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Managing accounting plays very important role for the success of Manac plc. in the future. In the reality, the company profit did not meet the objective. It might because of different problems, for example high actual expenses, low selling price, and cannot control expenses. Thus, in order to solve the problem the company should apply different models affecting the pricing decisions, santandard costing and variance analysis, and also activity-based costing system.
In this case, the company demand is elastic. Besides, the company should apply full cost plus pricing and variable cost plus pricing for long-term and short-term pricing decision respectively. Moreover, in order to control the cost the company should apply standard cost instead because of it is suitable to the company's product characteristic which require high technological specification. The other aspect also can affect to pricing decision of the company is taxation. In order to make more profit, the company can be more flexible in pricing of different subsidiaries in different countries. Otherwise, besides pricing decision, Manac plac also should apply standard costing, variance analysis and activity-based costing system in order to control the expenses more effectively.
Overall, according to the report's analysis and evaluation, the company can have an overview about how to control pricing and expenses more effectively.
TABLE OF CONTENTS
Manac plc is a large company. The company produces and sells a range of standard electrical goods in some countries. In the reality, the company's approach to strategic management accounting is standard costing and absorption costing. However, the company is not meeting its budgeted target profits. It might because of high actual expenses, low selling price, and cannot control expenses. Therefore, this report is produced in order to consider the reason for the lower than expected profits, bringing a comprehensive review of variances and also providing solution for this situation.
THE MODELS AND CONCEPTS AFFECTING THE PRICING DECISIONS
According to University of Sunderland (2008), price is important to the company. By making the right decision, the company can survive and make profit. Thus, understanding the models and concepts affecting the price decisions is very important.
First of all, in order to make pricing decision, the company needs to analysis the demand for the product and the level of output the firm produces (University of Sunderland, 2008). There are two kind of demand, which is elastic and inelastic.
Figure 1: Inelastic demand and Elastic demand curves (http://mmoorejones.com/2011/06/13/economics-lesson-price-elasticity-of-demand/)
In this case, assume that the company produces and sell electrical products, for example, floor lamp, air conditioning, television etc. In this case, these products have substitutes for them, thus they have elastic demand. It means that a small increase/decrease in price causes a large decrease/increase in the quantity demand (Nguyen, 2012). The customers will be more sensitive in price. They tend to buy substitutes product, when the price of the company increase and in contrast. For example, if the price of air conditioning increases remarkably, they might want to buy ceiling fan of other competitors, which has much lower price. Besides, because of the large business scale, Manac customer can be easier to find substitutes than others. Therefore, if the company increases the price, the profit might be decrease. However, this theory is difficult to apply. In the reality, Manac have many different products, thus measuring the change of demand and change of price is very complicated. Besides, the price of the product also should be based on the target customer buying capacity. Assume that the air conditioning of the company is makes from high quality material and has high class target customer. In this case, the customer might care more about the quality of the product than the price, thus, the increase or decrease of it does not have much impact. Moreover, the price is not only influenced by quality demanded, but also other criteria, for example, the figure of products and markets, the customer buying behavior etc.
Next, because Manac plc is a large company, which has strong position in the market and take advantages in inputs and raw materials, thus, the company could be a price maker/settler. In the reality, it will have to face to two kinds of decisions, which are long term and short term. According to University of Sunderland, for short-term pricing decision the incremental costs of accepting an order should be presented. It is used when spare capacity is available, the bid prices are a one-off price that will not be repeated, and the order will utilize unused capacity. Nguyen (2012) stated that, there is a model affects on pricing decision in short term which is:
Selling price = variable/marginal cost + pricing
"This method determines the sale price by adding a profit onto either marginal cost of production or marginal cost of sale" (University of Sunderland, 2008). The advantage of this method is that the company can apply easily and also can have variable mark-up (Appendixâ€¦.). However, this method is only useful in short-term price decision, but for long-term the company have to make sure that the price can recover all fixed costs and make profit (College Accounting Coach, 2006)
Turning to long-term pricing decisions, there are three approaches to pricing (University of Sunderland, 2008)
In pricing customized products, firms should use accurate costs. The company should use Activity Based Cost information in order to provide a better understanding of cost behavior.
