STRATEGIC MANAGEMENT ACCOUNTING

STRATEGIC MANAGEMENT ACCOUNTING

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Part A

Introduction

The fundamental issue in the costing approaches that is the marginal costing, absorption costing and activity based costing is the way costs of the underlying business’s input resources are best organized and presented. Best organization and presentation of resources aids in identification of individual product, service and total business profit. The choice of costing approach is influenced by the underlying costing method.

Marginal or variable costing

Marginal costing is a costing technique in which single variable manufacturing costs are taken into consideration and utilized whilst valuing inventories and determining cost of goods disposed (Scarlett, 2008, 341). Only underlying variable manufacturing costs are normally taken into consideration in regard to the product costs and are allocated to the products manufactured. The costs mainly include direct materials, direct labor and variable factory overhead. Fixed manufacturing overheads are not considered product costs thus not utilized in valuing of inventories but in the determination of the cost of goods disposed (Avis, 2008, 237). Moreover, fixed manufacturing costs are taken as period costs within the marginal costing since it is a function of time. Marginal costing is a technique of costing that aids the management in taking significant decisions specifically for the price fixation and examination of profitability. It normally reveals the inter-association amidst cost, volume of sales and corresponding profit. Marginal costing classifies cost into two sections viz fixed and variable cost. Variable cost is considered solely in finding the cost of production. Special techniques are normally advanced in finding out the underlying cost of production commonly known as marginal costing. Marginal costing is also utilized in finding out of the cost for every unit up to a particular level and output. Costs that fluctuate with decision ought to be included in the decision analysis

(Scarlett, 2008, 128). Numerous decisions that entail relatively small changes from the existing practice are normally limited in periods thus making fixed costs to be irrelevant in decision analysis.

It is taken as a method of inventory costing where all variable manufacturing costs are included. All the prevailing fixed manufacturing cost is excluded from the corresponding inventoriable costs which are considered to be the costs of a commodity concerning asset when they are incurred (Avis, 2008, 129). In regard to product and service costing, marginal costing system mainly emphasize on the underlying behavioral at the expense of the efficient, features of cost. The focus is mainly on segregation of the costs into the variable elements where the cost for every unit remains similar with the total cost varying in proportion to the underlying activity, and fixed elements where the total cost remain identical for similar duration irrespective of the prevailing level of activity. Since it is cumbersome to accomplish accuracy and oversimplification of the reality, marginal costing information are extremely significant for the short term planning, control and decision making process particularly within a multi-product business organization (Abdel-Kader, 2011, 211-8). Within marginal costing system, sales less the underlying variable cost measures the influence that single product or service make in regard to the total fixed costs sustained by the business enterprise (Scarlett, 2008, 287). Moreover, fixed cost is normally treated as a durational cost that is they are simply deducted from the corresponding contribution in the duration incurred to realize net profit.

Practical application of Marginal Costing

Marginal costing approach is applicable in profit planning in the determination of the profit level of a company in future period. Profit planning is a part of the every operational planning and marginal costing aids the management in the profit planning via calculation of the contribution ration.

Marginal costing is also applied in determination of the profit volume ration. Ration of contribution to sales is an efficient tool for studying the profitability of business (Avis, 2008, 227). It is also utilized in determination of the break-even point

Full or Absorption costing

Absorption costing is an inventory costing method which all variables pertaining to manufacturing costs and corresponding fixed manufacturing costs are involved as inventoriable cost. In regard to the product and service costing an absorption costing system allots a share of entire costs incurred by the underlying business enterprise for every product (Wilks & Burke, 2006, 234-7). Absorption costing is the charging of the prevailing cost both fixed and variable to the production processes and treat all the underlying costs as the product costs. Within absorption costing, fixed overhead cannot be absorbed exactly because of its exertion in the determination of costs and corresponding volume of output. It is normally consider all the prevailing manufacturing costs, variable and fixed costs as costs of production and is utilized in the determination of the cost of underlying goods manufactured and inventories. All manufacturing costs are fully absorbed into the finished goods. Under absorption costing all the prevailing costs are segregated into three categories namely manufacturing, selling and administrative costs. Within the income statement, all manufacturing costs which mainly include variable and fixed costs are subtracted from the sales revenue in order to get the required gross margin on sales and corresponding selling and administrative expenses both fixed and variables are deducted from gross margin in order to arrive at net income.

Activity based costing (ABC)

ABC is an approach of costing that is utilized in monitoring of activities. These activities trace resource and activities to the cost objects based in the consumption approximates. Resources that are mainly allocated to the activities and activities cost objects based on the prevailing consumption approximates.

Application of Activity based costing

ABC systems accumulate overheads for each organizational activity and are allocated to the activities in the production such as products and services causing that activity (Wilks & Burke, 2006, 276-9). The early activity analysis is clearly the most burdensome aspect of ABC hence activity analysis is the considered as a process of identifying appropriate output measures of activities and corresponding resources and impacts costs of producing a products. Activity Based Costing system provide distinct reports that empowers administration to make decisions pertaining to the costs of scheming, transporting and marketing of product Essential facet of ABC emphases on gathering of costs by activities whilst old-style cost distribution focuses on accretion of costs in purposeful locations (Scarlett, 2008, 341).

