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The main goal of the business for the organization is that to earn more and more profit and for the production perspective is to as much as increases the production in the limited or less recourse. On the other hand the more core business objectives are less cost of production and the utilization level will be more. Some of the more financial person wants 100% profitability and higher rate of return. (Drury, 2001)
The life cycle cost of the product emphasize on the cost against the life cycle of the product determining whether the profit earned during the manufacturing period will cover the cost incurred during the production stages (Drury, 2009)
MANAGEMENT'S ACTIVITY-BASED TECHNIQUES (ABC)
Activity-based costing (ABC) is a key tool for the organization to determine whether the production done in time as well as the quality of that is up to the whish customer need and there fulfillers of the organization. Activity based cost management (ABCM) is the major tool of the organization which describe the cost incurred in the resources and the management. (Drury, 2009)
Several steps need to be followed in order to use target bases costing.
1st Step: Find out the customer which we are targeting for the products.
2nd Step: Short down the profitability to capture the target marketing price as well as cost.
3rd Step: Authentic outlay of the manufactured goods.
4th Step: The key indicator to determine the expenses which we are incurred and trying to reduce down to meet the expectation of the market. (Drury, 2001)
BUSINESS PROCESS RE-ENGINERRING (BPR)
Business process re-engineering involves investigating business processes and making substantial changes to the present operating procedures of the organization. The concept is to redesign the work done. (Drury, 2001)
For Example: The handling of material can be classified as a business process as it is consist of different activities concerning with each other i.e. setting up the production, material storing, handing out the purchase orders controlling and inspecting the materials and paying off the suppliers
The aim is to have better business process activities in order to meet the customer satisfaction with the help of cost reduction, focusing on generalization and improving the quality, Consider the above mentioned example of material handling out where the process can be re-engineering setting up the production.
COST OF QUALITY (COQ):
Cost of quality in today's world becomes a higher need of the companies, Company like Jessup should also need to identify the quality of their products so that they can produce the products as per the need of customer with the expected quality, this quality check requires a higher cost but it is major competitive edge for the companies nowadays. Improvement in the quality are the major function and need of the customer, Jessup continuously need to identify the rapid changes in the requirement of the customers. (Drury, 2009)
BENCHMARKING OF THE COMPANY:
It shows the outstanding practices which are the role model for the organization. It also the quality if the products in the define manner which is prescribed according to the standards of the laws which is Implicated by the higher bodies or according to the promises which they provide to the customers. (Drury, 2009)
JUST- IN -TIME (JIT):
Just in time is another form of strategy generally use for the long time periods as a resulting the cost in JIT is reducing to match because it deducts the cost for the production by eliminate other activities which is not important for the management or production.
The just in time is one of the only that works for the perfection in each and every department of the organization and the business. The main purpose of just in time is to reduction in the cost of each function of the business and done in time which we are targeted for that.
Some of the precious contents of the just in time function are as follows:
Less loss in the form of defect.
Similar assignment done in one flow.
Less as much as no breakdowns.
A deliverance examine in a stable given time span during working. (Lu, 1986)
THE BALANCE SCORECARD AS A STRATEGIC MANAGEMENT SYSTEM
The goal of the balance scorecard are beyond than making a temporarily set of non-financial and financial statistics of performance. They are resulting from the top to bottom procedure provided by the business unit as per their strategies and missions. As per Norton and Kaplan
Norton and Kaplan explain how the organization uniquely using these scorecards to achieve the mentioned below critical management processes:
Specify the strategic goals from the illustrating and translating goals and strategies to analyze the criticalities from the specific strategic goals.
Communicate the strategic measures and goals to each employee of the organization, once employees able to understand the aims and goals of the company. They should work on the confined goal in order to meet the overall strategy of that business unit.
Once the above two processes are being accomplished there must be setting of targets, and planning to initiate the specific goals which means gives them direction for that specific goal to be accomplished. These targets must not be exceeded than 1 year so that the performance can be access easily which is been made for achieving the long term targets.
