Research Korner: Management Accounting

Application of ABC method for a vacuum cleaner firm : A case study of manufacturing and costing

Introduction Although not as stylish and elegant as the automobile sector, the UK vacuum cleaner industry has over 93% forecasted household penetration and at least six million units sales each year (MTProg 2006).  However, along with the growth forecasts, only less than half of the future sales will be accounted for new and additional unit buyers.  This is an indication that the industry is facing market contraction that triggers stiff competition.  Vacuum cleaner manufacturers must be able to provide innovative versions of earlier products as replacement accounts for almost 70% of future sales.  Dyson Corporation, the inventor of bagless vacuum cleaners, is one of industry players in the UK market.  It is established in 1993 by James Dyson in Wiltshire (Dyson Website 2008).  Central to the success of the company is the cyclone technology, formally referred as Root CycloneTM, which uses centrifugal force that separates dust and dirt from the air which allows stable suction capabilities, cleaner air discharge and other value-added features.  The technology’s prototype called G-force that is sold in Japan has even hit a price of $2,000 per unit in 1991.  Its featured online products are broadly classified into three categories; namely, upright, cylinder and hand-held. There are at least twenty Dyson vacuum cleaner models available in the market.  They are marked DC1, 2 and so on reflecting the current innovation from the original G-force model which varies on color, weight, suction power, filter ability and other upgraded features.  Aside from its major vacuum cleaner business, Dyson also entered but discontinued production of innovative ball-barrow (i.e. a wheelbarrow that uses plastic ball instead of metal wheels) as well two-drummed washing machine (e.g. for stronger dryer).  Currently, it introduces a breakthrough hand dryer called Dyson Airblade which only requires 10 seconds to dry the wet hands.  The quality of their vacuum cleaners is guaranteed through testing for bacterial growth, continuous prototyping for improvement and diligent testing for endurance and reliability.            Operational Control  The innovative nature of Dyson situates its budgeting position on zero-based method particularly on the production of a series of G-force improvement models.  It is also showed on how the company confronted production risks with expanding product lines such as ball-borrow and washing machine including potential success in its breakthrough hand-dyer.  Zero-based budgeting (ZBB) necessitates Dyson to allocate its annual budget starting at base zero.  This means that previous year-end income and expenditure figures are seemingly useless in creating budgets for highly-innovative products.  Due to this, controlling performance and costs for laboratory prototypes post problems and the firm must take action to prevent past losses in its ball-borrow and washing machine inventions.                    For an effective ZBB, determination of underlying costs for the ambiguous prototype is vital.  This would help in appropriate pricing using internal data and would tell whether the company has the price advantage or simply innovative upper-hand to existing competitors.  This stage is important because this is the part by which the firm will create cost parameters and will be use in every financial metric that will be applied in the future.  If the parameters are wrong, Dyson will price its products on a sub-optimal manner because relevant costs are not injected in the performance analysis.  In aggravation, this mistake will be carried into the life cycle of the prototype from its introduction to the market, growth and eventual demise.  Further, even though correct parameters are installed, there are adjustments to be made on a periodic basis.  This is because newer products face greater influence from the external environment such as regulation, prices of raw materials and response from distributors.  In effect, creating a trial-and-balance budget (e.g. flexible budgets) using the ZBB framework is necessary.    In product upgrades and marketing of new accessories, ZBB would be shed proxy from incremental method.  As mentioned earlier, the vacuum cleaner industry is showing signs of market contraction which provide opportunities to offer newer models or product/ accessory upgrade.  For the latter strategy, incremental method demands reference from previous cost performance which is likely on an annual basis.  A vacuum cleaner model will be positioned as a stable production.  As a result, previous cost parameters and periodic adjustments are highly relevant to future engagements such as upgrades and development of product add-ons.  In fact, based on the twenty models that Dyson developed over the years since 1993, much of the improvements have singular platform which is the G-force model.  ZBB is largely evident to extreme developments of G-force and also creation of ball-barrow, washing machine and had-dryers.             Activity-based costing (ABC) method might offer the best costing practices to Dyson and probably finally succeed in product introduction and support its innovation-centered design culture.  The method will define major activities in the creation of the firm’s products.  