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I take note of your need for a well charted course of your competitive strategy. Following my assessment of your company, I would want to bring a few issues to your attention. In the modern operating environment, you will need a strategic management accountant. A Strategic management accountant (SMA) will analyze and provide managerial accounting information about your company and its competitors for purposes of developing and evaluating your business strategy (Simmonds 1981, p.26) . The SMA will take an external focus and will utilize both financial and nonfinancial data to come up with information necessary for formulating your corporate and business strategies. This is in sharp contrast to what your managerial accountant currently does as he focuses on the internal managerial aspects of the company. The SMA will offer a generic approach to management accounting for strategic positioning of the company's strategic business units (Hoffjan & Wompener 2006, p.237). It will requires an accountant who is ready to embrace new skills that extend beyond their usual areas and liase with the general management, corporate strategists, marketing and product development departments for optimal output (Bromwich & Bhimani, 1994, p.130). In a small organization like Jessup limited, gaining and sustaining competitive advantage is its of paramount importance as you move to the next phase of growth. The following are the roles that the strategic management accountant will play;
Strategic costing and Aligning costs with strategy
The strategic management accountant must align the costs to strategy. The accountant must perform strategic cost analysis. It involves assigning operating costs to activities that caused them for a firm to understand its cost position. This occurs at the operational level so as to get to the required level of detail. In doing this, the accountant will identify the appropriate Value Chain to which costs and assets are assigned. The costs are assigned in line with the activities that cause them (cost drivers). The accountant has to compare the results at this stage with those of the competitor's value Chains. He will identify a few dominant competitors based on their balanced score card reports for these comparisons (Lindahl, 1997).
The results of the comparison will help the accountant reconfigure the value chain. In doing this, cost drivers that escalate costs are done away with. This is done to lower the company's cost position relative to that of its competitors. He will also make sure that this reconfiguration of the value chain doesn't affect the company's differentiation. Finally, the accountant will test the Sustainability of the cost reduction strategy. Only when a firm achieves a lower cumulative cost of performing all its Value Chain Activities than its competitors will it have cost advantage.
Strategic planning, control and performance management
The accountant will perform integrated performance measurement for both financial and non-financial aspects of the firm. This will involve competitor comparisons, benchmarking and trend analysis.
Strategic decision making
The accountant will participate in strategic cost management, downsizing and reconfiguring value adding processes. He will also participate in strategic pricing in view of the competitors and operating environment and the brand value/appeal in the market (Ashton et al, 2005).
Monitoring competitors cost structure
The accountant will analyze the cost structure of the competitors with a view to maintaining a unique market position based on cost leadership. He will get to the bottom of the competitors competitive advantages and activities in their value chain that yield such competitiveness with a view to replicating them in a better and cost efficient way. he will also appraise the company's performance and position relative to that of the organization
v) Measuring the progress towards the objectives
Although progress is measured in a longer term than conventional managerial accounting, SMA compares the set objectives with the actual results. Conventional measurement tools include the balanced scorecard which utilizes multiple objectives or simply the traditional measures of profit, cash flow, return, etc. a model measure that Jessup may utilize might include six measures for strategic performance such as Health, Added Value, Productivity, Diversity, Integrity and Development (Ashton et al, 2005). The six are considered in three different dimensions namely of economic, social and environmental. The following grid summarizes measurement criteria for diversity
The accountant will performs the customer profitability analysis and more specifically lifetime Customer profitability analysis. He will value Jessups customers just as assets of any business entity.
Relevant and irrelevant costs and revenues
Relevant revenues and costs are those that differ in relation to a different course of action. These actions are mutually exclusive alternatives that a firm makes in the course of its operations. If such future revenues and costs do not change according to the chosen alternatives, they are considered irrelevant. Committed costs i.e. costs that have already been set aside to be incurred in future are also irrelevant if they remain unchanged under competing alternative courses of action. Relevant costs are also referred to as differential costs. It is important to differentiate between costs and expenses when defining relevant costs. While costs are the value of resources used up in the pursuit of an objective, expenses are costs chargeable against revenue in a given accounting period. Therefore "cost" falls under economics while "expense" falls under accounting. Conventionally, only manufacturing costs are included in the inventory for pricing and valuation purposes. So Is the case at Jessup Ltd. Other costs are treated as period expenses. For external financial reporting purposes, it is important to classify costs in accordance with the value chain. The following are examples of irrelevant costs
These are costs that have already been incurred and there is no possibility of their being recovered. Related to these are Committed costs which are monies set to be used in future but the decision to use them can't be changed. In a practical sense, committed costs and sunk costs are equivalent in relation to their relevance to a given decision as they do not change with regard to change in decision. Commonly and by mistake, managers may support a decision even after an objective evaluation points at its abandonment. The book value of an asset is irrelevant for the purposes of future decision making. However, salvage value of an asset after useful life (the actual price that the asset can fetch in the market) is a relevant cash inflow. Losses on disposal of fixed assets are irrelevant cash flow since they do not form actual gains in cash. However, tax shield arising from such losses on disposal form relevant costs.