The last process should of expanding the learning and feedback strategy so that things can be monitor and can be adjust if required as per the feedback. And if there is any problem in can be changed easily. The strategy approach is not only limited for the customers but it is necessary for the internal processes. (Drury, 2009)
THE CLIENT PERSPECTIVE
According to the client perception the scorecard sheet helps the manager to determine the segmentation in which each unit of the business in the organization working effectively. Segmentation which is targeted which responses quickly by their clients. In this fastest growing world clients needs and expectations changes rapidly. The desires of the client can be easily determine by their core objectives and the loyalty related to the clients in the segmentation. Possible core objectives of the organization are as follows:
Client maintenance and devotion
Proposition measurement. (Drury, 2009)
THE INSIDE DEALING PERSPECTIVE
In the internal business process perspective, managers identify the critical internal processes for which the organization must excel in implementing its strategy. The internal business process measures should focus on the internal processes that are required to achieve the organization's customer and financial objectives. Kaplan and Norton identify three principal internal business processes. These are:
Function process. (Drury, 2009)
THE LEARNING AND GROWTH PERSPECTIVE
This is the last perspective of the balance scorecard which shows that in whatever the business the organization is dealing in, it must be planned to grow for long-term basis, and for improvement off-course. This gives the importance of investing in future and not only in increasing the assets or in launching new products at present. The organization must also think to invest in the infrastructure so that the first three perspectives can be achieved. Norton and Kaplan provide three principles for the organizations bases on learning and growth.
ESTABILISHING GOALS AND PERFORMANCE STATISTICS
As explained briefly above about the processes of balanced scorecard, we can now think about the processes of establishing goals and performance stats in all the processes of balanced scorecard.
Capabilities of the employers
Capabilities of the IS (information system)
Empowerment, alignment & motivation
Management accountant plays vital role in any organization so there is a great need to have got top management accountant in most of the organization is consider being the controller of the organization. Goals of management accountant are to formulation of strategies, business activities, plans, and reports including finance, tax, audit and system support for effective decisions which helps the organizations to achieve its future goals.
Question 2: What is meant by the terms relevant and irrelevant costs and revenues in Strategic Management Accounting decision making? Include several small numerical examples in your answer.
In the process of decision making, all the costs may not be relevant some may consider as irrelevant. Relevant cost is actually considered as future cost; where from the experiences of past management makes decision for the future.
RELEVANT COST AND REVENUES
It is not necessary that a cost which is relevant for one task is also relevant for the other, relevant cost varies from case to case, in the accounting defined term, it is known as a cost which management thinks most important for their decision making, its eliminates all other unnecessary cost. The important thing that has to be considered is that it needs to considered qualitative factors as well and not only quantitative factors. (Drury, 2009)
As mentioned above, costs that are irrelevant in a particular situation may be relevant for other, Sunk costs; overheads are the best examples of this. (Drury, 2009)
The analyzation of relevant cost and revenues and irrelevant cost required different approaches in different scenarios, as mentioned below:
Example 1 (A short-term order):
Monthly capacity for a department within a company 50 000 units
Expected monthly production and sales for next quarter at normal selling price of £40 35 000 units
Estimated costs and revenues (for 35 000 units)
£ £ Direct Labour 420 12 Variable cost 350 10 Manufacturing non-variable overheads 280 8 Marketing and distribution costs 105 3 Total costs 1155 33 Sales 1400 40 Profit 245 7
This example is based on a special pricing decision where a company is offered to buy 3000 for the next three month each; the selling cost for the additional unit would be £1 per unit. Here, the relevant revenue is higher than the relevant cost. Thus the order is accepted. (Drury, 2009)
Components X Y Z
Contribution per unit 12 10 6 Machine hours per unit 6 2 1 Estimated sales demand (units) 2 000 2 000 2000 Required machine hours 12 000 4 000 2000 Contribution per machine hour 2 5 6 Ranking per machine hr 3 2 1
(Assuming that the capacity of the period is restricted to 12000 machines hours)
Machine hours Balance of machine Production used hours available 2,000 units of Z 2,000 10,000 2,000 units of Y 4,000 6,000 1,000 units of X 6,000 -
The result for the production programme will be the following:
2,000 units of Z at £6 per unit contribution 12 000 2,000 units of Y at £10 per unit contribution 20 000 1,000 units of X at £12 per unit contribution 12 000 Total contribution 44 000
The above example are used for the product mix with limited capacity, where the company has to decide what product can give them more profit and make decisions according to that. Here, the qualitative factor must be considered by the company. (Drury, 2009)
Assume the periodic profitability analysis of sales territories reports the following:
Southern Northern Central Total
Sales 900 1 000 900 2 800
Variable costs (466) (528) (598) (1 592)
Fixed costs (266) (318) (358) (942)
Profit/ (Loss) 168 154 (56) 266
The company assumes that 250,000 of fixed cost and all the variable costs are neglect able whereas 108,000 cannot be avoidable, if the company discontinued the central.