Marginal costing is more appropriate in making managerial decision than Activity based costing and corresponding absorption costing. This is because marginal costing is easily and practically applicable in profit planning that aids in the determination of the profit level of a company in future period. Profit planning is a part of the every operational planning and marginal costing aids the management in the profit planning via calculation of the contribution ration (Abdel-Kader, 2011, 211-8). Marginal costing is also applied in determination of the profit volume ration. Ration of contribution to sales is an efficient tool for studying the profitability of business. It is also utilized in determination of the break-even point

Part B

Standard Costs and Costing

Standard Costs

Standard Costs is defined as the prearranged yardsticks costs incurred to manufacture a particular unit of commodity under effective and efficient operating situations. It depicts the prearranged cost that is related with a specific product or service (Barnett, 2007, 123). According to the Institute of Cost and Management Accountant, standard costs is define as the prearranged costs that are mainly based on the prevailing technical material, overhead and labour estimates over a particular period of functioning under prescribed set of underlying working situations. Thus, standard costing is defined as an accounting technique that is utilized in the determination of standard cost for every element. It is mainly suited for business organizations that are characterized repetitive activities namely manufacturing sectors. Prearranged costs are thus compared with the actual costs in the process of determining any probable deviation commonly known as variance (Wilks & Burke, 2006, 234-7). Moreover, standard costs technique is applicable in the stock appraisal, purpose of the selling prices, control and performance measurement. A standardized costing system mainly entail four elements namely comparison of actual standardize performance, investigation of any significance variance and recommending of suitable and sustainable modest actions, reporting and analysing variances that emanates from the possible differences amidst standard and real performance, and delineation of standards from the entire operations. This makes standard costing suitable for any type and size of organization.

Variance Analysis

Variance analysis is a process of measuring and assessing the performance of business organization against either underlying standards or budgeted performance targets. It entails breaking down of the prevailing total variance in explanation of effects caused by the utilization of resources differing from the standard and mean cost resources that also differ from corresponding standard. Variance assist in reconciliation of total cost difference through comparison of real standard cost thereby providing reasons for off-standard performance. Management normally advance operations via variance analysis thus correcting faults and deploy resources more meritoriously in order to reduce costs. Differences between real quantity and budget quantity are depicted by static budget variances. Moreover, static budget variance is mainly restricted as it equates the cost and profit of business organization against budget that is archetypically reflects budgeted volume level. Variances computation of any type and size of organization is based on the flexible budget as the stretchy budget normally reaffirms the master budget of the organization utilizing level of productions and sales (Abdel-Kader, 2011, 211-8). Therefore, flexible budget variance of any organization depicts the difference between actual results and flexible amounts for actual output achieved.

Flexible budget cost variances any organization is segregated into dual components namely price variances and efficiency variances. Price variances entail the variation in profits in an organization that results from differences between standard price for a single unit of material and actual price paid. Conversely, efficiency variance mainly measure the variation in organization profit resulting from the change in actual amount of materials used based on the underlying standard quantity allowable for real output (Scott, 2012, 112-8). Relationship between price and efficiency variances for any organization regardless of the size is the examination of the variances in regard to the tradeoffs. Higher priced of raw materials for business organization have corresponding higher quantity of production. Direct material standards are derived from amount of material required in production of each unit and consider suitable material of product dimension and design. Standard price for any material is purely based on appropriate and competitive price in regard to the underlying quantity of material. Thus, standard price in any organization entails economic order amount, discounts and corresponding credit terms offered by the suppliers. Comparison of actual material used within the underlying standards calculated material price coupled with determination of the material usage variance.

Business organization normally uses mix and yield variances that incorporate direct material usage variance measures of change in regard to the total material cost prompted by utilization of a non-standard quantity of material within production. Discrete components of input are combined during the process of production in order to help determination of production of an output of definite components. The subsequent outcomes are seen on the output process that differs from approximation. The material mix variance mainly measures change in cost due to corresponding change in input elements of the prevailing input mix within any organization. Material yield variance measures change in cost due to any unconventionality in output within an organization from the prevailing standard procedure yield. Substitution of different budget extents, material and labor productivity variances and are broken into the mix and yield variances. Mix variance reflects the effects on profit in place of the inputs and having different standard costs (Abdel-Kader, 2011, 211-8). The yield variance designates amalgamation of the aptitude loss or expansion. Understanding of variances is intricate for any organization regardless of the size. Variable overhead price variance is determined by the department within an organization and aid management in examining of each element that is not within the firm. It is caused by change in prices of variable overhead elements. Moreover, variable overhead efficiency variance formula adopt the existence of flawless cut comparative connotation between cost driver such as direct labor hours, machine hours and variable overhead expenses.

