Management and Cost Accounting - Assignment Example

Question Estimate for 100 Sandwiches 100 Sandwiches Particulars Cost per unit Total Costs Variable Expenses - Direct Material 1.00 100.00 Labour: Type 1 - Cut 0.06 5.65 Type 2 - Fill 0.06 5.65 Type 3 - Pack 0.06 6.01 Indirect Packing 0.03 2.80 Royalty 0.02 2.00 Other Variable Overheads (20%) 0.02 2.15 Total Variable Cost 1.24 124.26 Fixed Overheads (80%) 0.09 8.62 Total Costs 1.33 132.88 Mark-up (20%) 0.27 26.58 Total Selling Price / Quote 1.59 159.46 Assumptions Supervisors cost ( direct labour) is not included as there is no extra cost involved in hiring the supervisor nor the supervisor forgoes any other tasks performed by him. Currently the company uses standard cost accounting whereby direct material per unit is charged as an approximate instead of actual and fixed charge of overheads is included in the total cost of production i.e. on direct labour hour basis. This charge is based on historical data of costs which was available with ‘BITE ME’. Currently, the entity has not classified miscellaneous costs such as royalties and packaging costs under appropriate heads such as variable overheads, direct material, etc., rather direct material and overheads are included in total cost of production on approximate basis. Since the costs of direct material and overheads are not determined accurately, there is a big risk that company might not produce competitive bids and unreasonably high prices are quoted to the insurance company. Therefore it is highly recommended that firstly the entity should classify accurately the costs associated with the product into fixed and variable. Secondly, actual charge is (should be) considered rather than standard costs, as it should be able to measure its actual cost of production. Recommendation: It is recommended that entity should consider using marginal costing method as it will allow the management to derive more relevant & important information for the purpose of decision-making. Information such as Contribution per unit, Break Even Sales (in units & value), Net Profit per unit and total can be of significant value to the management. Question 2 Table of Contents Contents Page Number Introduction 4 Purpose of throughput accounting 4 Role 4 Function 5 Current setup at ‘BITE ME’ 6 Conclusion: Throughput Accounting’s appropriateness for implementation at BITE ME 6 Introduction In the era where companies are moving towards modern and world class business principles and reporting methodologies, there has been, since three decades, a significant debate on the validity of traditional absorption costing method in today’s decision making process. What are relevant costs when taking decisions relating to increasing the velocity of operating cycle and what are costs that are relevant solely when consideration is given to company objectives, goals and strategies? (Samford University, School of Business, Birmingham, Alabama, USA) We at William & Co. Consultants have made a feasibility study on the implications and benefits of implementing throughput accounting at BITE ME. Purpose "Throughput Accounting provides managers with a fresh set of eyes to identify and control bottlenecks. The drum, buffer, and rope will become part of the cost accounting lexicon in the future”, says Geoffrey Garland, Controller, StacoSwitch, Inc. (Steven Bragg). Throughput Accounting (TA) is a comprehensive management accounting approach which provides decision support information to managers for enterprise optimization. “Throughput accounting is a performance measure that seeks to identify the rate at which the organisation generates profits from sales through analysis of constraints and bottlenecks” (CIMA, 2007). It is a technique that is used in Theory of Constraints (TOC) as performance measures. It is the business skill used for profit maximization; however, Throughput Accounting focuses primarily on producing more throughput unlike cost accounting that focuses on curtailing costs and expenses reduction to generate profit. Whether the constraint is internal or external to the organization, Throughput Accounting pursues to enhance the speed or velocity of throughput generation by services and products in relation to constraints of the organization. Throughput Accounting is the unique methodology of management accounting that views constraints as limiting factors of the organizations’ performance. Throughput (T) is the velocity at which money is generated by the company through sales. TOC emphasizes the fact that production is primary source of generating sales money. Managers, with the purpose of generation of money, produce products which can be sold rather than manufacturing products for inventory. There are amounts which must be deducted from sales revenue when calculating throughput: subcontracting costs, commissions paid to salespeople, customs duties, and transportation, if the company does not own the transportation channel. Theory of Constraints recognizes that labour is often considered to be a fixed cost, especially where companies hire skilled labour and where laying off cannot be practically implemented