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Question 1: What are the key roles which a strategic management accountant would undertake in an organisation such as Jessup?
Note: All the values or costs which are used in examples are in pounds.
KEY ROLES OF STRATEGIC MANAGEMENT ACCOUNTANT
Detailed resolutions/ explanations which represent the key role from the strategic management accountant working in an organization, such as Jessup Ltd is stated below:
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 resource. 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 stage, As showing above the planning and design phase, the cost management can well implemented here. (Drury, 2009)
MANAGEMENT'S ACTIVITY-BASED TECHNIQUES (ABC)
Activity based management is a tool used for managing the activities of an organization, by managing these activities the expenses or cost can be managed for the long term. Knowing the activities of the organization can give company a competitive edge over others.
It been used in three different stages:
Identifying and analyzing the major activities in an organization.
Assigning cost for each activity.
For each activity, deciding the cost driver. (Drury, 2009)
It emphasize on managing the cost that has been decided during the planning and designing phase of the product life cycle.
It's been used in four different steps which have to be followed in the same order.
1st Step: Deciding a target price for the product, which the customer may agree to pay.
2nd Step: For deciding the target cost, short down the target margin of profit from the target price.
3rd Step: Find out the true cost of the product.
4th Step: If the true cost exceeds the target cost, then find out ways to drop down the true cost to the target cost.
Accurate costing system is necessary to be implemented for target costing. (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)
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 or services, 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 a 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):
The just in time works for the perfection in each and every department of the organization or business, the main purpose is to reduce those activities which gives no value added to the product, and to product the goods from raw material into finished goods within the expected time of the company without any defects. (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
How differently the organization using these scorecards to achieve the process of critical management is listed below:
From the translating and illustrating aims and strategies, it focuses on the strategic goals to analyze the criticalities.
Each employee of the organization should be communicated the strategic measures and plans, One the employee of the organization able to understand, they need to work on those strategies and goals to meet their business unit's overall strategy.
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.
Enhancing the strategy for feedback and learning is the last process, so that things can be evaluate and monitor or may adjusted or changed if necessary. The approach of the strategy is for both, the customers and the internal processes. (Drury, 2009)
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
CUSTOMER ACCOUNT PROFITIBILITY
It is based on the life time value of the customer by the organization which can be determined by the lifetime potential revenue of the customer deducting the lifetime cost. It helps to decide the customer lifetime profitability over the organization/customer relationship. (Drucker, 1999)
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
The total difference between the cost of two alternatives is known as a relevant cost, 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)
In a process of decision making, the cost and benefits of one alternative must be compared with the other alternatives, so the relevant and irrelevant cost can be analyzed, analyzation is critical because of two reason. First, ignorance of irrelevant data which saves the time and effort of the decision maker and the second is that bad decision can easily be identified
If john is trying to decide whether to go to watch a movie or rent a videotape, is this decision the rent of the apartment where john lives is irrelevant because whether he go to watch the movie or rent it the rent of the apartment has to be paid in both cases. However, to cost of the ticket of the movie or the cost for renting the movie is relevant in this decision because it is avoidable cost.
An avoidable cost can be clearly defined through this example as, it is a cost that can be eliminated in a whole or in part, If John choose to watch the movie then renting the movie is considered as avoidable cost same as if John choose the rent the movie then buying the ticket will be considered as avoidable cost. Whereas the rent of the house is unavoidable cost in this decision because, in choosing any of the alternatives it has to be paid by John. Avoidable costs are relevant and unavoidable costs are irrelevant costs.
There are two broader categories of costs that never considered as relevant cost.
Future cost that do not differ among the alternatives
Sunk cost are the cost that has been incurred in past and cannot be changed for future decisions, it is always the same no matter what type of decision has to be taken. Therefore, it is considered as irrelevant cost and needs to be ignored. (Garrison & Noreen, 2002)
Suppose a machine has been purchased in the past, the cost that has been incurred for the machine is a sunk cost because it has already been incurred and cannot be changed that is the reason why it don't need to be considered in the making of decision.
Future cost that do not differ among the alternatives should also be ignored during the decision making process. It can be more clearly defined by the help of the mentioned below example.
Let's continue the example that has been mentioned above where John has to choose between the alternatives whether he go to watch the movie or rent it, Suppose John intend to order a burger of his choice during the movie no matter he is watching the movie in theatre or he rent it, the cost of that burger will remain the same in both the alternatives. For the decision of ordering a burger, the cost is irrelevant because it is a future cost that does not differ among the two alternatives.
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 a 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.
Relevant cost and revenues are required or useful in some special cases which are mentioned below:
Decision for special selling price: These are one time orders only and they are below the current price of the market. It exists both in short term and long term basis. It is not the part of the ongoing business of the organization.
Product mix decisions when capacity constraints exist: It occurs in the limiting factor and its aim is to focus on those product or services which give the highest return of profit within the limiting factor.
Decisions on replacement of equipment: It is based on the decision where the original value of the old machine, depreciation and it's written off value is considered as irrelevant.
Outsourcing (Make or buy) decisions: it is based on the analyzation to carry out on the activities from the value chain within the organization rather than buy it from the supplier.
Discontinuation decisions: It is based on the analyzation of those products or services where the cost is higher than the revenue (which product or service the organization need to discontinue).
Note: The examples of these special studies are available in appendices.
To identify the avoidable cost for a particular task or decision which is therefore the relevant cost, a decision maker should follow the mentioned below step:
Eliminate the benefits and the costs that differ between the two alternatives, the irrelevant cost will be consisting of a) sunk cost and b) future cost that does not differ from the alternatives. After identifying and analyzing these cost, the decision maker will then need to analyze the future cost that differ between the two alternatives in a decision, the cost that remain are differential and avoidable costs. In the process of decision making the qualitative factors needs to be consider rather than quantitative factors.
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 to 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 base system which is also known as standard system is been in working from 75 years and a lot of companies still using this for the purpose of financial management statements and many other management purposes. It has some advantages for the companies like it is simple to use, the employees are more familiar with this system and the consistency of this system. But in today's business it is misleading the decision makers for the financial purposes. The reason for that is that it is not been made for the case of business in which it is being using nowadays, It has been designed for the companies that has 1) homogeneous products, 2) Large direct cost comparison with the indirect cost, 3) limited data to collect. Whereas in today's business 1) A large variety of complex product and services are required, 2) Increased overheads compared to direct labour, 3) overload of data and 4) Substantially non product cost that can affect the true product. (Drury, 2008)
The ABC costing system has been introduced because of the inaccuracy and misleading of the traditional system, these errors are the most unwanted things for the companies because of the environment set by the competitors in the market. The ABC system provides the accurate information and now most preferable over the traditional system, it is adopted when the overheads are increasing as compared with the direct labour costs. The smaller target cost that are built upon activities are measures through the ABC system, it gives more advantageous because it helps in simplifying the process of decision making and it makes the concept of the decision maker more clear and target oriented. It also helps the management to measure the performance and setting of standards which may help the manager to use the given information for the purpose of comparison. (Drury, 2008)
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 it's 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 labour, 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 centres 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 labour 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.