Management Accounting Techniques - Essay Example

Use of management accounting techniques for agricultural enterprises This case study with its solutions will be very beneficial to agricultural enterprises. This is because the solution considers the number of owners involved and the accounting can be done to ensure fair returns to all. These owners share common machinery. As the investment in machinery is in proportion to the area of land owned the costs can be conveniently allocated. A software is being used so that there is much more information and support for decisions. It will determine which crop is more profitable although the crop will be rotated in the normal manner. Management accounting is as important as production in the modern agricultural environment. The solution offered here is a responsibility center approach that sets up cost and profit centers. The system enables comparisons based on crops and land. It also lets the farm track performance on a year to year basis. The solution is long term and will ensure that the farm will run well even after the management is taken over by the next generation. The cost centers are for support, and stages of production. We have production cost centers for land owners. One cost center is for management. The cost centers are grouped under the profit centers associated with each commodity. The accounting techniques presented here will be applicable to any farm. The farms can have any combination of land ownership, equipment and crop. The responsibility for accounting is with the top management. The automated system lets the owner perform detailed analysis that would not be possible without a software solution. Benefits of the solution The solution uses responsibility accounting. This approach is aligned with the organizational structure. It also lets us control finances better. There is an individual cost center for each activity. Costs can be allocated according to the land ownership. We also have cost centers based on crop. Each crop has its own marketing cost center. All the cost centers are grouped by crop and function as profit centers. This solution is beneficial because management control can be exercised from the farm field to the profits. Costs are allocated fairly amongst the crops so that we know accurately how much money has been spent to produce a particular crop. The allocation base is selected based on the right measure of the costs. The costs can be subdivided between the cost centers according to the allocation base. The individual costs associated with the use of equipment are considered. The software used generates the financial statements required. These include cost allocations, crop cost analysis and, production and processing expenses on a quantity basis. The software generates an income statement. We also have the required inventory management features. The most important benefit is that the accounting is automated. The system has a high level of attention to details. Responsibility centers are a management control system that delivers excellent results. The system will function even if more crops are added to the farm in the future. The solution ensures managerial accounting and the numbers involved are used to make management decisions. As the owner is due to retire soon the system in place is evaluated to work in the long term. Possible drawbacks of the solution The solution is very complex and there are a large number of parameters to track. The solution requires a summary. While all the numbers are tracked, the relation of the numbers to the profits of the farm is not established. It is important to realize the physical and financial significance of the number for management. We also have to know the actions that need to be taken to ensure better performance. The system should clearly specify the numbers that are out of range and need to be focused on. A few key result areas should be identified to enable management control. The case specifies management discretion as a cost allocation method. This is not a valid approach because the allocation base used needs to bear a direct relation with costs and needs to be specified in terms of units. Use of activity based costing In activity based costing, activities are considered to be the fundamental cost objects. Costs of these activities are then allocated to the product that is the other cost object. The cost object in this farm is the crop output. We then identify the direct and the indirect costs. The direct costs can be easily traced to the cost objects. The costs that cannot be traced easily are the indirect costs. For each indirect cost there is a cost allocation base. This assigns each indirect cost pool to the cost object. The rate per unit of the cost allocation base is used to allocate the indirect costs to the cost object. The activity based costing approach has a cost pool for each activity. The cost allocation base is often a variable like time or number of units produced rather than a financial figure. Cost drivers are factors that affect cost. Many cost allocation bases in activity based costing are also cost drivers. The farm uses activity based costing for the support costs. These include production, harvesting, general farm, processing, storage, sales and marketing, general and administration, and financing. These are then distributed to the two cost objects that are corn and soybean. Activity based costing is increasingly replacing other costing methods because of its accuracy and simplicity. Dysfunctional decisions with traditional cost allocation In traditional cost allocation there are a few indirect cost pools for the entire operation. All the indirect costs get grouped and hence the cost allocation base does not relate to the indirect costs perfectly. Many times the cost allocation base used is not a real cost driver. Cost drivers are factors that affect the cost. Traditional allocation uses financial variables for measurement as opposed to the variables that are proportional to costs. As the pools are few, an average cost gets used instead of the accurate cost. This leads to errors in pricing. The method does not measure the way resources are used in the production of different crops. This problem is more severe when different quantities of products are produced along with different use of resources. Traditional cost allocation is being increasingly replaced by activity based costing. The initial solution is preferred to the alternative solution The alternative solution presented in the case is comparable to the suggested solution. The primary reason is its simplicity. As fewer numbers are used it becomes easier to analyze the accounts and profits. The support infrastructure is allocated to the production activities. General, sales and administration expenses, and financing expenses are allocated to the profit centers. However we see that the crops are not considered individually and that is a disadvantage of this model. The reason for this is that the crops have to be priced separately. This alternative solution does not give us the individual accounts for soybean and corn. Rather it works on the overall annual picture and compares the years 2001 and 2002. The key to the success of this model is the use of the right cost allocation base. Another important factor is the use of the right accounting software. The software for this alternative solution will need to be created. The initial solution considers corn and soybean separately. Each crop is considered a cost center individually. This will lead to the right pricing. This is the main reason why the initial solution is preferable to the alternative solution. Another reason is that the initial solution has many indirect cost pools. This leads to more accurate allocations of costs. The inventory management features of the initial solution are also important. The initial solution includes the distribution of numbers according to the landowner as well. For these reasons we can say that the initial solution is better than the alternative solution in the case. References Horngren, C, Foster. G, & Datar, S. (1996), Cost Accounting, 8th edn, Prentice Hall, Inc., U.S.A. Horngren, C., Sundem, G. & Elliott, J. (2006), Introduction to Financial Accounting, 8th edn, Pearson Education, Inc., UK. Read More