in periods of low demand and where labour cannot b easily hired again when demand increases. Therefore, in TOC, direct manufacturing labour costs are not deducted from sales in calculating throughput. (Ruhl) Role Management accounting is internal set of techniques and methods of an organization whose purpose is maximization of shareholders’ wealth. Throughput Accounting is an internal tool for reporting of the management accountants tool kit, that ensures not only the whole organization’s overall effectiveness but also its efficiency as well. Throughput Accounting revamps the thinking way of organization internally with respect to recognition of revenue, profit and costs hence changing the data used for decision making. However, it does not revise the annual and legal accounts (the basis of which is prescribed by corporate and taxation laws) which are nevertheless not the basis of significant decisions anyway (Science of Business). Benefits, from using Throughput Accounting as a tool for measurement and decision making, are: Focusing sales efforts on products that are cash cow products Better analysis of potentially more fruitful investments Make/buy decisions that are based on the real effect on the bottom line In relation to its goal, more realistic reporting of the effectiveness of the system as a whole in giving returns, both present and potential. Sound and secure business decisions backed with sky high confidence are characteristics of Throughput Accounting. Throughput Accounting measures the velocity of throughput in pounds (money) per second (time) indicating the actual source of returns. Knowing the’ Throughput Speed of products and services, empowers strategies & tactics increasing net profits and investment returns Function Throughput Accounting is different from cost accounting as it is cash-focused and whether variable or fixed expenses, it does not allocate them to products and services that are sold or provided by an entity. Considering the laws of variation, only costs that vary completely with units of output e.g. raw materials, are allocated to products and services. These are then deducted from sales to determine Throughput. Measurements of Throughput, Inventory and Operating Expense are used by Throughput Accounting, that are easily applicable company-wide and all easily understandable by people involved in shop floor decision making. It is worth mentioning that Throughput Accounting rejects the typical reliance on efficiencies, labour efficiencies in particular which it sees as counterproductive. Furthermore, throughput accounting increases the profitability through better management decisions by implementing measurements that reflect precisely the effects of decisions on three critical monetary variables (throughput, investment in inventory and operating expense). Throughput accounting revolves around the basic idea that the investment made to enhance the capacity of the business cycle should be effectively utilized. Throughput accounting, in combination with throughput, totally variable costs, and operating expenses, uses the following formulas to help make investment decisions: Revenue – totally variable expenses = throughput Throughput – operating expenses = net profit Net profit / investment = return on investment While making decisions that involve making variations to investment, revenue or expenses, the above three formulas can lead to accurate decision, which must yield a positive answer to one of the following three questions: Has the throughput been increased? Have the operating expenses been reduced? Has the return on investment improved? When the above three questions have been answered, it is recommended to opt for decisions that lead to increased throughput. Decisions that result in reduced operating expenses, should be least considered since not only there is a limited amount of operating expense that can be reduced but also the reduction in operating expenses may lead to reduced production capacity of the entity, which eventually may produce less throughput. (AccountingTools.com) Current Setup at BITE ME Currently, direct material costs are roughly available hence there is a possibility that some costs are left unaccounted for or are over-stated resulting in over or under pricing of sandwiches. Furthermore, royalties are not accounted for. Although the impact of royalties is negligible when it comes to small orders, but over a period of say 3 years, which is the period of the contract with insurance company, this cost may have significant impact over the profit. The data relating to the ingredients is available, i.e. £100 worth of ingredients can produce 200 sandwiches while on the other hand, and the Management Accountant assistant states this figure to be £100 for 100 sandwiches. Such inconsistencies may adversely affect the pricing of the product and cast significant limitations with respect to data accuracy for decision making. As far as direct labour cost is concerned, although supervisor’s hours are included in the cost of the product but as the supervisor has nothing to forgo if he devotes his time to the sandwich orders, his