Managerial Accounting
Evaluation of Contemporary Issues in Management Accounting
The last several decades within the business world has witnessed major changes leading to a much faster changing competitive environment. The continuous advances have altered the way in which managers should conduct themselves with regards to the day to day running of an organization. The financial techniques administered by managers are vital with accordance to the way the business is performing. Firms with poor management accounting (MA) will more than likely suffer in performance and meeting company objectives. As Glynn et al. (2003) states management accounting is especially relevant to planning, decision taking and control. Making the right decisions will aid the managers in their work towards cost accounting to capitalize on the measurement and control of production and other costs which is a major task within their work load. Until recently, MA had been criticized for failing to provide timely and accurate information (Johnson and Kaplan, 1991). In response, firms have started to drop the use of traditional approaches to product costing and adopt new costing techniques including the most common, Activity-Based-Costing (ABC). A troublesome area within MA has been the inaccurate overhead allocation of costs to products. In the past, the bases used for allocating overhead were either volume driven or financial measures. The idea behind ABC is that it is an activity that drives costs. ABC relates to the cost of an overhead activity directly to the product that demands that activity (Atrill & McLaney, 2002). ABC systems refine costing systems by focusing on individual activities as the fundamental cost objects and are more finely structured costs in the cost pool along with their cost drivers which lead to more accurate costing of activities. There are different stages that a firm must go through to implement ABC into their business, these are defined in appendix one. Under Traditional Cost Accounting (TCA) there is a simple method by which to implement allocation of overhead for the purpose of arbitrarily assigning indirect costs (overhead) to cost objects (products or services). When using TCA, the sum of a company’s overhead is allocated among products based on some sort of volume measure (Proctor, 2006). In TCA it is assumed that there is a direct relationship between overhead and the volume of output based on the volume measure. The different stages of implementing a TCA method are demonstrated in appendix two. TCA is now outsourced in most organizations. This is due to the effect that product costing serves an important function in an organization and also helps in achieving goals and to implement some principles like setting targets for competitors, growth and improvement, coordination between units and processes and measurement and control. ABC has become an increasingly popular process for which many organizations are replacing traditional methods that no longer meet their demands. As Reinstein and Bayou (1997), argue the switch from the traditional system to an activity-based costing (ABC) system opens new avenues for eliminating waste and reducing costs. Implementation of ABC provides management with a different point of view on the profitability of products and services, providing insight into pricing. Middle management and technical performing organizations are involved in the line item reporting provided within the ABC system, enabling management to achieve more responsibility of reported information throughout all levels of the organization. By understanding how resources are transformed into products or services, and by focusing on the cost of activities, ABC helps an organization and its managers to obtain a greater understanding of how costs behave and which activities create significant amounts of cost. Firms can then begin to control their costs based on tangible activities rather than relatively uninformative general ledger or cost centre reports. Stevenson & Barnes (1996) stated that ABC can more realistically model the cost structure facing businesses today. As agreed by many other authors, ABC is highly accredited to business’ in society today than the TCA due to competitive environment and advances in technology (Proctor, 2006). The improved accuracy within ABC is accomplished by tracing costs to products through activities. Essentially, an attempt is made to treat all costs as variable, recognizing that all costs vary with something, whether it is production volume or some non-production volume related factor. Both manufacturing costs and selling are traced to products in an ABC system. In traditional full absorption costing indirect manufacturing costs are allocated to products on the basis of a production volume related measurement such as direct labour hours. Furthermore the significant differences between traditional systems and activity based systems are: How the indirect costs are assigned and which costs are assigned to products. The main differences are also demonstrated in the diagram in appendix three. Most traditional costing systems utilize a single basis, (e.g. direct labour) to distribute the indirect costs to all products and services. This method of allocating indirect costs commonly results in erroneous cost data. Often products which have high volume are over costed. Likewise, the cost of lower volume products are often understated, and many of the indirect costs of these products are overlooked. Rather than relying on a single basis to distribute costs, ABC assigns costs to activities and products based on how the costs (resources) are actually consumed by the process or product. By moving away from traditional cost allocation methods and using improved ABC methods of tracing and assignment, ABC provides managers with a clearer picture of cost of processes and the profitability of customers and products. As Helberg et al. (1994) states ABC provides answers that can be crucial to the survival of the company, so it is imperative to make sure the right decisions are made. ABC differs from TCA and is advantageous as overhead costs are broken down into activities that cause the costs. The determined results can help management implement a more thorough understanding of product costs and they should be able to see the relationship between product complexity, product volume and product cost. This would be vital information for pricing decisions and profitability strategies. Traditional methods would not be able to give a firm this data which could give a sustainable competitive advantage. Activity Based Costing accurately predicts costs, profits, and resource requirements associated with changes in production volumes, organizational structure, and resource costs for the present and the future. Where in Traditional Cost Accounting, although future costs are somewhat predicted based on the current allocation of costs, the accuracy of those predictions is dependent upon the strength of the correlation between the selected cost driver as it relates to the actual usage of overhead. If a company is to rely on such predictions for future product costing it could hinder business performance rapidly. This is also stated by Glynn et al. (2003) as he denotes the total cost figures can understate the ‘real’ cost and these costs will not be sufficiently accurate or reliable for use in forward decision making. Activity-based costing requires a much more detailed breakdown of costs into activities that cause costs. Under TCA the drawback of assigning costs based on a predetermined overhead rate is the assumption that the selected cost driver is what drives a large percentage of the costs in an organization. In most organizations, there is no one single cost driver, rather a multitude of cost drivers. A company should implement ABC only if it thinks the benefit from improved management decisions will outweigh the cost of establishing and maintaining the new cost system. Furthermore, Activity Based Costing is not appropriate for every company.