The financial information that needs to be considered is as follows:
Keep Central Discontinue Difference open Central
Variable costs 1 592 994 598 Fixed costs 942 692 250 Total costs to be assigned 2,534 1,686 848 Reported profit 266 214 52 Sales 2,800 1,900 900
The third column which is the difference between the two shows that there will be 900,000 relevant revenue can be earned if the company opens the central and the relevant cost are calculated to be 848,000, which shows that it will provide 52 profit against the fixed and variable costs. (Drury, 2009)
These are the cost of acquired resources of the firm where there will be no change in the total by the choice between various alternatives. Sunk cost are such cost which are as a result of the previously decision makers and such cost cannot be change as a result of decision which will be made in future. (Garrison & Noreen, 2002)
Previously purchased material which has been write off, the expenditure on the acquiring of such material which on longer required
Suppose if a machine is purchased at the cost of $200000 whose useful life will be of five years with no scrap value then the written down value will be 40000 if straight line method is used and such cost have to be write off no matter what possible decision will be taken in the future. This cost cannot be changed by any future decision and is therefore classified as sunk cost.
It is the cost of the commodity that one leaves for getting the second one among the two different alternatives. (Garrison & Noreen, 2002)
Item Quantity Amount Benefits Wheat 10,000 tons 20,000 100,000 people fulfil the daily necessity Industries 1 unit 20,000 100 get employment
Here we can see two different options available, we assume that a particular country having two different options available, whatever the option the decision maker will select the other would be consider as the opportunity cost.
INCREMENTAL AND MARGINAL COST
Incremental cost and Marginal cost are the cost of difference between cost of the product and the revenue getting by the sale of product for the corresponding items under each alternative being considered. (Garrison & Noreen, 2002)
The incremental cost of generating or producing an increasing output of product A from 2000 to 2200 units per month are the additional cost of producing an excess units of 200 per month. Incremental cost may be or may not be included in fixed cost. If as a result of in change in the decision of an organization fixed cost fluctuate then the increase in cost is represents an incremental cost. If there is no change in fixed cost then the incremental cost will be zero.
As per the economist's concept of marginal cost and marginal revenue Incremental cost and Marginal cost are same. The main difference is that marginal cost per revenue (marginal cost/revenue) denotes the additional cost per revenue (additional cost/revenue) of every single extra unit of output of an organization whereas incremental cost per revenue represent s the additional cost/ revenue as an result of additional group of output units.
Past cost are suppose to be irrelevant for the current decision making process so the cost that to be incurred in future are also be calculated which effect the decision making process for future decisions & decisions should be made as to what is best now. (Garrison & Noreen, 2002)
Relevancy is an important factor in accounting system there for relevant cost which cause fluctuation in contribution as in loss of contribution margin as relevant cost incurred due to decision making. Therefore identifying that which cost is relevant and which cost is irrelevant cost also known as unavoidable and avoidable cost is an important factor to calculate accurate contribution margin. The main terminologies which use in relevant cost are opportunity cost which is calculated as the scarifying cost due to previous decision making, sunk cost are such cost which incurred as a result of scarifying cost due to acquiring the resources of longer use and Incremental and Marginal cost are the cost of difference between revenue and cost of production.
Problem areas for determining the relevant cost are determining relevant cost of direct material short term basis or for specific order in regular production at utilization of maximum capacity of production, and determining relevant cost of direct labour use for short term basis or for specific order in regular production at utilization of maximum capacity of production.
Question 3: What are the benefits and problems of introducing activity based costing into an organisation such as Jessup?
ACTIVITY BASE COSTING
ABC method has been in use since the start of 20th century. Activity Based Costing is the costing according to the activity. As far as Jessup Ltd is concern the board of director should have to consider the implementation of the activity base costing to achieve organization goal. The steps of implementing Activity Base Costing are as follows.
1st Step: - First step is to identify the activities which are the analysis of operating process of each segment and each segment consist of one or more activities required for the production of an output.
2nd Step: - Second step is to assigning resource costs to activities and there are two costs which are assign to activities known as direct cost which directly concern with the current production for example the material cost (nail, paint, wood) to built table, indirect cost which are the cost who directly which cannot allocated to a single output and benefit two one or more outputs, and the last assigning cost is general and administrative costs which is not associated with any product or service to offer, such cost remain the same no matter what output the activity produced for example salaries of administration, depreciation on plant and equipments.
