the traditional method. These differences is eminent since this approach uses direct labour to determine cost allocation, and therefore, a product typified by a high direct labour is subjected to an increased cost allotment, as opposed to products with low direct labour pay. 3.0 Activity Based Costing This approachdetermines all the processes associated with the production and allocates a cost to them. It then determines their production cost. It provides a more credible and accurate view of the product cost. The costs assigned to processes are then associated to the products that require the production activity. Despite this approach, most organizations usually apply it to a secondary costing system. ABC is a more accurate method because it considers a number of important factors before allocation of a product cost namely; administrative and managerial costs. These costs are addedto the direct costs of production such as cost for raw materials, labor, and other inputs. Activity-based costing is more accurate compared to traditional costing approach. The approach has a simpler breakdown of indirect costs. Dataret al., (2013) advocates that ABC traces overhead cost directly to cost objects. For instance, the customers or the products assist the managers in making informed decisions when dealing with competitions of services and products in markets. Pike and others (2011) define activity-based costing as the costing and monitoring activities that involves tracking of resources consumption and costing the final outputs. Resources are aligned to the activities, whereas the activities of cost objects are linked to consumption estimates (Pike et al., 2011; Pernot et al., 2007). The system cost driver is utilized by attaching activity costs to the outputs (Crossan and Apaydin, 2010). Therefore, it implies that for each activity in a company, the overhead costs are accumulated on aspecific activity. After that, it assigns the cost of activity to cost objectives which involve the products services or customers causing those activities. Overhead Cost Hongren and Oliver (2010) thatABC are accounting attempts to identify the real costs that are linked with serving the customers. Thus, both attributes of cost and overhead cost must be traced back to each customer. Arguably, the expenses in keep up and indirect resources are segregated from activities of this approach, in which, the expensesare allocated with respect to drivers of these activities (Namazi and Heshmati, 2009). This explains why ABC provided plant managers have an increasingly higher structural approach in evaluating the expenses linked with specific activities in maintaining a product (Crossan and Apaydin, 2010; Kuchta and Troska, 2007). In this approach, n each actibity’s overhead cost are accumulated, where services, producta and or other objectys are assigneed specific costs that have resulted from the activity. In creating a relationship between cost object and activity, cost drivers are identified for the various activities. Activity analysis is incorporated where it is subject to cost drivers and its effects on cost providing the services and products (Lutilsky&Dragija, 2012; Schulze et al., 2012)). ABC is flexibility when focusing on tenets of financial reporting requirements to manage in facilitating the decision-making (Schulze et al., 2012). The cost drivers have adirect effect on the occurrence of a particular cost (Dalci, Tanis, Kosan, 2010). In order to achieve a preferred approach, Lutilsky and Dragija (2012) affirms, prior to computing the variables one has to identify the activities and activities pools,identify the cost of each activity and link acticvity cost pools to subsequernt cost. The cost are linked to cost objects by using activity measures and activity rates. 3.1 Decision making in ABC The ABC facilitates the decision-making operations in companies. The system requires cost behaviour approach for decision-making (Duh et al., 2009; Weetman, 2010). Through its presentation as cost allocation or product costing, the managers should have a chance to adjust the cost when they are linked to levers. Through the recognition that the cost vary depending on batch and product levels, it helps in decision-making. 