Applications of Management Accounting Principles - Essay Example

?Table of Contents Implication of Porter’s Competitive Strategy 2 Cost Leadership 2 Differentiation 2 Focus Differentiation 2 Implications of Porter’s Generic Strategy 3 a)Product Differentiation 3 b)Focus Differentiation 3 c)Cost Leadership 3 Critical Success Factors for Porter’s Competitive Strategies 4 Strategic Management Accounting Tool for Maintaining Competitive Advantage of Parts Limited 4 i.Balance Scorecard 4 ii.Target Cost Management 5 iii.Strategic Variance Analysis 5 Implications of Activity Based Costing 5 Inaccurate Costing in Product Diversity 5 Activity Based Costing 5 Measuring Actual Cost through Activity Based Costing 5 Time Driven Activity Based Costing 6 Life Cycle Costing 6 Definition and Explanation of Life Cycle Costing 6 Life Cycle Costing and its Problems in relation with XYZ-325 6 Pre-Production Cost 7 Bibliography 8 Applications of Management Accounting Principles in the scenario of Parts Limited Implication of Porter’s Competitive Strategy Competitive advantage benefits an organization by providing it an ‘edge’ over its competitors. Anything in which a firm excels than its competitors is considered as its competitive advantage. Michael Porter has mentioned three main strategies in order to gain the market share by acquiring competitive advantage. They include: Cost Leadership Differentiation Focus Differentiation Cost Leadership Parts Limited is that company which doesn’t earn through number of units sold, but it maximizes its profits through the price of units. Parts Limited charges higher prices to its customer which means that they sell their products on relatively premium prices. When it comes to cost differentiation, this strategy is an option for Parts Limited. There is a possibility that the company start focusing on generating revenue not through premium prices but through number of units sold. This strategy can only be adopted if the company has preferential access to raw material, advanced technology, utilizing economies of scale etc. If a firm has the potential to excel the cost leadership then it means that the firm is an above average firm provided that it sells its products at ornear to the industry average. Differentiation Differentiation strategy refers to being unique in an industry by having all those dimensions which are valued by the customers. In my opinion, this strategy is currently availed by Parts Limited because it is selling its unique products and charging premium prices for them. These products are perceived as unique and important in the eyes of the customers and the firm utilizing this strategy, usually is aware of the needs and unique demands of its customers. Focus Differentiation This strategy usually consists of two variants. In focus strategy a firm can either go for: a) Focus differentiation in its own target market b) Cost focus to seek cost advantage within its target market In this regard, usually targeted customers have unusual needs or the delivery of production system. Cost focus assist in acquiring cost advantage of a particular segment whereas focus differentiation fulfills the special and unique needs of the customers. As far as Parts Limited is concerned, this type of strategy cannot be applicable for a company dealing in machines industry. The reason is hardly customers are concerned about using unique and high priced parts for their machines. In fact, the emphasis is basically on sustainable and good quality products. This type of strategy mostly applies in the apparel & garment industry, cellular industry, electronics industry (including personal computers, T.Vs etc.), cosmetic industry etc. Implications of Porter’s Generic Strategy In the above section, a brief analysis has been done of each of the three porter’s strategy. Coming to back to Parts Limited and before analyzing which strategy can prove to be productive for Parts Limited; all the three strategies need to be analyzed in respect of Parts Limited. a) Product Differentiation Parts Limited has been utilizing product differentiation strategy. It means that it has been selling its products on premium prices. For machines, customer generally require good quality product and customers also feel reluctant in paying high amount of cost to parts which are to be used in machines. The result of this strategy has also been mentioned in the case study, where the market share and share price of Parts Limited is declining. This is an alarming sign for Part Limited which clearly states that it needs to change its strategy now and product differentiation strategy is no more useful for parts Limited. b) Focus Differentiation As mentioned above, this strategy cannot be applicable for any company dealing in machines industry. Customers do not want to pay premium or extra ordinary higher prices for getting spare parts in order to fix their machineries. Therefore, even this strategy cannot prove to be beneficial for Parts