3rd Step: - Third step is the identification of the output of the result of the production for which activity is performed and consumer resources. Output can be product services or customers.
4th Step: - Fourth and the last step is to assign activity costs to output by using activities drivers which assign activity costs to outputs which are based on individual outputs' consumption or demand of activities which is being performed. (Geoktuerk,2005)
COMPARING TRADITIONAL AND ABC SYSTEM
The traditional system usually depends on the random division among the department whereas the ABC system only looks at the particular cause and how it might affect the cost.
The cost for the production and support centre is being merged in traditional whereas in been consider individually in ABC system.
Both systems are using a two stage allocation process, in the first stage, the traditional system are more looking at the cost for departments whereas the ABC system considers the activities.
In the second stage, the traditional system considers only few cost drivers like labor, material etc whereas the ABC system considers a large numbers of cost drivers. (Drury, 2009)
TRADITIONAL BASE COSTING TWO STAGE ALLOCATION
ABC COSTING TWO STAGE ALLOCATION
FEATURES/ BENEFITS OF ABC SYSTEM
There will be number of cost centers and drivers available as per the need of the company or which company could manage.
Establish accuracy in the process of different costing with regards to the product, production, end user of the product.
Better assist in the production to understand the overhead cost which is assign to the production of the product of service.
Easy to comprehend.
Easy to interpret according to the activity.
Provide the better allocation of different resources as they are used in different product line.
Play vital role to identify the activities and through such system decision makers can eliminate such activities which are a burden or stress for the production of the organization or for the business.
Works effectively with the performance management systems which are employed by the human resource department of the company.
Allow organization to implement costing strategies across another diagonal of the business process.
Help in the process of benchmarking which is an important part of the quality control system. (Geoktuerk,2005) , (Drury, 2009)
Require a great no of data and the data collection process for this system.
Generate capital expenditure.
This system is supposed to be transparent system which some manager would not improve.
Requires a huge wealth to sustain this system.
Traditional system is more familiar than this system and most of the managers prefer traditional system because of the same reason.
The companies who already having the traditional system may have problems to setup this system.
It is like land of information where the image of the company cannot be clearly seen. (Geoktuerk,2005), (Drury, 2009)
The ABC system is less emphasize on direct cost and more on indirect cost, Company like Jessup which is a service oriented company doesn't have labor and material cost so more need for ABC costing is required, where the company need planning to identify and analyze the meaningful pricing because tendering a contract is having a proper understanding of cost so that the best competitive price can be set, ABC costing is necessary in a competitive environment like Jessup have.
Drury, Colin. (2009). Management accounting for business decision. 4TH edition. (London Thomson learning).
Garrison and Noreen. (2002). Managerial accounting. 10th edition :(Irwin/McGraw-Hill).
Goektuerk, Haman. (2005). Activity-Based Costing (ABC) - advantages and disadvantages (Lancaster University).
Lu, David. (1986). Management begins at the workplace. Revised edition. (Tokyo. Japan Management Association).
Drury, Colin. (2001). Management accounting for business decision. 2nd edition. (London Thomson learning).
Identifying relevant and irrelevant costs
Identifying relevant cost and irrelevant costs are most important factor to be considered before taking any decision. The recognition of relevant an irrelevant cost in dissimilar decision making conditions is mainly depends on the experience, analysis and off course common sense of the decision maker for the particular area for which the decision needs to be made. Equipped with these tools one should be able to filter through all the information that is obtainable high opinion of any pronouncement and take out those costs which suits to the decision.
In recognizing the relevant costs for different decisions, it may come across that various costs are not mentioned in the accounting records of an organization are relevant and various costs mentioned in such records are irrelevant. It is important to know that there is a considerable variation among the cost which is recorded in accounting books and relevant cost for decision making. The accounting records are used to record the prevalence of actual costs and income as they occur. Pronouncements, while on the other side are depends upon the benefits and the relevant cost which is suitable for a particular decision. (Garrison, Noreen, 2002)
Example for identifying Relevant and Irrelevant Cost
At present, John is a student of MBA in London city and for the weekend he wants to meet his friend who lives in Manchester. He is confused whether to reach there by his own vehicle or by the train. The budget for john is not that much and he needs to watchfully think about the cost among the two alternatives, If the difference among the two options are far different from each other the decision will be easy to take for him. If he goes by his car, the distance between his apartments to his friend's is 230 miles. Mentioned below is the list which he made:
Automobile Costs (Values is Pound)
Annual cost of Cost/Mile fixed items (10,000 miles per year)
Car's depreciation [(18,000
Original cost - $ 4,000 expected resale price in 5
years)]. 2,800 0.280
Cost of gasoline ( 1.60/gallon /32 miles/gallon) 0.050
License & Insurance cost/Year 1,380 0.138
Wear & Tear 0.065
School parking fees (45 per month X 8 months) 360 0.036
Total average cost per mile 0.569
Additional Data (values in Pounds)
Reduction in car's resale value 0.026 per mile
Train's ticket for trip from London to Manchester City 104
Relaxing, Reading & Learning benefits by
train ride rather than having drive ?