James, the company's finance officer, is a masters student at Oxford University. He has just completed his first year and is preparing to join his second and has already paid for two years tuition fee. He ponders whether to go for the second year and finish his degree or simply drop out to do concentrate on the job and earn 100% of his salary as opposed to 85% earned while on study leave. He however knows that his salary will increase if he completes but also contends that the current job is enough to sustain him and his family. The tuition fee already paid is a sunk cost (irrelevant) while lost earnings while in school for the next year will form opportunity cost. And the opportunity cost of convince them to drop out and get a job. Equally, the expected high earnings in his entire life after finishing his degree pull him to wanting to finish the two years. He knows that the tuition fee for his third year is not refundable under any circumstance.
James paid tuition fee is a sunk cost as it has already been incurred and cant be recovered under any circumstance. It is therefore irrelevant for this consideration. The relevant costs for this decision include his salary for the expected job, his foregoing in regard to loosing prospects for a better job after college and the unpaid fourth year tuition fee.
Three Jessup employees were to attend a customer service course at the Regent Management School. Jane paid $24,000 annual fee for the 3 years as she was a citizen while John, being a noncitizen, paid $48,000 annual fee for the same course. Jacob paid nothing as he won a scholarship. John later qualified for in-state tuition fee when he became a citizen for his fourth year while Jacob's scholarship was revoked just after the end of his third year and could only pay in-state tuition fee for his last year.
the three face the same decision as to whether to attend their final year and complete their studies. Though they paid entirely different tuition fees for their studies for the first three years ($0, $24000, $48000), it is irrelevant for the decision to pay for the fourth year. As such, it would be wrong to conclude that any of them would be more likely to stay and finish.
Opportunity cost refers to the cash flow/profit foregone as a result of taking the next best alternative among several mutually exclusive choices.
Opportunity cost is a relevant cost in as illustrated in the following example;
Jessup has $500,000 available for her to invest. The investment options available include certificate of deposit paying 5% annually for the next five years ($2500) and paying off a $500000 outstanding loan bears interest at 7% and thereby saving the interest expense of $3500 for the five years. The opportunity cost in this case would be a loss of $1000 (i.e. 3500-2500) if the company decides to invest in certificate of deposit.
Â Example 3
Model I printing machine used in the manufacture of Print Ads is already 24 months old with a remaining 4 year useful life. A brand new machine Model 1 machine costs $80,000 and has zero estimated salvage value. The company's Management is considering replacing the machine with a new Model II machine that is better and more efficient. It costs $80000, has a 4 year useful life and zero residual value. The company can also convert the model 1 machine at a cost of an extra $80000 to match the performance of model II. The total revenues will be the same under both machines at $100000 as well as selling and administration expenses at $40000. However, inspection and adjustment costs will be higher for model I at $20000 per month while for model II will be at 6000 per month
Buy Model II Keep Model I
Total revenue 100000 100000
Both options are equal so the total revenue is irrelevant for this decision
Buy Model II Keep Model I
Conversion 80000 80000
Conversion costs are irrelevant as they differ among the two alternatives.
Buy Model II Keep Model I
Selling and distribution: 40,000 40,000
Inspection and adjustment: 6,000 20,000
Inspection and adjustment under are relevant as they differ among the two alternatives while selling and distribution cost are irrelevant.
Activity Based Costing
Activity based costing is a method of assigning costs according to the activities that caused them (Cost drivers). These activities consume resources and the total resources used for manufacture are accumulated and assigned to products and services based on the number of activities involved in the process of providing them. Traditionally, volume based costing systems allocate costs in relation to a single, usually non-volume measure such as direct labor hours which doesn't fit the cause and effect criterion needed in cost allocation (Horngren, Gary &William, 1999). The following are the benefits of ABC system;
In modern manufacturing and service industries, direct labor is increasingly becoming a smaller cost component as a percentage of total production costs. Direct labor is being replaced by machine hours due to the increasing automation. In line with that, an organization's indirect (shared) costs are rising as a percentage of total costs. ABC is keen to apportion costs according to the activities that cause them and therefore it presents an accurate picture of the production costs. Furthermore, due to rapid technological change that has significantly reduced product life cycles for most products, most companies have no time to make cost or price adjustments when they detect costing errors. ABC system ensures constant cost adjustments since each cost object can only be assigned costs incurred as a result of activities performed in producing them. Inaccurate cost measurements make firms to over-cost their products or to incur hidden losses as a result of under-costing and make them fail to identify cost-ineffective activities (Daly, 2001).
