Enzymes Limited Needs Revaluation - Essay Example

Enzymes Limited Table of Contents Enzymes Limited Needs Revaluation 3 Are Traditional Costing Methods Still Effective for the Company? 3 Can Alternative Costing Methods Do Better Than Traditional Costing? 5 Helping the Company with Life Cycle Costing in its Boom 6 Should the Target Costing Method be considered? 7 How to Redesign the Cost Structure in Order to Reduce Cost 9 References 11 Bibliography 13 Enzymes Limited Needs Revaluation Enzyme Limited has enjoyed a growing demand and increasing market share in the last decade with their activities in the sphere of manufacturing and distributing unit of medical equipments. Although it is very important to maintain a continuous watch on the market scenario and update the marketing and pricing strategy in order to control the growth and strengthen the maturity period. Therefore, the present market scenario and the pricing strategies should be analysed and restructured in order to provide the company a sharper competency. Are Traditional Costing Methods Still Effective for the Company? Traditional costing assumes any one variable to participate in the fluctuations of manufacturing costs. As such, the company was also using the same method to calculate the cost incurred thereof. But, conceptually thinking of traditional costing methods brings about many errors in the modern era and therefore raises many doubts regarding its effectiveness in this changing module. There are numerous variables that add upon the cost structure of a manufacturing company rather than only labour or machine cost e.g. advertisement, customer, raw materials, and few others. Moreover, the traditional costing method applies a volume based allocation which often proves to be inappropriate in the modern market assuming something which is not adhered to the actual causes of costing (Averkamp, n.d.). But to take any kind of management decision regarding costs, the information about accurate product costs, resource allocations and many other variables is very significant part. Here the traditional method fails to work with accuracy and therefore has a very minimum contribution in managerial decision making. In this context the growing applicability of Activity-based method is non-negligible, as it emphasises on almost every aspects that traditional methods do not. Activity-based Costing Method assumes that cost variables causes demand for activities, which in turn causes expenditure, unlike the traditional method that assumes only variable cost as reasons of expenditure. Moreover it proves to be more accurate than traditional method in calculating the overhead costs of a product (Minbiole, 1998). Numerically, according to the traditional method, if the total overhead cost is $ 1, 00,000 and the total direct labour dollars comes to a figure of $ 1, 20, 000, the overhead cost per direct labour comes to be $ 0.83, (i.e. $ 1, 00, 000/$ 1, 20, 000). Again assuming the per unit labour cost to be $ 0.387, the overhead cost will stand at the figure of $ 0.32. In the case of Activity-based calculation, assuming the figure of overhead costs assigned for manufacturing 1, 20, 000 pieces if surgical scissors are considered as $ 80, 000. Therefore, the overhead per unit costs comes to be ($ 80, 000/1, 20, 000) which is equal to $ 0.66. Hence there is a vast difference between the two figures, and in return implies differently. Because of all these disadvantages of Traditional Costing method and accuracy of Activity-based method, the later is gaining importance in the field of management accountancy and this call for a re-evaluation and re-thinking of the costing method used by the company. Can Alternative Costing Methods Do Better Than Traditional Costing? Considering the drawbacks of Traditional Costing Methods and the fact to re-structure the costing method, some alternatives can be appropriate for the company. The ABC or Activity-based Costing method also comprises of some drawbacks. Such as, the data collection procedure may run too long and technically it is a bit complex, and can generate error in the part of data collection and calculation. Apart from ABC there are many other modern techniques used for costing and financial decision making. The Process and Job-Order costing are two of them. In the Process costing method calculates the cost incurred during the manufacturing process considering all aspects of step by step manufacturing variables. And the other process emphasizes on the individual or per unit product basis. In the management of cost accounting all these methods also have their limitations. Therefore, a combination of two or more methods can represent a more dependable and accurate answer to the management decision making (Kucera, n.d.). On this context, even the Just-in-time costing method can also be useful. This method is a volume based costing system that focuses on the products, and is a time oriented and process oriented method of costing. Notably, the JIT costing method considers the time taken to complete the entire process of manufacturing from the purchase of raw materials to the final products. As such it can be quite significant in identifying the production cost and therefore can conclude on the matter of cost reduction by restructuring the entire process in a cost-effective manner (Emblemsvåg, 2003). Helping the Company with Life Cycle Costing in its Boom Life cycle costing entirely depends upon the life cycle of the product and suggests the appropriate budgetary plan for the business. Generally, life cycle implies the five stages of a product life in market, i.e. development, introduction, growth, maturity, and decline. But when speaking about manufacturing or production prospect, the phases shall be referred to the purchase, operating, support, maintenance, and disposal. As the life cycle theory considers all the phases of product life cycle it defines its ability to presume the future contradictions and thus helps the management to come up with a beneficial planning. As the product of Enzymes Limited is at its boom and is going to reach the phase of maturity and then decline gradually with the course of time according to the Product Life Cycle model, it can be stated that a very urgent and efficient restructuring should be planned in order to increase the time period of maturity (Dhillon, 1989). A few of the major benefits that this costing tool provides are, generating an improved and accurate awareness regarding the total cost in the near future. It also provides a forecast about the budgetary planning that the organisation should consider, and also an insight about the Trade-off costs. Conceptually, there are different methodologies used for LCC model such as, cost breakdown structure, cost estimating, discounting, and inflation. All these methods have their individual priority in the calculation. The technique of cost break down structure aims at defining different cost elements. In the case of Enzymes Limited, the procedure must consider all