Expense for doghouse 40
Car availability benefits in London ?
Parking problem in London ?
Parking charges in London 25/day
To find out the relevant expenditures, benefits in the stated above problem? According to the principles expenditure, benefits are relevant when it vary among the options. All the other things besides could be unnoticed and consider as irrelevant. The similar picture shows in depreciation amounting 2,800/year which represents the number of years for the extending sunk cost.
The expenditure (gasoline) which will need to reach London will definitely be consider as a relevant cost .If John moves by train there is no need to consider this expenditure (gasoline). For this reason the cost vary among the alternatives to relevant.
License and insurance (expenditure) per annum for john's trip to London is not relevant because it will occur on annual basis and not for this particular trip. Therefore, both car and train's trip will not be affected by this expenditure.
The expenditure (wear & tear) are said to be relevant because it will occur during the trip to London. Because wear & tear would be occurring when he drives the car and the estimated cost for this expenditure is 0.065/mile which is considerable.
The parking fees that Johns give throughout the academic year on monthly basis will not be consider as relevant in this case because weather he will reach there by train or car he will compulsory pay this amount of fee for the parking.
This expenditure is the outcome of the several expenditures mentioned above in the table. The cost as an average occurred 0.569/miles. As we explained the expenditures above in the suggested solutions some of them are relevant and some are not relevant. The economical depreciation of the car is said to be relevant and gasoline expenditures as well as wear & tear because it will calculate in mileage. Hence, the insurance or license and school's parking fees is said to be not relevant for the reason that it will pay on annually basis as well as monthly basis so it would not be incorporated. The matter of the fact is the average expenditure that we have is been taken for 1000miles/ year and for driving from London to Manchester it will require (230miles X 2), which means that some of the above mentioned expense are not relevant in this case because it is valued overstated.
The reduction in the car's resale value is relevant in this case because as much as john's drives his car the cost of the car will be reduced .in this scenario the car used more and the value will be reduced as a result the cost of the car listed below the original price and if he wants to change or exchange with another car he will pay more because the car will be depreciated according to the usage in mileage amounting 0.026/miles. The depreciation which we discussed is not an accounting depreciation; it is an economic depreciation because it will depreciate according to the usage of the car in mileage.
If John wants to reach London by train the cost for the ticket that he needs to purchase would be consider as relevant for the overall trip.
Relaxation in this trip is to be relevant or irrelevant under two fold, the first one is that if he considers train he would be able to learn or read during the trip which is said to be a relevant for John's trip. And the second one is that if he consider car he would not be able to learn or read during the drive which is said to be irrelevant for John's trip.
While John is going for the trip to London he put his dog to the doghouse because when he will go weather by the train or by the car he will not put his dog during the journey so the cost is not relevant for this case.
In the mentioned above selected cases (ix, xi & xii) are said to be relevant even it is complicated to consider while the cost which will occur for parking in London is also said to be a relevant in the above stated scenarios.
After having all the data that is relevant, John analyzed the relative cost among the driving and taking the train are mentioned below:
Financial cost that is relevant for choosing the train to London
Gasoline used in a trip (460 miles @ 0.50/mile) 23.00
Wear & Tear (460 miles @ 0.065/mile) 29.90
Reduction of car's resale value (460 miles @ 0.026/mile) 11.96
Parking cost (London) (2 days @ 25/day) 50.00
Cost that is relevant for choosing the train to London
At the end John analyzed according to the financial facts and figures, train is the better option with respect to the car because the train cost 10.86(114.86 - 104.00) lesser than the drive. And the additional benefits is that he will entertain is relaxing, reading or learning and there will be no parking problem as well. (Garrison, Noreen, 2002)