Strategic Management Accounting: Manac Plc - Case Study Example

Strategic Management Accounting: Manac Plc Introduction: Financial planning is an essential element of every business and it plays a role in the success of every business. Over the years there have been several different methodologies that have been developed to assist companies make appropriate decisions and also to help the companies develop their business. Any entity, to ensure its achievement of goals and objectives, has to be assessed and monitored effectively in financial terms. Also, financial statements provide summarized information about an organization’s transactions. (Arnold, 1985, p17) They play an important role in decision-making and ‘stewardship’ – Keeping track of what has been done with the financial resources (Britton, 1996, p3). Every company uses several different methods to keep track of their finances and the expenses of the company. The traditional method of doing it was using the Profit and Loss Account and the Balance Sheet. Ratios are calculated from these statements and these were used for the analysis of the organization’s performance and for predicting future success or failure. The traditional financial statement analysis makes use of the data from the Profit and Loss account and the Balance Sheet. The large number of financial statement items is broken down to relatively small number of key ratios. Though combinations of ratios have proved very effective in making predictions about companies, they have their limitations. “… the lack of any conceptual foundation surrounding ratio analysis and decision making. It has been assumed that ratios will be useful without ever establishing that usefulness.” (Pendlebury, 2004, p117). However it is essential to note that there are other methods and techniques that can be used within companies not only to keep track of the costs but also to use the financial resources in a more appropriate manner along with reducing the costs to the minimum levels. The following sections will detail the various techniques that can be used by the companies to assist the companies better their financial resource planning and also to develop a well structured company. Standard Costing: According to the CIMA, London standard cost has been defined as “a predetermined cost which is calculated from managements standards of efficient operations and the relevant necessary expenditure” (Globusz, 2009). Standard is the fixed amount that has been budgeted as the price of a product and a single unit of output. There are several different modes that can be considered for the term standard and it is essential to note that the term ‘standard’ can mean not only cost but also revenue, and both physical as well as non physical elements i that are involved in the process of a firm. A standard can be explained as a predicted value for a unit of output based on certain specified conditions (Britton and Watterston, 1996). There are several different sources of information from which the standard cost of the unit or output can be determined, and these include elements like, a) the price list of the company or the average price that is assumed in the sales budgets, these have a direct impact on the standard selling price of the company, b) The price of the raw materials and the current price of the material based on the market forecasts and the budgeted prices, c) The quantity of the materials used per unit and other resources like time taken for the production, and d) both the levels of labour as well as material costs also need to be taken into consideration for the processes (Pendlebury, M. and Groves, R., 2004). In short the process of standard costing is where the quantities of the inputs can be clearly obtained based on factors like the ideal performance, or also on the expected performance. These are mostly however based on the efficiency and attainability of the performances. The main reason for this is the fact that the various researches in the past have highlighted that people tend to work better when the goals are somewhat difficult to attain but are not extremely difficult. The managers and employees will tend not to work hard if the goals are simple and straight forward; hence there is a need for the goals to be difficult to bring out the hard work in the people and to ensure efficient and attainable performance as well (Gillespie, Lewis and Hamilton, 1997). It is essential to note that standards are a major part of standard costing and companies might use standards in the business without implementing standard costing systems.  In the case of Manac Plc., it can is better if the company does not adopt the standard costing method of accounting and uses the Variances analysis instead. This will allow the company to gain better results and will also allow the company to keep complete track of all the costs and the company will also be able to keep complete account of the variable costs that they incur. This will also allow the company to gain a complete grip over the finances of the company.   Variance Analysis: Variance analysis is normally used to explain the difference between the standard costs allowed for a good output and the actual costs. An excellent example of this is the difference between the actual labor and the standard direct labor costs that have been set aside (Gillespie, Lewis and Hamilton, 1997). Differences like these allow the management to understand the costs that the company is facing currently and also assists the companies to control the future costs to a great extent. It is also essential to understand that the variance analysis can be used to explain the difference between the actual sales and the budgeted sales as well. The various examples also include the sales price variance, sales volume variance, overhead variances, variable overhead variances, and the sales mix variances. The differences in these rates have a direct impact on the company’s profits and hence need to be recognized at the earliest stages. Profits are a vital element of entity survival, but it is also necessary that there is a related cash inflow from operations to cover the capital expenses, taxation and dividends. Profitability ratios indicate the ability of the company to generate profits from the capital employed. But too little cash flow from operations and too much from additional borrowing are indicators of potential liquidity problems. It reveals a possible lack of operational viability and the firm’s inability to meet its expenditure requirements. Though a company is profitable, if there is continuous lack of cash inflows from operations, then