Advanced Management Accounting - Case Study Example

Advanced Management Accounting Name Tutor Unit Code What are the major problems facing Formosa Plastics Group Management in the early 1990s? Formosa Plastics Group Management had a successful run of its activities since it was founded in 1954. However, in the 1990s the company facing serious challenges including insufficient quality labour, high wages and radicalisation of the environmental movement. Apparently there were also problems with the central staff/ division due to conflicts between the divisional managers and the staff. The Formosa Plastics Group chemical division desired to be a low cost producer. There was a business case for the division to produce at full capacity seeing as most of the production costs were fixed apart for raw materials and selling expenses. Labour expenses generally accounted for around 20 per cent of the overall production costs. However, wages in Taiwan were on the rise as the country’s standards of living went up, thus pushing labour costs up. The company was also facing a low return on investments made in improving existing products, product quality and productivity plus avoiding pollution. Formosa Plastics Group devoted resources to the development of new products. But, even though the company was able to develop new, higher volume and higher value products such as carbon fibre, they contribution to the total sales was still low. The company paid up to 3.6 per cent of its total sales to labour required for the new product development. Formosa Plastics Group too faced a serious challenge in acquiring ethylene required in the production of polythene. Due to a low supply of the raw material, the company had to pay higher prices. The desire to build an ethylene production plant was distracted by the government because of overcapacity concerns. Moreover, the government ethylene plant (CPC) faced environmental concerns compounding the problem of shortages in ethylene supply. Describe the major elements of Formosa Plastic Group’s management accounting and control systems. Categorise these elements into action, results, personnel and culture controls. Formosa Plastics Group had instituted a management accounting and control system that constituted both financial controls as well as performance standards and evaluations. The main element in the financial control system was the return-on-investment measure on the affiliate companies and divisions. The result control was used to evaluate the companies’ and divisions’ profitability based on earnings after interest but before tax. The financial control system was also characterised by a comprehensive cost accounting and reporting system. The company had set standard costs for all aspects of the manufacturing process from raw materials, labour, packing, steam, to waste. The historical records were used given the stability in the manufacturing processes such that the standard costs were polished and accurate (Merchant & Van der Stede, 2012). The accounting system allocated indirect costs to entities and products by a number of allocation bases such as production quantity and number of people. The company made continuous improvements through revising cost standards once conditions dictated so. Through monthly performance results, the management would arrest challenges promptly. The cost standards were closely monitored by the company’s president. It is through this meetings that the president together with the senior and divisional managers thoroughly reviewed their performance. The meetings focused on sales, competition, future trends and future products (Merchant & Van der Stede, 2012). The company’s control system was also characterised by personnel controls under performance-related bonus plans. The performance plans gave employees the freedom to control their performance and were rewarded for the same. For example the company awarded year-end bonuses to every employee under an entity based on the performance of that entity. This also integrates the cultural control based on the Chinese culture where companies based in Taiwan give a bonus of one to two months of the total pay. Even though Formosa Plastics Group’s plan is based on base salary, at an average of 4.2 months it is close to the Chinese cultural norm. For senior chief personnel, the performance bonus was based on the position and level of attainment of performance targets (a result control) (Merchant & Van der Stede, 2012). Another result control are the targets set on yearly revenue, costs, and profits early in the course of bottom-up planning process. For each division, there were set labour cost parameters involving corporate and divisional managers. As part of the continuous improvement process, it was generally established and expected that all sections in each plant reduce costs on a year-on-year basis. There was a conflict as to the appropriate level of achievement of this results. Whereas corporate managers wanted an 80 – 90 per cent probability of achievement of the targets, divisional managers pressed for a lower probability of achievement of 30 – 40 per cent, particularly on profits given the pressure from the president. This generally indicated the trouble with action controls on the part of divisional managers. Action controls at the corporate level were rather successful as the deviation between budgeted and actual expenses was usually below 3 per cent. “Although they (results controls) are important form of control in many organizations, results control cannot always be used effectively”. Will Formosa Plastic Group’s choice to allow high subjectivity in performance evaluations be effective with respect to its results controls systems? Explain your answer. Yes. Management control systems are a vital part of every organisation, whether big or small. Big organisations are disposed to have formal systems but small organisations tend to use informal systems. Formosa Plastics Group being a big corporation had set up a formal management control system, but informal systems were manifest by interactions between the president, senior and divisional managers and staffs. Therefore, management control systems can either be formal, informal or a mix of the two. In all organisations some form of subjectivity is manifest when using the system. The people tasked with overseeing the results controls are likely to be influenced by bounded rationality (Bradshaw et al., 2008). They therefore, may well vary their thinking on the desirability of realising the set targets. For instance, on the issue of the appropriate level of achievement of the divisional results, corporate managers wanted an 80 – 90 per cent probability of achievement while divisional managers wanted a probability of achievement of 30 – 40 per cent. Since all organisations exemplify a bit of informal controls, it is natural to expect a high form of subjectivity in performance evaluations to show fairness to the user of the system. In the case of the polyolefin division, managers were not evaluated like the managers from other divisions. Their division faced challenges and were therefore evaluated differently to show fairness. Subjectivity cannot be avoided since the results controls by themselves are not perfect. People are expected and have the will to be fair in order to create better management control systems and improve organisational performance. In this way, subjectivity in performance evaluations improves the effectiveness of the results controls systems (Bradshaw et al., 2008). Are any of Formosa Plastic Group managers’ management control choices affected by national or cultural factors? If so, which choice/s is/are affected and which factor/s affected them? Formosa Plastic Group managers’ management control choices are indeed affected by both national and cultural factors. At the national level, the management control choices are affected by government legislation (Merchant & Van der Stede, 2012). This mainly affected Formosa Plastic Group’s polyolefin division that produced polythene. The regulatory controls on the raw material required (ethylene) were tight particularly because of environmental concerns. The sole supplier, CPC, owned by the government could not satisfy the demand in the market. Even though the firm was allowed to set up another ethylene production plant, there was a delay owing to environmental problems. This meant that the supply of ethylene was limited and Formosa Plastic Group had to cope with tough financial times. Ethylene was the major cost item in the polythene division, accounting for between 60 to 65 per cent of the overall production costs. The cost of importing ethylene was too high and the process was challenging given that ethylene had to be stored at high pressure and very low temperatures of -104 degrees Celsius. The importation costs from Korea or japan was between $60 – 80 per ton and around $120 per ton from the United States. The Taiwanese prices were set based on the US and UK prices, but were around 4 – 5 per cent higher and the prices kept fluctuating. Worse still, the government refused to allow Formosa Plastic Group to construct its own plant due to overcapacity concerns. At the cultural level, the management control choices are affected by the Chinese cultural norm on the payment of year-end bonuses. The company had to pay the bonuses given that all other companies in Taiwan paid the bonuses to every person in the corporation. References Bradshaw, J., Khanna, B., Hunt, C. and Fowler, C. (2008). Accounting for the organisation’s Internal Environment and Risk. North Shore, NZ: Pearson Education New Zealand. Macintosh, N. and Quattrone, P. (2010). Issues: Why Management Accounting and Control Systems (MACs)? An Organisational and Social Approach. Wiley Merchant, K. and Van der Stede, W. (2012). Management Control Systems: Performance Measurement, Evaluations and Incentives. 3rd ed. Harlow, Essex: Pearson Education Limited. Read More