Limited. c) Cost Leadership According to the scenario of Part Limited, its customers are switching to ‘low cost providers’. It means that this is the time for Parts Limited to change its strategy and focus on cost leadership instead of generating revenues through charging premium prices. If the prices of competitors are lower than the products of Parts Limited, then there is no reason that customers will buy products from Parts Limited on such higher prices. Therefore, Parts Limited needs to pursue the cost leadership strategy. Critical Success Factors for Porter’s Competitive Strategies According to Michael Porter, in order to outperform the competitors, one must do different activities or should do similar activities in a different matter. Therefore, critical success factors are ‘critical’ for Parts Limited. In order to get higher revenues, management accounting principles needs to go hand in hand with the strategies of the company. For this reason, management accounting principles have been quantified in terms of Key Performance Indicators (KPIs) so that it gets easy to measure the performance of the company after applying each strategy. The key performance indicator for each strategy and critical success factor are mentioned below in the table. Strategies Key Performance Indicators (KPIs) Critical Success Factor Cost Leadership Reducing overhead expenses by 8% this year. Increasing competitiveness in terms of cost reduction Differentiation Expanding the range of products to attract new customers Locally sourcing new products Focus Expanding the space in stores to bring in new products and thereby customers. Putting aside finances for expansion Strategic Management Accounting Tool for Maintaining Competitive Advantage of Parts Limited Strategic management tools required to maintain the competitive advantage of Parts Limited include: Balance Scorecard Target Cost Management Strategic Variance Analysis i. Balance Scorecard Despite of quantifiable measures of performance, a lot of qualitative measures of performance are also utilized by company which includes delivery service measure, quality measures, customer satisfaction measures etc. balance scorecard is also a form of non-financial measure which provides the top management about clear, fast and comprehensive view of the operations. Balance scorecard measures the performance of the company in the following four dimensions: Business process perspective- includes quantitative measures such as quality, cost, order completion, production, material procurement etc. Learning and growth-includes employee retention, customer satisfaction, employee satisfactions etc. Financial perspective- includes economic value addition, capital employed, cost reduction, operating profit etc. Customer perspective-includes customer retention, market share, customer satisfaction etc. ii. Target Cost Management Three stages which are included in Target Cost Management (TCM) include: Establishing that prices on which customer agrees to pay Long term factors of profits which a producer seeks to attain Continual reduction in cost iii. Strategic Variance Analysis Strategic variance generally comprises of profit variances which includes market share, market size, product volume, selling prices, mix variances etc. Depending upon the size, structure and performance of the company, the company selects appropriate measures. As far as Part Limited is concerned, the best possible management accounting tool for maintaining the competitive advantage of the company is Balance Scorecard. Numbers of companies are utilizing this tool to attain the qualitative as well as quantitative measures. For the continual increase in profits and reduction in cost, Balance Scorecard can help a great deal to Part Limited in cannibalizing the market share and to come back to its previous market position. Implications of Activity Based Costing Inaccurate Costing in Product Diversity Due to number of products, when a company starts allocating cost to each product there are chances that the cost is inaccurate for instance, instead of allocating cost to each task or activity, the firm allocates the cost of product on average basis which results in misleading results. Activity Based Costing Parts Limited can utilize activity based costing. In Activity Based Costing (ABC), cost is allocated to each activity for example, number of machine hours, number of labor hours, number of products on which raw material is used etc. If Parts Limited utilizes ABC approach then the costs will be more accurate as compared to volume based costing system. Measuring Actual Cost through Activity Based Costing Activity based costing can be highly useful in determining the exact cost which means that it will help Parts Limited in determining the actual cost. In this way, the firm can get aware of the actual cost which will be lower than before and which will ultimately reduce the costs of the company leading to cost leadership approach. By