it will ultimately lead to the demise of the entity. (Lee, 1984, p94) Hence performance cannot be assessed solely in terms of profit. In assessing the performance, specific attention has to be given to the liquidity position of the reporting entity. To ensure the future success of a company, it is essential that it makes sufficient investments that will lead to future profitability. In the traditional method, the ratio of capital expenditure to depreciation does give an indication of the replacement rate of new for old assets. But investment decisions do need to consider the cash flowing in and the trends of cash flow as important factors (Gillespie, 1997, p363). These forecasts have to be given great importance in investment decisions. Also, the Capital Acquisitions ratio (the ratio of net cash received from operations after payment of interest, tax and dividends to the amount invested in capital assets) derived from the cash flow statements depicts the company’s ability to purchase capital assets and hence obtain or maintain competitive advantage (Pendlebury, 2004, p184). Benefits and Drawbacks of Variance Analysis: One of the biggest advantages of the variance analysis is that the companies can identify and also clearly differentiate between the planned and the actual results based on two main dimensions, i.e differences caused by money values and that have diverged from expectations and the differences caused by the levels of activities or physical quantities that are also different from the expectations. The ability to differentiate and to track these differences, allows the company to gain complete and full explanations from the managers of the individual areas of responsibilities and who will be able to provide the best solutions to any discrepancies (Gillespie, Lewis and Hamilton, 1997). The ability to track these differences will allow the company to gain a better view at where the expenses of the company are focused and will also allow the company to redirect or correct the issues that are being faced within the company (Lee, T.A., 1984). An example of this is when the profits of a company are different from that those have been budgeted, then there are clearly only two possible reasons for these, a) the costs are different compared to those budgeted, b) the sales are different from those that have been budgeted. This is simple and clear as the difference between the income and costs is basically the profits of the company. Another major advantage of this form of accounting is that the isolation of the differences can indicate the main issues and the management can then focus on the resolution for the issues one at a time. The variance analysis also allows the corrections to be made in terms of the standards and this will allow the discrepancies to be reduced and to be corrected at the early stages rather than waiting until the situations become worse and the company moves into high levels of losses or issues. Another major advantage of this form of accounting is that a comparison of standardized quantities and values with current achievement levels may provide a better guide to trends in the future, it may be possible to extrapolate from current costs and performance levels to forecast future costs and efficient levels more accurately (Britton and Watterston, 1996). Activity Based Costing: The accountants view about the company’s costing is right and the company requires changing the costing system. For the benefit of the owner of the business it is essential to understand the various costs that are incurred within the organisation. It is important to understand that the traditional costing systems when introduced were good enough then however there have been a number of changes and the costing systems that are needed now are different since the company operates in a capital intensive market. As already advised by the accountant, Activity Based Costing (ABC) is the best as unlike the traditional method of coating ABC separates the overheads into portions and allocated the over heads to the products, whereas the traditional method of costing considers all the overheads and spreads them across all the products (Kaplan & Cooper, 2008). It is essential that the concept of ABC analysis is understood better as it will help the owner make the change easily and understand where the monies are being spent. ABC analysis is a costing model which assigns costs to every activity in accordance with the actual usage. This is done in order to generate the actual cost of the products / services to ensure that no product is overpriced or underpriced. As mentioned earlier, in traditional costing the cost of production of all the products within a firm and spreads it across evenly for all the products (O’Guin, 1991). This can result in a product / service being over priced or underpriced as the actual expenditure for every product within the organisation is different and it is possible that the production of a particular product costs much more than the production of another product. Hence by the traditional method every product would require to bear the costs equally, unlike in the ABC costing where the products bear only the costs that have actually been incurred in the production and hence are priced accordingly (12 Manage, 2008). Advantages and Disadvantages of Activity Based Costing: ABC does have a few limitations: a) The process of collecting the data is very time consuming b) Buying, implementing and maintaining of the systems does cost the company c) It highlights the wastes which most of the managers would prefer the bosses are not aware off Even though the limitations, ABC has a number of advantages which makes it more desirable. Firstly the costing of the products /services is very accurate which helps the business correctly allocate the overheads. Also it provides a better and clearer understanding of the overheads. The system being so simple and straight forward makes it easier for everyone to understand the system better. It utilises unit cost rather than the total cost which makes the calculations more accurate, and along with the integration Six sigma, it ensures there is continuous improvements. Also as already mentioned it highlights the wastes and the non – value added which enables the owner rethink the expenses and if unnecessary they can be stopped. ABC analysis also supports the performance management and scorecards which allows a better view of the company’s performance and it mirrors the way the work is done. It also enables the costing of processes, supply chains and value streams which allows a clearer picture of the