For non-customized products, pricing is based on direct negotiation with the customers
Using target costing for non-customized products. The selling price, rather than the cost, is the start of the costing process
In long-term, the selling price is equal to full cost plus pricing (Nguyen, 2012). Acording to Accounting tools (2012), if Manac plc uses this method, the company is very likely going to earn a profit on sales as long as the budget assumptions used to derive the price turn out to be correct. In contrast, this method also has some limitations (University of Sunderland)
Fail to recognize that there will be a profit-maximizing combination of price and demand
There may be a need to adjust price to market and demand conditions
Suitable basis for overhead absorption must be selected especially when a business produces more than one product
In order to apply this method, Manac has to calculate many times per year, which is complicated. Thus, in order to reduce the limitation of this method, the company also needs to control cost effectively. In the reality, there are two cost systems which are actual cost and standard cost. "Actual cost is the total amount of materials, labor costs, and any directly associated overhead costs that can be charged to a specific project" (Wise Geek, 2012). Although, standard cost is also aimed to calculate the profitability, it is being the budgeted cost of a single unit of production, but is now often appropriate in service industries (University of Sunderland, 2008). In this case, because Manac produces and sells electrical goods, which requires high accuracy in technology specification, the material cost is very exact. Therefore, it can able to apply standard cost easily. Moreover, the company also can make price decision in whole month which is more trustable than in the beginning or the end of the month in actual cost.
Besides, making price decision also depends on the type of products. For example, if the product is customized, the profit margin will depend on the average of market profit margin. In this case, the company should apply penetration pricing policy, which means the price should be reduced in order to increase the market share. Otherwise, if product is newly designed, the company should use price skimming policy. According to University of Sunderland (2008), this policy is an attempt to exploit sections of the market that are relatively insensitive to price changes. However, the company should not use this policy if there is a number of substitutes are being marketed.
Finally, the other criteria that Manac also should be care about, when it makes price decision is taxation. Because the company is participated in different countries, it can have cross border transactions among parents and subsidiaries, which might have different income tax. In the reality, the after tax profit is equal to profit deduct minus income tax (Nguyen, 2012), thus it will be higher when the company can lower the income tax. In different countries, the company will be taxed in different rate, therefore, the company can reduce tax responsibility by increase profit of products in subsidiaries which have low tax and reduce profit of products subsidiaries which have high tax. Thus, the net income will be increase.
THE ROLE OF STANDARD COSTING AND VARIANCE ANALYSIS IN MANAGEMENT ACOUNTRING
In order to control expenses of the company more effectively, Manac should use standard costing and variance analysis.
"Standard costing works by comparing the standard, pre-determined costs with the actual costs, and then analyzing the reason for an variances, but in more detailed way than in budgetary control" (University of Sunderland, 2008). It plays important role in managing accounting for the company. The company can be provided a basis for performance measurement, for valuing stock, and also enable control by exception reporting by using standard costing (Nguyen 2012). Besides, Manac can decide the cost should be and evaluate actual production performance. It helps the managers to make important decision, for example, setting up production plans and price policies. By using standard costing, the company also can build up effective cost reporting system. However, according to Periasamy (2005), there are also some disadvantages of it. In the reality, standard costing is lack of technical aspects and difficult to establish standards. It also cannot be used in non-standardized products and fixing of responsibility is difficult. However, because the products of Manac require high technological specification and the company already used this system; standard costing is relevant and reliable for the company.
Turning to variance analysis, according to Cross (2012) it is tool applied to financial and operational statistics in order to identify the cause of the variance. It assists Manac to maintain and control the expenses by monitoring the actual costs. Besides, variance analysis helps to fix the responsibility, thus the manager can identify and understand the amount of the variance, the reasons for the difference between actual performance and budgeted performance, and also remedial actions to be taken (Periasamy, 2005). The following diagram illustrates the steps of using variance analysis to control costs in Manac plc.
Figure 2: Using Variance Analysis to Control Cost (Gail, 2005)
However, it also has some limitations. In the reality, variance analysis is costly and takes long time for analysis. Besides, because of the business scale of Manac, it will become complicated when collecting data from different countries. It provides for the company accounting data about variances but not the reason of it. Thus, the company cannot have information in order to solve the difference. Moreover, because of using current data, variance analysis also cannot assist Manac to make decision for future.