the cost elements irrespective of the category in a well defined manner, and it should be related to the costing method adapted by the company with the intention that it can provide a better insight about the future prospects. As such it might be a bit complex but of course accurate if two costing methods, i.e. the ABC and Process and Job-Order Costing method are co-related with the LCC theory it shall prove to be beneficial (OGC, n.d.). Next is the cost estimation. In this process, the cost of each element or category, say the labour cost, or cost of raw materials are separately calculated. This helps in understanding and estimating the cost of each category. If, the costs of all categories are predetermined and planned it shall broadly reduce the cost of manufacturing and provide a cost efficient structure to the organisation. In this phase the part of Discounting and inflation should also be considered in order to achieve the prime objective of an accurate and reliable picture of the financial structure of the company (OGC, n.d.). Should the Target Costing Method be considered? To an answer to this question, Target Costing method can be very beneficial to the company at its current stage because of the fact that Target Cost is referred to the cost expected to be realised at the maturity level of the product, certainly the upcoming phase of the surgical products manufactured in the company. Notably, it is not the initial or actual product cost but an estimation of the desired cost. Target costing has been from ages used as a systematic tool to reduce costs and create an interface between accounting and marketing through identifying customer needs and calculating the achievable target price for sales. As such it works under some principles. Such as, the process starts with targeting a selling price of the product and then after determining the profit to be gained, the two variables are subtracted in order to calculate the targeted manufacturing cost, i.e. Target Cost=Target Price-Target Profit. Additionally, as it is entirely based on customer satisfaction, efficient product design, market and accounting teams, involvement of the value chain model and most significantly the consideration of life cycle costing process altogether makes the Target Costing process an important approach for taking management decisions related to manufacturing (Monden & Et. Al., 2007). Figure 1 - Three Main Elements of the Target Costing Process (Oulu University Library, 2000) Therefore, by considering both the LCC and Target Costing approach the cost incurred by the company can be reduced in a productive way, without disturbing the interest of profit margin. Contextually, products of Enzyme Limited have witnessed an increase in its price with each change of its life cycle phases and are gradually tending to fall as it enters the end of maturity period. Therefore, with the implementation of both ABC and Target Costing the manufacturing costs can be forecasted and planned to control its price increase and maintain a volume of profit even in the declining phase with productive reduction in cost structure. How to Redesign the Cost Structure in Order to Reduce Cost As the company is enjoying a growth in demand and hence is forced to increase its production quantity to meet the customers demand. To achieve this goal the company may follow some common strategies that many other manufacturing and marketing companies do follow. A few of them are, Improving the factory utilisation and efficient mistake proof manufacturing process shall eliminate the wastage of raw materials and energy and thus number of products can be produced with a reduction in cost. For example, If the profit per unit is $10 and the selling price per unit is $80, then the cost of manufacturing will be ($80-$20) =$60. But, if the cost of wasted materials and energy is reduced by $10, then the figure comes to be $50 and the selling price comes to be $30 with a given profit margin. Reduce unproductive manpower can also be useful in the process of cost reduction. Any manufacturing unit is not without this problem. Therefore, reducing inefficient manpower can in return reduce the amount of wages and other indirect cost related to manpower, resulting as a cost reduction. As a marketing strategy, partnership with suppliers can also be beneficial in the process of cost reduction by affecting the cost of raw materials and inward carriage. Introducing new working capital in the company may also be beneficial to reduce the cost structure of the company. This shall directly create an impulse on the fixed cost of the manufacturing unit. As a long term strategy in the context of cost reduction this can be quite useful. Apart from all these strategies the company may adapt a new product lining, restructuring the workplace in a more productive manner, take preliminary actions to reduce the variable cost incurred. These strategies can prove to be beneficial in their endeavour to manage their finance and accounting section in a much efficient manner. References Averkamp, H., No Date. What Is The Weakness Of Traditional Cost Allocations? Activity Based Costing. [Online] Available at: http://blog.accountingcoach.com/traditional-cost-allocations/ [Accessed November 10, 2010]. Dhillon, B. S., 1989. Life Cycle Costing: Techniques, Models, and Applications. Routledge. Emblemsvåg, J., 2003. Life-Cycle Costing: Using Activity-Based Costing and Monte Carlo Methods to Manage Future Costs and Risks. John Wiley and Sons. Kucera, D., No Date. Costing Methods (Manufacturing). Advameg Inc. [Online] Available at: http://www.referenceforbusiness.com/encyclopedia/Cos-Des/Costing-Methods-Manufacturing.html [Accessed November 10, 2010]. Minbiole, E. A., 1998. Accounting Principles I. John Wiley and Sons. Monden, Y. & Et. Al., 2007. Japanese Management Accounting Today. World Scientific. OGC, No Date. Life Cycle Costing. Implementing Plans Introduction Life Cycle Costing. [Online] Available at: http://www.ogc.gov.uk/implementing_plans_introduction_life_cycle_costing_.asp [Accessed November 10, 2010]. Oulu University Library, 2000. Implementation of Design to Profit in a Complex and Dynamic Business Context. Life Cycle Analysis and Product Costing. [Online] Available at: http://herkules.oulu.fi/isbn9514264509/html/x1194.html [Accessed November 10, 2010]. Bibliography California Institute of Technology Industrial Relations Center, No Date. Accelerating Cost Reductions. Courses. [Online] Available at: http://www.irc.caltech.edu/p-46-accelerating-cost-reductions.aspx [Accessed November 10, 2010]. Schoch. H. P. & Teoh. H. Y., 1995. An Entrepreneurial Role for the Accountant: Innovations in the Cost-Price Relationship and the Accounting-Marketing Interface. Canadian Council for Small Business & Entrepreneurship. Word Press, No Date. Manufacturing Cost Reduction Strategies. Cost Leadership Strategy. [Online] Available at: http://www.costleadershipstrategy.com/manufacturing-cost-reduction-strategies/ [Accessed November 10, 2010]. Read More