costing for the entire organisation. Lastly it facilitates benchmarking which allows companies to ensure good quality of goods and services (Value Creation Group, 2008). Thus it is quite evident that ABC method has a number of benefits which help improve the costing method within the organisation and provide a clear view to the owners of the business which allows them to make appropriate decisions regarding the products and services, to ensure profits (Cokins, 2001). Having understood the concept of ABC and understanding the advantages of the concept it is always advisable to follow this method in every company whether big, medium or small. ABC is not a gimmick and is very beneficial to the owners of the company as it provides a crystal clear image of the various costs. It provides the management with an increased insight into why costs occur which allows the managers to associate even the indirect costs and correctly price the products to ensure the company makes profits. This will allow the owner to understand not only the cost causation but also the levels of costs that can be reduced and will also suggest in long term how low costs can be designed into the business process. Absorption Costing System: Absorption costing systems is another costing techniques that is used irrespective of whether it is variable or fixed costs and the costs that are charges based on the cost units produced. This method is very useful as it unlike the marginal costing. In marginal costing the fixed costs are taken as the period costs. The basic thought process behind the investment decisions revolves around the profit gained by owning a large or small share of a corporation or other businesses. The investment decision is really a two-pronged question: ‘What is the Potential Income?’ and ‘How risky is the venture?’ (Silbiger, 1999) High returns is not the only deciding factor for investments. It depends on the risk involved in that investment. Hence the investment decision is dependent on the returns, the risk involved (amount of uncertainty in generating the expected returns) and also the investor’s utility indifference (attitude towards risk and expected returns). There are several advantages and disadvantages of the absorption costing. However before moving into the various advantages and disadvantages it is essential to get the definition of absorption costing. Absorption costing has been defined as, “The cost accounting system in which the overheads of an organization are charged to the production by means of the process of absorption. Costs are first apportioned to cost centres, where they are absorbed using absorption rates. Although this method has the advantage of simplicity, it involves an essentially arbitrary allocation of costs; for this reason the system of activity-based costing is now widely preferred” (Encyclopaedia, 2006). The main advantages of absorption costing is that it allows the company to recognise the importance of fixed costs in the production line and allows the company to analyse the fixed costs to a greater extent. Also this method is beneficial as it is allowed and accepted by the Inland Revenue because the stock is not undervalued in this method and all the costs are based on the real values. The financial statements are prepared based on this method, and the method ensures that all costs are marked at the right prices rather than any undervaluing or over valuing of the costs. This method also ensures that all the fluctuations that are seen in the sales are not shown in the profits very prominently. The method also ensures that the stock valuation is appropriate and no extra or reduced charges are seen on the stock values. The disadvantages of this method however are very few. The method concentrates on both the fixed as well as the variable costs ad this method is hence not very beneficial in the decision making process and the planning and control processes. The process emphases on the total costs and the cost volume profits of the relationship are not considered here. Hence in terms of the decision making process the managers are required to take their intuitive decisions and there is no strong backing for the decision making processes. Recommendations for Manac Plc: Manac Plc can use the process of absorption costing system for the company. This will help the company keep track of all the costs and have a clear idea of the expensive of the company. The company can also use the combination of variance analysis along with the absorption costing systems to help the managers provide more focused and informed management decisions. The combination of the two methods will allow the company to make very informed decisions as well as have a strong basis for the financial statements as well (Arnold, J., Hope, T. and Southworth, A., 1985). Hence in recommendation it is suggested that the company uses both the methods to make well informed decisions along with gaining a good grip of all the expenses that are incurred within the firm. References 12 Manage, 2008, ‘Activity Based Costing (ABC)’, 2008, Accessed on 28 November 2009, Retrieved from http://www.12manage.com/methods_abc.html Arnold, J., Hope, T. and Southworth, A., 1985, Financial Accounting, 1st edn, Prentice Hall, Exeter Berry, A. and Jarvis, R., 1996, Accounting in a Business Context, 2nd edn, Chapman and Hall, London Britton, A. and Watterston, C., 1996, Financial Accounting, 1st edn, Addison Wesley Longman, New York Cokins, G., 2001, ‘Activity Based Costing: An executives guide’, 7 September 2001, 1st edition, Wiley Publishers Gillespie, I., Lewis, R. and Hamilton, K., 1997, Principles of Financial Accounting, 1st edn, Prentice Hall, Europe http://www.valuecreationgroup.com/activity_based_costing_advantage_disadvantage.htm Kaplan, R.S., and Cooper, R., 2008, ‘Activity Based Costing: Introduction’, 25 October 2008, Harvard Business School Press Kasikorn Bank, Cash Flow Analysis / Investment Decision, http://www.kasikornbank.com/Calculator/Cashflow1/0,1064,EN,00.html Lee, T.A., 1984, Cash Flow Accounting, Von Nostrand Reinhold, Wokingham NetTom, Transport Financial Analysis, http://cbdd.wsu.edu/kewlcontent/cdoutput/TOM505/page26.htm O’Guin, M.C., 1991, ‘The complete guide to Activity Based Costing’, 1991, Prentice – hall, United States of America Pendlebury, M. and Groves, R., 2004, Company Accounts – Analysis, Interpretation and Understanding, 6th edn, Thomson Learning, London Value Creation Group, 2006, ‘Activity Based costing: Advantage and Disadvantages’, 2006, Accessed on 29 November 2009, Retrieved from Silbiger, S., 1999, The 10-Day MBA, Magna Publishers, Mumbai Read More