cost should not be included while making calculations for pricing purposes, whereas the entity does include the same. Conclusion: Throughput Accounting’s appropriateness for implementation at BITE ME Throughput accounting basically is cash focused and does not allocate all costs such as fixed and variable overheads. In the case of BITE ME, there are significant uncertainties as to the accuracy of costs which should be included in the cost of sandwiches. Charges which are allocated to the cost of sandwich are neither reliably measurable nor consistent for standardization as different types of sandwiches are produced at the entity. Therefore, if throughput accounting is implemented, focus will be on actual costs that incur directly in relation to the number of units produced rather than approximate allocation of costs. This will better help in pricing of the product hence result in submitting extremely competitively bids to obtain contract from the insurance company. Question 3 Organizational Chart and its issues Currently, the organizational chart does not have any logical hierarchy and reporting lines are not clearly defined. Marketing/Admin manager and Production Supervisor are reporting to Management Accounting who is not expected to take decisions which are better than those reporting to him. In current scenario, restructuring is highly recommended so that people who are made responsible for tasks are both competent and knowledgeable in their respective fields. Suitable organizational chart should be such that the Marketing/Admin Manager, Production Supervisor ,Management Accountant and the Financial accountant report individually to the CEO and not anyone among themselves. Furthermore, it is recommended that job descriptions should be documented to clarify roles and responsibilities of each employee. The diagram below shall provide better understanding of the recommended organizational structure. Figure1 Performance Evaluation of divisions The divisional performance measures should be established after taking into consideration both the long term and short term objectives and analyzing the strategy to be followed to achieve those objectives. David should establish production department as an investment centre and marketing department as a profit centre and assign June Babangida (Financial Accountant) the task of evaluating divisional performance of marketing department by using the return on investment method and production departments’ performance on the basis of percentage of material wastage involved in the production of sandwiches. Simply evaluating divisional performance on the basis of net profit and residual income will not be fruit-full as relative figures with investment will help in making investment and divestment decisions and also assist in making comparisons with industry benchmarks. Furthermore, additional department-specific performance measures should also be introduced for e.g. Number of new customer orders obtained by the Marketing Department or for e.g. number of labour hours required by the Production Department. It is essential that when such goals are established, consent of the respective division is obtained so that they might not have the feeling that unrealistic targets were assigned to them. Thereafter, quarterly, bi-annual or annual evaluation should be undertaken where the targets are compared with the actual activity and on the basis of that, promotions and compensation packages should be amended. While setting the targets, it should be ensured that co-ordination between the divisions among themselves remains at its best and the targets should be such that no division tries to achieve its target at the cost of other division suffering (Rexford et al). References A constraint based framework for strategic cost management (Article) Samford University, School of Business, Birmingham, Alabama, USA Goldratt. Throughput Accounting. Available at: http://www.goldratt.co.uk/resources/throughput_accounting/index.html Accessed on April 3, 2010 Mahesh C. G and Lynn H. B. Theory of constraints: a theory for operations management. College of Business, University of Louisville, Louisville, Kentucky, USA. Management Accountant Blog. Throughput Accounting. Available at: http://www.managementaccountant.in/2006/12/throughput-accounting.html Accessed on April 3, 2010 Science of Business. Why is Throughput Accounting Effective? Available at: http://www.scienceofbusiness.com/consulting-services/throughput-accounting.aspx Accessed on April 3, 2010 Steven Bragg. Throughput Account. Available at: http://accountingtools.com/Pages_Books/Throughput_Accounting.html Accessed on April 3, 2010 Rexford, H. D., Archie, Locakmy, James, F.C. Constraint Based Accounting and its impact on organization’s performance: A simulation of four common business strategies. TOC-Lean Institute. What is Throughput Accounting – TOC Financial Measurement vs. Cost Accounting? Available at: http://www.toc-lean.com/PDF/What_Is_Throughput_Accounting.pdf Accessed on April 3, 2010 TPACC. Benefits of Throughput Accounting. Available at: http://www.tpacc.com/ Accessed on April 3, 2010 Read More