utilizing ABC approach, it will become much easier for Parts Limited to utilize the cost leadership approach. Time Driven Activity Based Costing Time driven activity based costing not only determines the activity on which the costing is based upon, but also determines the time in which those activities are completed. Incorporating ‘time’ in cost is essential because the cost is mainly depended upon time. Those activities which have less time usually cost higher than those which have much time left. In other words, for crash activities one has to pay higher amount due to urgency. In this regard, time driven activity based costing is utilized. Parts Limited can also utilize this capacity by determining the time required to complete activities and available capacity of the company. In this way, costing will become more accurate for Parts Limited. Life Cycle Costing Definition and Explanation of Life Cycle Costing Life Cycle Costing is mainly used when a new product is going to be launched by the company. Since the product has a particular life in which it passes through, therefore the whole life of a product is split into various different stages with respect to the growth of the product. Generally there are five stages of a product 1) Research & Development Stage 2) Introductory Stage 3) Growth Stage 4) Maturity Stage and lastly, 5) Declining Stage. In life cycle costing, the cost of a product is estimated for each of the stage such that the costs of all stages are then accumulated to obtain the total cost of the product. Those costs are then compared with their corresponding revenues so that the viability of launching a new product can be assessed. Life Cycle Costing and its Problems in relation with XYZ-325 As far as the new product XYZ-325 of Partz Limited is concerned, the company needs to define the particular life of the product and duration of each stage of the product. After that the company needs to estimate the associated cost of a particular stage and then combine all those costs. The combined cost should be compared with the revenues to evaluate the profitability of the product. The difficulties that may arise in life cycle costing of XYZ-325 include several different prospects such that it is difficult to estimate the overall duration of the life of the product along with the duration of each individual stage. Similarly, the estimation of the cost associated with each stage is also a difficult and complex task for the company. Pre-Production Cost Pre-production cost generally relates with the cost pertaining to the Research and Development Stage. This is the stage where company just throws its cost away in anticipation of earning revenues as soon as the production commences. However, normally many products do not even go ahead with the next level of production and die down in the pre-production stage. Cost Committed is the cost that the company has to incur once the production of the products starts off whereas the cost incurred is the cost that has already been incurred in the pre-production stage. So the company needs to evaluate both types of the costs in order to analyze the true behavior of the cost over its whole life. Bibliography Barringer, H. Paul. A Life Cycle Cost Summary. May 23, 2003. http://www.barringer1.com/pdf/LifeCycleCostSummary.pdf (accessed April 17, 2012). Brekiri. Competitive Advantage by Michael Porter, Part 2. n.d. http://www.brekiri.com/blog/244/competitive-advantage-by-michael-porter-part-2/ (accessed April 17, 2012). Chartered Institute of Management Accounting. The adoption of strategic management accounting tools in agriculture post subsidy reform:a comparative study of practices in the UK, the US, Australia and New Zealand. n.d. http://www.cimaglobal.com/Documents/Thought_leadership_docs/cid_ressum_adoption_strategic_management_accounting_tools_sept09.pdf (accessed April 17, 2012). Clark, Wendel. Strategic Management Tools & Techniques. n.d. http://www.ehow.com/info_8053366_strategic-management-tools-techniques.html (accessed April 17, 2012). Fuller, K. Sieglinde and Petersen, Stephen R. Life Cycle Costing Manual. February 1996. http://fire.nist.gov/bfrlpubs/build96/PDF/b96121.pdf (accessed April 17, 2012). Kaplan, Robert S. Time-Driven Activity-Based Costing. July 5, 2006. http://hbswk.hbs.edu/item/5436.html (accessed April 17, 2012). New South Wales Treasury. Life Cycle Costing Guideline. September 2004. http://www.treasury.nsw.gov.au/__data/assets/pdf_file/0005/5099/life_cycle_costings.pdf (accessed April 17, 2012). Porter, Michael. What Is Strategy. September 26, 1996. http://www.mastersforum.com/PastPrograms/MichaelPorterCompetitiveAdvantage/tabid/63/Default.aspx (accessed April 17, 2012). Product Costing. Time Driven Activity Based Costing. n.d. http://www.productcosting.com/time_driven_abc.htm (accessed April 17, 2012). Stark, John. A FEW WORDS ABOUT ACTIVITY BASED COSTING. n.d. http://www.johnstark.com/fwabc.html (accessed April 17, 2012). Read More