Managerial Accounting and Control (Coursework Sample)

Managerial Accounting and Control
1 Many businesses try to compete on price: that is, they try to provide goods or services at prices that compare favorably with those of their competitors. To do this successfully over time, they must also compete on costs: lower prices can only normally be sustained by lower costs. A strategic commitment to competitive pricing must therefore be accompanied by a strategic commitment to managing the cost base. Explain FOUR forms of costing that an organization can use to manage costs strategically. (6 marks)
ANS:
Total life-cycle costing is concerned with tracking and reporting all costs relating to a product from the beginning to the end of its life. If the revenues generated over the life cycle of the product are also tracked, we can assess its profitability.
Total life-cycle costing can be used to manage costs. Managers will be able to see, at an early stage, the cost consequences of incorporating particular designs or particular elements into products. Where the costs are unacceptable, changes may be made.
Target costing
Target costing is a market-based approach to managing costs. the starting point is to set the target price of a product on the basis of market research, which may include an analysis of competitors’ prices. The target price, less the required profit from the product, will be the target cost of the product. Target costing places demands on managers because the target cost is usually lower than the current full cost of the product. Thus, to achieve the target cost, a systematic approach to cost reduction is often required. A team of managers, drawn from each of the main functional areas, such as design, production, purchasing and marketing, will normally be charged with achieving the target cost. Together they will examine all aspects of the product and the production process to try to eliminate anything that does not add value. This can place considerable pressure on designers, as they are likely to be asked to redesign the product to a specification that is more acceptable.
Kaizen costing
Once the product design and the production process have been agreed, the production phase can begin. Kaizen costing may be used to manage the efficiency of this phase. We saw in Chapter 5 that kaizen costing aims at continual and gradual incremental improvements to the product design and the production process. Like target costing, it also involves target setting: a cost reduction rate will be specified for a period and actual performance will be compared against it. To achieve the required cost reduction, the involvement of employees is normally essential. The suggestions they make can often lead to significant savings. Kaizen costing is closely associated with lean manufacturing, which is committed to the elimination of waste through continuous improvement.
Value chain analysis
To secure competitive advantage, a business must be able to perform key activities more successfully than its competitors. This means that it must either obtain some cost advantage over its competitors, or differentiate itself in some way from them. To help identify particular ways in which competitive advantage may be achieved, it is useful to analyse a business into a sequence of value-creating activities. This sequence is known as the value chain, and value chain analysis examines the potential for each link in the chain to add value. For a manufacturing business, the value-creating sequence begins with the acquisition of inputs, such as raw materials and energy, and ends with the sale of completed goods and after-sales service.
2.) Explain the FOUR measures of the balanced scorecard showing the link between them. (6 marks)
ANS:
1 Financial. This area will specify the financial returns required by shareholders and may involve the use of financial measures such as return on capital employed, operating profit margin, percentage sales revenue growth and so on.
2. Customer. This area will specify the kind of customer and/or markets that the business wishes to service and will establish appropriate measures such as customer satisfaction, new customer growth levels and so on.
3. Internal business process. This area will specify those business processes (for example, innovation, types of operation, and after-sales service) that are important to the success of the business, and will establish appropriate measures such as percentage of sales from new products, time to market for new products, product cycle times, and speed of response to customer complaints.
4. Learning and growth. This area will specify the kind of people, the systems and the procedures that are necessary to deliver long-term business growth. This area is often the most difficult for the development of appropriate measures. However, examples of measures may include employee motivation, employee skills profiles and information systems capabilities.
* A balanced scorecard will be prepared for the business as a whole or, in the case of large, diverse businesses, for each strategic business unit. However, having prepared an overall scorecard, it is then possible to prepare a balanced scorecard for each sub-unit, such as a department, within the business. Thus, the balanced scorecard approach can cascade down the business and can result in a pyramid of balanced scorecards that are linked to the ‘master’ balanced scorecard through an alignment of the objectives and measures employed.
1 Explain FOUR methods that an organization can use to set transfer prices between divisions. (6 marks)
Market prices
Market prices are the prices that exist in the ‘outside’ market (that is, outside the business whose divisions are involved in the transfer). Intuition may tell us that market prices should be the appropriate method of setting transfer prices. Using this approach, the transfer price is an objective, verifiable amount that has real economic credibility. Where there is a competitive and active market for the products, the market price will represent the opportunity cost of goods and services. For the selling division, it is the revenue lost by selling to another division rather than to an outside customer. For the buying division, it is the best purchase price available. The market price, however, may not always be appropriate.
Variable cost
We have just seen that using variable cost is appropriate where the division is operating below capacity. In these particular circumstances, the opportunity cost to the supplying division is not the market price. The division will not have to stop selling to the market in order to supply its fellow division since there is a capacity to do both. In these circumstances, the opportunity cost is equal to the variable cost of producing the good or service. However, this represents an absolute minimum transfer price and a figure above the variable cost is required for a contribution to be made towards fixed costs and profit. Where the division is operating at full capacity and external customers are prepared to pay above the variable cost of the goods, a variable-cost internal transfer price would mean that inter-divisional sales are less profitable than sales to external customers. Managers of the selling division would therefore have no incentive to agree transfer prices on a strictly variable-cost basis (even though the business as a whole may benefit). If top management imposed this pricing method, divisional autonomy would be undermined.
Full cost
Transfers can be made at full cost. In such circumstances the selling division will make no profit on the transactions. This can hinder an evaluation of divisional performance. It will also lead to more difficulty in making resource allocation decisions concerning the level of output, product mix and investment levels within the division, as profit cannot be used as a measure of efficiency. It is possible to add a mark-up to the full cost of the goods or services to ensure that the selling division makes a profit. However, the amount of the mark-up must be justified in some way or it will become a contentious issue between buying and selling divisions. A cost-based approach (with or without the use of a mark-up) does not provide any real incentive for managers of a selling division to keep costs down, since they can pass the costs on to the buying division. This will result in selling divisions transferring their operating inefficiencies to buying divisions. Where the mark-up is a percentage of cost, the selling division’s profit will be higher if it incurs higher costs. On the other hand, where buying divisions have the ability to go to outside suppliers, pressure can be exerted on the selling divisions to control their costs. Although use of the full cost approach is found in practice, it is not an approach that is particularly logical, since it is not linked to the opportunity cost approach. Transferring goods or services between divisions can be based on either a standard (budgeted) cost or an actual cost approach. The case for using standard costs appears to be the stronger.
Negotiated prices
It is possible to adopt an approach that allows the divisional managers to arrive at negotiated prices for inter-divisional transfers. However, this can lead to serious disputes, and where divisional managers are unable to agree a price, top management will be required to arbitrate. This can be a time-consuming process and may deflect top management from its more strategic role. Furthermore, divisional managers may resent the decisions made by senior managers and see these as undermining the autonomy of their divisions.