In order to solve these limitations of variance analysis, the company needs to build up accounting central system which connect accounting system in different subsidiaries in different countries. Besides, because of using standard costing already, the accounting data is available, thus the company can reduce the limitation of time.
In generally, standard costing and variance analysis assists the company to control the costs and expenses more effectively. Besides, they play important role to company in order to have guideline for long-term or short-term plan and success.
THE ADVANATAGES AND DISADVANTAGES OF ACTIVITY BASED COSTING SYSTEM
In the reality, the company uses absorption costing system. "Absorption costing is an old method of product costing which aims to include the total cost of product (unit, job and so on) an appropriate share of an organization's total overhead" (University of Sunderland, 2008). This traditional method is easy for implementation in the company. This method uses direct labor hours to calculate cost, while Manac Plc is a large electrical goods company, which mainly use machines in production. Thus, this current costing system of the company is not useful anymore. Besides, based on it, the manager does not have enough data to make decision, because it excludes non-manufacturing costs.
In order to repair the limitation of the current absorption method, Manac plc should replace it by Activity Based Costing system (ABC). Differently from absorption costing, ABC involves the identification of the factors which cause the costs of an organization's major activities (University of Sunderland, 2008). According to Nguyen (2012), there are three steps in order to design ABC system:
Step 1: identify an organization's major activities
Step 2: Identify the factors which determine the size of the costs of an activity or cause the costs of an activity. These are cost drivers
Step 3: Collect the costs associated with each cost driver into what are known as cost pools
According to example of the difference between traditional and ABC system (Appendixâ€¦.) with the same data but the cost per unit, which is calculated by ABC is different. Based on it, Manac is able to be used better in designing products or redesigning production than by traditional method because the data is calculated in more detail. Besides, ABC can be used for measuring the effectiveness of business activity process of the company. The data of ABC method assists the manager to identify the relation between time, quality, productivity, flexibility and also costs of Manac plc. According to Hurngen (1992), ABC emphasizes activities as collection main costs objects. Then the costs incurred in this activity will be allocated to the object in order to count the cost of operation, that this object was used. ABC does not replace for the traditional methods, but it adds the ability to handle and provide information in order to make short-term or long-term decision for the company.
Otherwise, ABC method has some benefits and also limitations. Firstly, ABC provides information about more accurate production cost, which assists Manac manager can identify profitability better, and also evaluate product price, type and others criteria. Next, ABC helps to measure activity costs more exact. Bases on it, the manager can improve products, productivity process, and increase the value for customer by the lowest cost. Besides, ABC assists manager to indentify non value adding activity, cost behavior and also potentials to improve cost estimation. ABC allows Manac to evaluate the relevant costs, when it makes business decision. Besides, according to Nguyen (2012), Manac plc also can take more advantage when it use ABC system, for example, the company can have greater understanding of customer profitability and identify non adding value activities. Otherwise, the company can also identify and understand of cost behavior and potentials to improve cost estimation by statistics about production cost in ABC system.
Turning to the disadvanteges of ABC, this method does not involve other costs, for example, advertising and promotion cost, R&D cost etc. because these costs are period costs. However, in the reality, they are the added costs for each individual product. Moreover, in order to develop and implement ABC, Manac has to spend a budget and it wastes a lot of time. However, because Manac is a large company, the company might not affect much on financial problem. In the reality, Manac plc might need over 1 year to prepare and apply it. Otherwise, because the company takes place across a number of countries, it might have to spend more time for standardization all ABC system in each country and has to hire specialist for training accountants. It might be very complicated. Besides, to build up effective ABC system, the company also needs the co-operation between departments in order to have specific costs of activities. The company also has to count more and requires new account software system because the current software might be not useful and need to be replaced. It will cost and need time to apply new software for all accounting system of the company in different countries.
To sum up, comparing traditional and ABC system, Manac plc should use ABC costing system. In order to solve problem of ABC system, the company should hire specialist and create training course for accountants from different countries. Besides, by using account software, the company can standardize costing system and easier to control in the future.
In conclusion, the reason for the lower than expected profits of Manac plc comes from variable factors of pricing decisions. Therefore, with the analysis and comparison above, the company should use standard cost and activity based costing system as a part of its approach to strategic management accounting in order to meet its budgeted target profits.