Managerial Accounting: Value Chain Analysis - Dissertation Example

Managerial Accounting: Value Chain Analysis Introduction Traditional managerial accounting system was mainly developed to represent the efficiency of the internal processes. Back in 1980’s, the traditional accounting systems practitioners have been criticised on the ground that despite of noticeable changes in the business environment, the traditional practices have experienced a little or almost no change in its framework (Geense, n.d.). Traditionally the foremost performance report used to be the variance analysis. However, now a days companies use a number of systematic approaches to generate performance reports (Geense, n.d.). This report aims to provide an insight into the managerial accounting system. Techniques like Activity Based Costing (ABC), Balanced Score Card, Value chain and Profitability measurements have been discussed to look into the every aspect, which supports the decision made by the mangers, inside the organisation. 1. Managerial Accounting The operational control and authority of an organisation lies in the hands of the managers within the organisation. So it is of much significance that the managers must be conversant with the accounting information of the organisation. “Managerial accounting is concerned with providing information to managers- that is, to those who are inside an organisation and who direct and control its operations” (Geense, n.d.). Managerial accounting is different from the financial accounting as financial accounting is concerned with presenting information to the shareholders, suppliers, creditors and others, presiding outside the organisation (Geense, n.d.). The necessary information would include the information about the cost of the organisations’ products and services. For an instance managers use the products’ cost to derive the pricing of those products. In turn this helps to calculate the inventory value and profitability of the organisation. Managerial accounting information also enables the mangers to plan the budget and produce performance reports. These reports highlight the deviation of the actual results from the estimated budget amount. From this managerial accounting information, mangers can fetch the information on the revenue generation from the products and services, supply and demand quantities. Activity Based Costing Activity Based Costing identifies the cost pools or the activity centres within the organisation and allocates cost to the activities using the multiple cost drivers (Akyol, Tuncel & Bayhan, 2005). The cost is assigned to the products based on the product’s usage of the various activities. As ABC system uses multiple cost drivers assigned to various activities, the distortion risk is reduced in a much greater extent, providing appropriate cost information (Popesko, 2010). ABC enhances the traditional costing system through carrying out the calculation of each of the activities. It is a set of activities relating overhead costs to the products and services, produced and delivered to its customers. The steps in the ABC system include identifying the company’s significant activities, identifying the cost for each of them, establishing a cost pool for each of the major activities and allocating the activity costs to the products as per the contribution of those activities to the product division. So ABC has certain benefits of better profitability measures, detailed realisation of the overheads and proper decision and enhanced control. Balanced Score Card A number of companies are using balanced score card to track organisational performance. Before moving more into this topic, it would be better to discuss about the factors those have given rise to this balanced score card system. Corporate accounting scandals reveal that managers are taking some unethical means, in non accordance with the long term interests of the company, to reach to enhance levels. As a consequence the organisation has to suffer in the long run. The companies are unable to give a shape to their strategies as managers are looking at their short term achievements. Traditionally corporate used to believe that financial profitability is the only measurement to evaluate the managers and their divisions. However, now more and more organisations are conversant with the fact that the organisations and their managers’ success depends upon a number of factors; financial is only one significant part of it. A balance score card can be defined as the set of vigilantly selected quantifiable measures drawn from the organisation strategy (Wiley, n.d.). The attributes chosen for the score card is a too for the leader to convey its missions and strategic objectives to the internal and external stakeholders including the managers working inside. Almost every organisation has beautifully crafted visions on their websites. However unfortunately, the companies fail to align their strategies and performance in compliance with their vision statements (Wiley, 2010). The balanced score card allows the organisation to realise their visions and strategies through the formation of a new framework. It reveals certain other key elements, apart from the financial one, in the attainment of the strategy. The score card balances the financial measurements with operational measurements towards customer satisfaction, organisation’s innovative and enhancement activities. It comprises of four perspectives as Financial perspective, Internal Process, Customer Perspective and Innovation and Learning and aligns each of them with the vision strategy. The ultimate financial goal of any organisation is to make profit. Financial perspective would dig deep into the fact if the company’s strategy and implementation of the same are contributing to enhance the profitability of the organisation. This also reminds the managers that some time all the improvements and enhancements need to be put into quantifiable financials, if