Importance Of Management Accounting And Activity-Based Costing For Organizations

Management Accounting

In the given case, the CEO of Pearson company is in need of the management accountant as he has heard that the management accounting system can be very beneficial for the company in terms of providing both the financial as well as non-financial information to the managers as well as the employees (Bromwich & Scapens, 2016)

Management accounting is a branch of accounting which provided the analysis of the financial data and the business activities so that the decision making can be enabled by the internal management of the company. It helps in day to day short term and long term decision making. It is different from the financial management as it is not statutory and compulsorily required as in the case of the financial management. It depends upon the requirement of the company and can be employed anytime and at any scale. There is no particular format or law or rules or standards for reporting of the same (Alexander, 2016). Unlike the financial accounting which produces the reports annually and for the external stakeholders, the management accounting is mostly for the internal requirements of company and can be daily, weekly or of any period. Some of the typical management accounting reports being prepared to enable decision making by departmental managers and CEO are ageing analysis of payable and receivables, cost cutting measures, cost optimization measures, variance and trend analysis, inventory days and outstanding analysis. It is one of the critical function in the organization and helps in planning, decision making and the controlling functions. It sets up the standards and the benchmarks against which the actual performance is being measured and the variances are being established. Budgets are the forecast and the laying of the platform as to how the company can achieve profits and thus is a way of performance measurement as well (Barnes, 2015).

The management accounting function is well known for planning and the controlling functions through regular monitoring of the same. It considers both the financial as well as non-financial information as well the quantitative and the qualitative data points. Some of qualitative information which is being considered are employee morale, environmental awareness, employee safety, company’s image and reputation in the market (Raiborn, et al., 2016). Some of the basic planning and controlling functions undertaken by the management accountant is cost accounting, budgeting, performance evaluation, special projects, SOX, tax reporting and filing and external reporting as well. They are the ones who decide and recommend to the top management as to when the prices should be increased or decreased, whether the company should enter the deal or not and providing the alternative courses of action, etc. Thus, it has been rightly said that “management accounting helps organizations in planning, decision making and controlling functions.”

Activity Based Costing

a. In the given case, the ABC costing and its relevance has been discussed in detail. The same was being used by General Electric back in 1960s and then its widespread use began in the 1980s in the US but off late the same is being started to be used by many companies as it leads to greater profits and helps in company in many product related plans and strategies like that of product pricing, profitability and emphasis(Baker, 1989). Likewise there can be various reasons for the implementation of the ABC system which may force a company to consider implementing it. Some of which are listed below:

1. It helps to reduce the overall cost and helps in the proper allocation of the costs. It gives meaningful financial information based on which several decisions are being taken.
2. It also helps in downsizing the operations when it is not effective and helps in finding out the critical points which needs to be removed from the value chain, thus making the company competitive(Bennouna, et al., 2010).
3. It helps in determination of the product service costs and proper allocation of the manufacturing and other overheads such that there is no overvaluation or undervaluation of the products.
4. It is one of the great enablers in decision making especially in make or buy decisions of the company or if any activity needs to be subcontracted to the external agency.
5. In a company where the product is being manufactured post going through several departments, ABC costing plays an instrumental role in cost allocation and thereby setting up of the transfer prices(Goldmann, 2016).

                                                   

b. There are various examples where we can see that the ABC system results in more reliable product costs as compared to the conventional labour based product costing system. Some of them are listed below:

1. Though both the methods are being used to allocate the indirect costs based on a cost driver, labour based costing method used the predetermined rates of allocation which were inaccurate and was mainly based on the average rate. On the other hand, activity based costing has more accurate cost drivers and is not unrealistic(Kew & Stredwick, 2017).
2. The traditional method was simpler and no logic was involved whereas ABC costing is more complex and is backed by a reasonable rationale which leads to correct pricing of the product.
3. The splitting of the fixed and the variable costs is often unrealistic in case of traditional costing system and thus it leads to inaccurate costing and higher value of the closing stock thus making the data not worthy of financial decision making(Trieu, 2017).
4. Nowadays, most of the operations of the company is being automated and very less of the activities is labour driven and hence it renders the traditional system useless.

These are some of the ways and reasons which hints that the ABC system can help in more reliable costing of the products.

c. Off late there has been a shift in the focus and the use of the ABC costing from accurate product costing to using it as a way of better cost planning and as a cost reduction measure as it is one of the techniques of costing which not only highlights the productive areas to emphasize upon but also the unproductive and inefficient areas of operation which should either be shut down or should be removed from the operation cycle(Linden & Freeman, 2017). Thus the process helps in cost planning and reduction of the costs. It also plays an instrumental role in making management decision as to make or buy a product or to outsource it to a different company so that the cost can be saved. It gives an efficient analysis of costs to the company so that the better planning can be done via budgeting and forecasting measures. This is the main reason why the use of ABC has gained importance amongst the companies and it serves the dual role of reporting of the costs as well as giving out ways for reducing the same.

d. Activity based costing is a method whose primary objective is allocating of the indirect costs and the overheads correctly and accurately amongst the different products and services, divisions and departments so that the appropriate pricing and costing can be done and no overvaluation or undervaluation of the products is encountered(Dumay & Baard, 2017). This is an effective way of knowing where the cost can be saved and how the same should be distributed amongst the activities. The overall analysis helps the management in knowing the problem areas and where the cost can be saved and where the more profit can be earned. The cost volume profit analysis is used to determine the rate of change in profitability of the entity with respect to the change in costs and the demand and the activity based costing plays an instrumental role in such an analysis. When there is an improvement in the process of the company, there is a change in the resources mix required to manufacture the product and therefore the profitability as well as the sales is being impacted. ABC technique helps in determining this relationship as well.

References

Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp. 411-431.

Baker, W., 1989. Why traditional standard cost systems are not effective in today’s manufacturing environment. Industrial Management,, 31(4), pp. 22-24.

Barnes, J. L., 2015. How to Tell If Standard Costs are Really Standard. Journal of Management Accounting Research, 25(3), pp. 130-143.

Bennouna, K., Meredith, G. & Marchant, T., 2010. Improved capital budgeting decision making: evidence from Canada. SCHOOL OF BUSINESS AND TOURISM, 48(2), pp. 225-247.

Bromwich, M. & Scapens, R., 2016. Management Accounting Research: 25 years on. Management Accounting Research, 31(1), pp. 1-9.

Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, p. 145.

Dumay, J. & Baard, V., 2017. An introduction to interventionist research in accounting.. The Routledge Companion to Qualitative Accounting Research Methods, p. 265.

Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, 4(3), pp. 103-112.

Kew, J. & Stredwick, J., 2017. Business Environment: Managing in a Strategic Context. second ed. London: Chartered Institute of Personnel and Development.

Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), pp. 353-379.

Raiborn, C., Butler, J. & Martin, K., 2016. The internal audit function: A prerequisite for Good Governance. Journal of Corporate Accounting and Finance, 28(2), pp. 10-21.

Trieu, V., 2017. Getting value from Business Intelligence systems: A review and research agenda. Decision Support Systems, 93(1), pp. 111-124.