3.2 Limitations of ABC i. Information offered by ABC are insufficient in offering continuous improvement programs that are significant in enhancing competitiveness in the dynamic industry (Gunasekaran et al., 2005 p. 525). Information is crucial since it helps to set improvements and priorities. Evidently, this approach offers metrics and measures that only improve a company’s functional performance. Functional classification seems to be outdated given the integrations of functional attributes such as augmented prevalence of networked companies and information technology. Simply put, Information enables the decentralisation of some decision rights in new economies and organisations. ii. ABC does not report activity information needed to augment functionality (Gunasekaran et al., 2005 p. 525). The natures of overhead cost have changed from the labour cost that is affected by output volume, to an approach that integrates diversity and complexity production. Overhead costs arise from the need to exploit economies of scale, wherein, knowledge workers, notably software specialist and engineers have replaced most direct cost (Gunasekaran et al., 2005 p. 525). Moreover, overhead outside the plant that is linked with marketing, engineering and distribution has exceeded direct labour cost. 4.0 Recommendation The two forms of costing are appropriate given the prevalent situations. A specific need for your project frame should be the focus to which method need to be applied. ABC has become increasingly popular in recent business environment. It is a powerful tool that effectively measures performance and identifying, describing and assigning cost to agency operation. Its adoption is a more accurate cost management, as opposed to traditional cost accounting. As such, they say that this strategy identifies opportunities to improve processes effectively and efficiently by identifying “true” cost of a product or service. Traditional costing should be taken into account when there is a limitation of time and during occasions when accuracy will not be compromised. However, traditional costing has become ineffective, if not obsolete in the present global competitive market. The business scenario in the early 70’s for which it was developed is no longer attuned to the presentbusiness trend. Employing standard cost, in traditional costing applied to companies with limited ability for data collection and large direct cost as opposed to indirect cost, to name a few. 5.0 Conclusion The choice of accounting system has a profound effect on the company’s strategic implication. Using an ineffective product costing approach would be detrimental. It is of significance importance that firms realize the type of accounting approach to using with respect to its present set of business organization. Traditional costing applies a direct labour as a platform for computation if the overhead cost on the cost expended on the product. This approach is outdated and fails in presenting accurate information since it is accounting. Tentatively, it lacks the inclusion of certain non-manufacturing costs, pertinent to decision-making. On the other hand, ABC is a proffered accounting tool that significantly integrates a multiplicity of accounting attributes. Firstly it identifies real cost where, both overhead cost and overall cost are tracked back to the customers, where overhead cost is accumulated for each activity. Although it is typified by a number of limitations, it is highly recommended for any accounting practice. Efficiency and effectiveness are evident when using such a practice. Therefore it is highly advised that companies incorporate such an approach. Reference List Anvari, R., and Rezayat, E. (2007) The comparative assessment of profitability of Islamic bank contractions using activity-based and traditional costing systems: A case study of Tosee-y-Saderat bank in Iran.Accounting and Auditing studies, (48), 25-28 Crossan, M., and Apaydin, M. (2010) A multi-dimensional framework of organizational innovation: a systematic review of the literature. Journal Management Studies 47(6):1154–1191. Datar, S. M., Rajan, M. V., Wynder, M., Maguire, W., & Tan, R. (2013) Cost accounting: a managerial emphasis.Pearson Higher Education AU. Drury, C. (2008) Management and Cost Accounting. Andover: Cengage Learning Dalci I, Tanis V, Kosan, L. (2010) Customer profitability analysis with time-driven Activity-based costing: a case study in a hotel. International Journal Contemporary Hospitality Manage, 22(5):609–637. Duh, R., Lin, W., Wang W., Huang, H. (2009) The design and implementation of activity-based Costing: a case study of a Taiwanese textile company. International Journal Account Information Management, 17(1): 27–52. Gunasekaran, A., Williams, J., McGaughey, R. (2005). McGaughey Performance measurement and costing system in new enterprise. Technovation 25: 523–533 Hongren, C., and Oliver, M. (2010) Managerial Accounting. Person Education Kallunki, J., and Silvola, H. (2008) The effect of organizational life cycle stage on the use of Activity-Based costing. Management Account Research 19(1):62–79. Kuchta, D., and Troska, M. (2007) Activity-based costing and customer profitability, Cost Management, 21(3): 18–26. Lutilsky , I., and Dragija, M. (2012) Activity based costing as a means to full costing: Possibilities and constraints for European universities.Manage (Croatia), 17(1):33–57 Namazi, M., and Heshmati, R (2009) ‘Designing a model of assessing information technology projects by using a fuzzy activity-based budgeting method’. 