not now. Some of the measures which can be included in the financial perspective are Gross Margin, Return on Investment, Earning per Share, Return on Equity and so on. In the Customer perspective, managers identify the target customer segments in which the business units compete and measure the performance. The factors those are of significance for the customers include quality, performance, time and proper service. This part of the score card typically consists of measures like customer satisfaction, customer retention, customer acquisition, customer profitability and the market share. As the company is now more conversant with the financial and customer objectives, they must look for the means which would help the company to attain its tactical goals. Value Chain Analysis Interconnected relationships between the organisational activities have thrown new challenges for the organisations. It has been quite important but tricky to coordinate the activities of the firm in a value chain and optimize the same. The value chain analysis has been introduced to solve this problem. A value chain can be defined as “the linked set of value-creating activities al1 the way from basic raw material sources for component suppliers through the ultimate end-use product delivered into the final customers’ hands” (Dekker, n.d.). To understand the behaviour of the costs and the sources of product differentiation through disaggregation of the firm’s tactically relevant activities is the way to derive the value chain. The value chain helps the organisation to understand the entire systems, offering values to its stakeholders. By performing those activities which add more value to the organisations in an enhanced but cost effective way is in the epicentre of the organisation’s competitive advantage. 2. Performance Measurement System Organisations use a number of performance measurement system to measure the performance of the major operating divisions and their respective managers. As of now the organisation is using profit margin to assess the performance of the managers. However there are certain loopholes to evaluate the managerial capabilities based only on the profitability margin. Apple Plc has divided three divisions, each taking care of the each product. Profit margin is the profit amount against the sales of the respective products. The profit amount has been reached by deduction of cost of sales and other expenses from the sales amount. However it is quite unreasonable to generalise the divisions on the same scale of minimum profit margin. Different products can have different amount of cost incurred to the each of them. For an instance, the raw material requirement for candy bar and other sweets can be different; so as the relative cost. For the same amount of sales, the profit margin for the different projects can be different for each of the products. So the benchmark profit margin needs to be different for several distinct products. Apart from this, the accounting income is that the calculation of economic profit is dependent on the measurement method. The profit amount ignores the intangible gains. The investments, which are supposed to raise future gains, are ignored in the calculation of the profitability margin. If the managers are evaluated based on the profit margin, they will try to enhance the profit margin by any means which may not be in best interest of the company. Any company, which is using profitability margin as its performance measurement method, should consider the pros and cons of this performance system. There can be certain measurements, through which an organisation can measure their strategic competitiveness of the divisions. The organisation can take market share growth into account. There can be changes in the profitability due to the changes in the market share. An increase or decrease in either the value of the total unit value sold or the total percentage of market serve by the company can change its profitability. Price Premium can be another competitive effectiveness measurement of the divisional managers as price premium would reveal the efficiency of the managers to pull out ore value through product differentiation. Residua Income can be used by deducting the capital change amount form the profit amount. Residual Income = Profit Amount – Capital Charge, Where capital charge = Investment Base * Cost of Capital. This actually makes the performance targets uniform as the organisations now will invest only in those projects, carrying higher internal rate of return than the cost of capital. This is quite advantageous for the company from the fact that it would remove some of the biases presiding in the profitability margin or other economic profitability measurement like return on investments. The measurement will help in maintaining the projects’ higher NPV and will not encourage managers to take considerable debt on its balance sheet instead of the equity amount. Another enhanced profitability measurement, which also considers the intangible investments like investments in the research and development, training of the employees etc, is Economic Value Added (EVA). The calculation of EVA is as follows. EVA = (modified after tax operating profits – (weighted average cost of capital * investment base)). The investment base in the calculation takes both tangible and intangible assets into account. In all, performance measurement of the divisions and the respective managers is a significant task, which every organisation should do to attain their goals. However, before zeroing down on one performance measurement, Apple Plc must carry on an in depth analysis of their divisions, including their products, the cost incurred, investment etc. So that, it will b easy to zero down one comparative index which can encourage healthy competition among the managers to achieve the company goals. The performance measurement should encourage the managers to take on such means, which are in alignment with the overall organisational goals, to reach at their personal goals. Apple Plc can use Economic Value Added as their performance measurement system. At the same time they can take balanced score card approach to remove some of the discrepancies, inherent to the economic profit amount. 