Ideal for industries with wide fluctuations in volumes
Some industries (e.g. services) experience wide fluctuations in volumes of output due to various factors. This makes volume based costing systems less ideal for costing their products. Activity based costing directly associates the cost of offering a service to the activities that drive such costs making it immune to the vulnerabilities inherent in volume based costing systems.
Better understanding overhead
In implementing an ABC system, a thorough analysis is conducted of all the overheads to identify the activities that cause them. The cost accountant identifies all activities and activity pools and traces the costs to activities in a bid to establish a causal relationship. It therefore provides insight into the least visible and/or fastest-growing element(s) of the overheads. This way, an organization is able to understand the overheads in a detailed manner and can therefore also identify those that do not result in added value. The management can therefore do away with the non-value adding overheads in their value chain.
Objective and Easier to understand
Traditional volume based systems are hard to understand for most people. This is because they rely on subjective judgment as to what caused costs. As a result, different people will come up with different overhead allocation criteria for the same company. Activity based costing is an objective way to allocate costs in a manner that is easy to understand-according to the costs drivers. Cost drivers are relatively easier to identify as they mirror the way work is done.
Emphasis on unit cost as opposed to total cost
The emphasis of ABC system is the cost object. Traditional volume based system emphasize on the total cost and work backwards to arrive at the estimated unit cost of production. the aspect of unitary or departmental level costs is important in that it enhances the management's ability to make decisions such as make/buy, pricing and forecasting since the unit costs are based on costs reflective of the manufacturing process This helps in controlling costs at the unit level which is easier as opposed to at the organizational level.
Consistent with continuous improvement programs such as Six Sigma
ABC is preceded by a thorough cost analysis so as to determine activities that result in cost. As a result, cost drivers are accurately identified and the total costs accumulated into cost pools are apportioned to cost objects. Non-value adding costs are done away with thus ensuring continuous improvement of production processes and maintenance of competitive advantage. In line with that, the organization can benchmark its process costs or use other performance management scorecards to assess its advances (Karolefski, 2004).
Facilitates the costing of supply chains, processes and value streams
ABC gets down to the basic value adding services in a firm. Consistent with the value chain analysis, a company can come up with the costs of each constituent elements of the value chain. It can therefore identify the most costly processes and make the necessary adjustment to realize cost leadership (and better product positioning) if such is its basis for competitive advantage (Hicks, 2002).
Facilitates activity based management(ABM)
In order for companies to manage costs, managers must concentrate on the activities that accumulate or drive costs. ABC system has an extensive focus on activities that cause costs and thus enables managers to manage costs by identifying them along with their value adding nature (Dolan & Schreiber, 1997). The use of ABC in order to improve organizational financial management is referred to as Activity based management (Cokins, 1998b). ABM aims at improving value for customers thereby improving profits. Critical to ABM is the differentiation of value added costs from non-value added costs counterparts. Non-value added costs can be successfully eliminated without harming the quality of the end product. On the other hand, value added costs cant be done away with without affecting the value of the end product. Care should be taken since there are some value adding costs that are needed such as inventory storage, transportation of raw materials etc. these cant be eliminated entirely in any organization. However, costs of redundancies in the production line can be successfully eliminated or significantly reduced. Most non-value adding activities can be eliminated by carefully redesigning the plant layout as well as the production processes.
Disadvantages of ABC
Expensive and time consuming.
Though advances in technology have brought down system prices, the process of formulating and implementing the system is both time consuming and expensive. For companies producing several different products like Jessup ltd, they that require a lot of resources and time to collect, measure and record information on all their products. Maintaining ABC requires continuous adjustments to take account of changing production processes. Further, Most organizations keep record of costs of resources in separate accounts such as supplies, utilities, purchasing, salaries, material handling etc and it very involving to determine costs incurred in relation to a single cost object (Garrison &Noreen, 1999).
Difficulty in Classifying costs
There are some overheads that are difficult to assign to cost objects even under ABC system. for instance, the managers salary has no direct relationship to cost objects. Such and other business sustaining expenses have no meaningful method of allocation to cost objects despite the fact that they must be offset by the products' contribution (Cokins, 1998a). Though these overheads are not as large as when volume based systems are employed, they form a significant cost that must be arbitrarily apportioned to cost objects. While many argue that these untraceable costs should be allocated arbitrarily, the scientific basis of ABC sharply contrasts with such subjective criteria (Brimson, 1997).