3rd International Conference on operational budgeting: Tehran. Naidoo, M. (2010) Traditional costing systems of South African Private Higher Education Institutions, Problems and Perspectives in Management, 8, pp. 1-9 Pike, RH., Mike, E., Tayles, N., Naha, M. (2011) Activity – based costing user satisfaction and type of system: A research note. Br. Account. Rev. 43(1):65-72 Pernot, E., Roodhooft, F., Van, D., Abbeele, A. (2007) Time-driven activity-based costing for inter-library services: a case study in a university. Journal of Academic Library 33(5):551–560. Popesko, B., and Novák, P. (2008) ‘Principles of overhead cost allocation, from Issues in Global Business and Management Research - Proceedings of the 2008 International Online Conference on Business and Management (IOCBM 2008), Universal-Publishers USA. Potkány, M. (2008) Personnel outsourcing processes, E+M Economics and Management, 4 Singer M., and Donoso, P. (2008) Empirical validation of an activity-based optimization system, International Journal of Production Economics 113: 335–345. Schulze, M., Seuring, S., Ewering, C. (2012) Applying activity-based costing in a supply chain environment. International Journal of Production Economics, 135:716–725. Tsai, W., Lai C., Tseng, L., and Chou, W. (2008) Embedding management discretionary power into an ABC model for a joint products mix decision, International Journal of Production Economics, 115, 210– 220. Weetman, P. (2010) Financial Accounting, 5th Edition, Harlow: Pearson Education Ltd. APPENDIX Traditional Costing and Activity-Based Costing Calculations Assuming that Garden Lite Company manufactures two types of equipment, shovels, and mowers. Similar equipments are used in the production of balls in different operations. As such, it is important that the equipments are cleaned and maintained between uses. The shovel packaging consists of two; two shovels per package and one mower per package. Garden Lite co. anticipates to make two million mowers and one millions shovels. The table below shows the allocation of the overhead cost on each activity pool is highlighted below; Table 1.0 Object Cost Materials £100,000 Equipment Testing 370,000 Product Packaging 400,000 Maintenance 288,000 Setup of machines 240,190 Overhead costs (Total) £ 1,398,190 The cost drivers and the anticipated total units have been highlighted below through analysing the activity pools. Table 2.0 Activity Cost driver Total expected units for cost driver 1 Total cost (2) Unit cost per cost driver (3) =(2) divide by(1) Materials Order purchase 150 £100000 £666.67 Assembly Setups 170 240,190 1412.88 Product package Filling Containers 2300000 400,000 0.17 Equipment Testing #tests 2800 370,000 132.14 Maintenance #of Runs 351 288,000 820.51 The activity by product is shown below: Table 3 Expected use ABC cost assigned Activity Cost driver Unit cost per cost driver (3) =(2) divide by(1) Shovels (4) Mowers (5) Shovels (3) ×(4) Mowers (3) ×(5) Material purchase orders £666.67 40 40 £26666.8 £26666.8 Assembly setups 1412.88 117 117 165,306.96 165,306.96 Product packaging containers filled 0.17 400000 1000000 68,000 170,000 Testing tests 132.14 1500 2500 198, 210 330, 350 Maintenance Runs 820.51 79 159 64, 820.29 130, 461.09 Totals £523,004.05 £822, 784.85 When using ABC to compute to the per unit overhead cost, the division of cost and available units should be done. In this case the unit cost for shovels and mowers amounted to £ 0.523 and £ 0.411. Table 4 Overhead costs on shovels £523,004.05 ----------------------------------------------- = -------------- =£0.523 Number of shovels 1,000,000 Overhead cost on mowers £822, 784.85 ----------------------------------------------- = ------------- =£0.411 Number of mowers 2,000,000 The traditional method of allocation uses the direct labour approach. In this case, the product’s total cost needs to be divided by the total direct labour dollar for the equipments in determining the per unit cost. In the case that the estimated direct labour cost amounts to one million dollars, where shovels and mowers account for £ 250,000 and £ 750,000 respectively, its per unit direct cost stands for shovels will be ; Table 5 i. Calculating overhead cost Total overhead costs £1345788.9 ------------------------------- = ------------- =£1.34 per direct labour dollar Total direct labour dollars £1,000,000 ii. To obtains Overhead Allocation Overhead cost per direct labor dollar × per unit direct labor dollars Shovels- £1.34×£0.25 = £0.34 overhead per unit Mowers- £1.34×£0.375 = £0.50 overhead per unit Read More