3. Cost Accounting ” The absorption costing method could distort product costs because it allocates overhead costs proportionally to the portion of direct costs” (Popesko, 2010). Apple Pc is till now using the Traditional absorption costing system which has certain limitations on its own. These limitations include. Some organisation use the labour cost for the assignment of the manufacturing costs. This is quite irrelevant as the cost is much lower than the overhead and even many overheads do not have any relationship the labour cost or the labour hours. The technological cost is not assigned to the products, depending upon the usage. In the recent times, service related costs have shown a faster pace. Some years back the cost related to the service was non existent. Customer related costs like discounts, distribution, sales, financial and after sale service are not related to the object of the products’ costs. Organisations must remember that customer profitability has become much more crucial, as crucial as that of product profitability (Popesko, 2010). In some cases where there are very few departments, homogenous output and even similar types of customers, the traditional absorption costing method can provide better outputs. However, as Apple Plc has several divisions and each of them have certain processes, it would be better to use the activity based costing system, where the cost is allocated to several divisions as per as the multiple cost drivers they have. Activity Based Costing can bring about noticeable improvements in the overhead cost allocation process. In such a case usage of traditional costing system can result in cost distortion, hindering the profitability analysis. In Activity Based Costing, Apple Plc needs to identify all the activities including mixing, cooking and packaging. The organisation must calculate the activity costs for each of the activities. In this case determining the cost drivers is also very significant. In this case the cost drivers would be machine hours, set up numbers etc. After doing all these, the activity data is collected. It has been mentioned in the case that some processes are common to the products, which means there are certain processes which are not universal for all of the products. The product cost would be determined allocating the appropriate activity costs to each of the three products including candy bars, chews and other sweets. In such a way the organisation would be able to find out its most and least profitable products. Apple Plc would be able to identify the contribution margin for each of the products. The product cost would be measures more appropriately as the activity costs would be allocated as their contribution to the distinct products. Through activity based costing the company would be able to properly identify the root factors which have been contributed mostly to the product costs. Minimising those costs would lead Apple to achieve a competitive position in the respective market against its competitors. Using this costing approach, the managers would be more equipped to achieve sustainable profit margins. Conclusion As the business arena is getting more competitive, the organisations are looking for betterment in each and every area of its activities. However, post Enron the organisations have realised relying on the financial measures only can be devastating for the company in long run. In alignment with these thoughts there have been significant changes in the company activities. The managers of Apple Plc must understand the fact that profitability may be the ultimate financial goal of the company, but there are certain supporting factors which will assess their managerial capability. Their ability to align the activities in compliance with the organisation goals and at the same time adding value to its value chain will be the deciding factor for their future growth in their company. In such a way the company can motivate its managers to perform the proper accounting system for their product division, develop a proper balanced score card and create and add valuable measures to its value chain. Hopefully, this will enhance Apple’s performance in the coming years. Reference Akoyl, D., Tuncel, G. & Bayham, M., G. 2005. A comparative analysis of activity-based costing and traditional costing. Available at: http://www.waset.org/journals/waset/v3/v3-11.pdf [Accessed on April 01, 2010]. Dekker, C., H. No Date. Accounting Information and Value Chain Analysis. [Pdf]. Available at: ftp://zappa.ubvu.vu.nl/2001011a.pdf [Accessed on April 01, 2010]. Geense, M., I. No Date. Managerial Accounting. [Online]. Available at: http://74.125.153.132/search?q=cache:tWuo8bOva7kJ:www.managerialaccounting.org/index.html+managerial+accounting&cd=8&hl=en&ct=clnk&gl=in [Accessed on April 01, 2010]. Popesko, B. February, 2010. Utilization of Activity-Based Costing System in Manufacturing Industries – Methodology, Benefits and Limitations. [Pdf]. Available at: http://www.bizresearchpapers.com/1.%20Boris.pdf [Accessed on April 01, 2010]. Wiley. No Date. Introduction to the Balanced Scorecard. [Pdf]. Available at: http://media.wiley.com/product_data/excerpt/89/04714232/0471423289.pdf [Accessed on April 01, 2010]. Bibliography Horngren, T., C., Foster, G. & Datar, M., S. Cost accounting: a managerial emphasis. Hong Kong: Pearson Education, 2001. Maher, M., Stickney, C. & Weil, R. Managerial Accounting: An Introduction to Concepts, Methods and Uses. USA: Thomson Higher Education, 2008. Needles, B., Powers, M. & Crosson, S. Financial and Managerial Accounting. USA: South West Cenage Learning, 2008. 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