In standard costing system, a prearranged rate applied in fixed overhead cost is calculated based on the total anticipated fixed factory overhead and total anticipated fixed factory overhead (Scott, 2012, 112-8). Thus, fixed factory overhead is applicable in form of variable cost whilst fixed overhead rate for each unit is solely valid for particular volume level. Flexible budget for the fixed overhead is similar to the corresponding master budget when the flexible budget activity level is in a particular range. Moreover, no fixed overhead efficiency variance is calculated in the short run since it is not affected by efficiency. Standard variable overhead rate is utilized where the underlying overhead fluctuate with activities. Nevertheless, numerous diverse activity measures exist thus making it significant for organization in the identification of measures that influences most overhead cost (Scarlett, 2008, 149).

. Variable overhead rate for every unit is applicable to the standard labor and in the computation of standard variable cost for every unit. Two variances computed for variance overhead are mainly variance overhead expenditure variance which equate with the prevailing difference amidst the budgeted flexed variable overheads for the corresponding real direct labor. Variable overhead proficiency variance depicts the difference amidst the standard hours input and the corresponding real hours output for the period multiplied by the underlying standard variable overhead rate.

Overheads are massively autonomous of alteration within activity and remain unaffected in short term over underlying broad ranges of activity. Budgeted yearly fixed overhead is normally divided by the corresponding budgeted level of activity in the determination of standard fixed overhead rate for every activity. Direct labor standards are consequential of analysis of activities required for different functions. Machine hours are used for machine related overheads and direct labor hours consumed. The standard rate is germane to standard labor for each unit to calculate standard fixed overhead cost for the commodity. Output variance results emanating from centralizing fixed costs and quantity pertaining to fixed overhead is engrossed by the prevailing product which contradict production level used in calculation of the predetermined overhead rate. Organization utilizes output level variance in determining cost not used in the production of the master budget volume. Variance is calculated through employment of absorption costing system since it possess static overhead ,which is time cost of the underlying variable costing structure. Sales-Price variances of any organization entail measuring of change in profit of actual selling compared to the budgeted prices. It is normally classified under sales variances and used in reflection of the competitive factors that an organization possesses little control over. Moreover, sales-price variances are normally utilized by business organizations to reflect the problems that professed desirability of an organization’s products related to the underlying competitors. Sales variances are used in the analysis of performance of the sales function in any business organization which is identical to the manufacturing cost.

Total fixed overhead variance of organization is the difference between the underlying standard fixed overhead charged to manufacturing and actual fixed overhead spent. The under and over repossession is mainly due to expenditure that arise from fixed overhead spending. Moreover, fixed overhead volume variance emanates from actual production differing from budgeted production. In several product organizations sales-volume variance is commonly decomposed into the sales quantity variance and sales mix variance. Sales-quantity variance is used in calculation of change in revenue within quantity of yields sold. It is classified into market share variance and market size variance. Market share variance separates the impact in capturing extra market share than budgeted. Market size variance is used in separation of impact on the organization’s revenue in regard to change in whole market size. Sales-mix variance is used in the process of measuring alteration of revenue from change in the underlying mix products sold. Favorable variance reflects the actual sales mix that pertain to a relatively higher than corresponding budgeted quantity of products that possess upper contribution margins. Contrariwise, unfavorable variance emphases on the actual sales mix that is relative to the quantity of products having lesser contribution margins.

Variances require that substances which are different normally fail to reveal the problem within the management of organization. The problems make variances to have unfavorable direct materials proficiency variance due to the pitiable design of the commodity, inattentiveness of workers, inadequate training of workforces, inappropriate assignment of labor and excessively confident standards (Barnett, 2007, 245). Moreover, variance analysis is complex by the inter relationship in the variances and occur in buying of poor quality material, which result to slowing down of workers efficiency hence making unfavorable labor proficiency variance. Where labor hours are computed in the form of cost distribution and based on the variance overhead cause a negative variable overhead proficiency variance. Standard costs variances possess no profit and loss information. Application process of standard costing is purely based on the reports on actual costs. Few organizations have added back the variances whilst supplementary up to dated material standards are approximated in the form of actual costs. Mainstream of the standard cost organizations calculate material and labor variances in controlling underlying purposes (Wilks & Burke, 2006, 234-7). Overhead variances are less used by organizations therefore company normally sub divided both underlying adjustable and corresponding fixed overheads.

Conclusion

Most of the manufacturing organizations use standard costing and are extremely selective in the application of the variance analysis especially overhead variances. Thus, they tend to utilize fixed overheads that are normally scarce. Managers normally concentrate on the business locations that do not meet the set expectations and predominantly assume the basic parameters that conform to the expectancy (Barnett, 2007, 123). A properly advanced and understood standard costing system having complete input coupled with fixation generates a positive impudence towards cost control in the entire organization. Modern technology and recording software authorities undertakes instinctive variance analysis without requirement of complex manual computations. Design of standard costs enables an organization to accept detailed variance analysis and aids in embellishment of differences amidst actual proceeds and budgeted returns. Variances are seen as sign of problems in regard to investigation that is demanded in the identification of the causes of the problems. I therefore concur with the statement that standard costing and Variance analysis are suitable to any type and size of organization.

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