This may include research design, testing, prototyping, raw material acquisition, machining, quality assurance, receiving and packing.  These activities have substantial overheads in them due to supervisory intervention in the assembly line, quality specialist in the receiving area and highly computerized processes.  The method can determine the cost of each activity, thus, reducing the difficulties of allocating the seemingly invisible overheads.  Next, the cost driver for each activity is required in order to allocate the total cost of each activity to each product line (e.g. vacuum clear models).  By capturing these components, it will be easy to control the cost driver based on the budgeted cost pool.             To illustrate this, we will use the ZBB.  Assuming that there are three primary activities that Dyson have in its production; namely, prototyping, machining and packing.  The cost of each is $900, $500 and $300 respectively.  The products that are ordered are G-force and DC-1 for 100 and 110 units respectively.  Direct labor for G-force is $20 for two hours (e.g. $10 per hour) and DC-1 is $40 for four hours (e.g. $10 per hour).  In traditional costing, if total overhead is $10,000 and the total direct labor is 200 hours, the overhead is allocated on a labor hour basis totaling $50 per hour.  As a result, the traditional costing will result for overhead allocation in G-force is $100 per unit and DC-1 is $200.  However, when ABC method is applied, the results in Table 1 will show the big difference in costing.  Although the results showed that the costing of Dyson using traditional method overpriced its products, in most cases, it is the inability of this method to reflect all overhead cost post the major problem.             As observed, ABC method can improve the costing parameters of ZBB or incremental budgets.  The products of Dyson and vacuum cleaner models are produced by different number of labor hours and machine hours which can obtain various times that each activity occurred in their respective production processes.  This can give Dyson flexibility in using the same budget spreadsheet to allocate overheads of each product line.  Another, the budgets that the firm uses can be easily flexed to reflect potential changes in the operating environment.  For example, the demand for G-force units is lowered, the estimated cost of the production will be easily viewed.  In effect, faster quotation of the products will be provided to clients.  Top management also has baseline information on how efficient labor or machine performed during a particular production cycle.  If the overhead cost of prototyping has increased, it is easy to detect where the problems occurred (e.g. in the production of G-force or DC-1).              Dyson can also use the ABC spreadsheets to forecast, flex and experiment on either ZBB or incremental budgeting.  In doing this, the company will be more vigilant of its status when an unexpected drop in demand occurred in the future due to stiffer competition and inability of its innovation to capture the market taste.  It can establish pro-active solutions to upcoming risks and even disastrous events that can lead its sales virtually to zero.  With or without exaggeration, building cost pools and flexing them according to economic and market expectations can provide useful information to Dyson.  Rationalizing product introduction can also be achieved.  The company can use the ABC spreadsheet to know whether being efficient in machining (e.g. reduction of times the machine is used) can contribute in cost-savings.  These savings can then be distributed to key innovation areas (e.g. hand dryers).  ABC method can open new opportunities to Dyson particularly on providing additional strategic options.  With greater competence on decision-making, it can operate more competitively and know the benefits of minimizing production errors are.  Finally, performance indicators (e.g. ROA) can be improved without trade-off to other balance scorecard components (e.g. employee motivation)                                     Operational Planning ABC method proved to be useful in Dyson simply because the manufacturing process of the firm is substantially affected by human intervention.  On extremely computer-operated production assemblies, the benefits that ABC can provide are limited due to minimal activities involved.  However, even with ABC compatibility with Dyson style of production, it is not an easy task to integrate the method into the production process.  As admitted, Dyson production process involves several human interventions which make change in cultural production an issue of operational planning.  Kaizen also invokes reduction of wastage which is vital to the efficiency benefits of ABC control on operations.  Further, the balance scorecard suggests that financial and customer objectives are as important as employee motivation and welfare.                                    The adoption of ABC method should be initiated from the top management to the bottom rank-and-file.  This will ensure commitment to the production and costing change including allocation of the right resources that will fund training, performance benefits and improved conditions of work.  When the managers are committed, appraising the performance of the organization towards the early parts of ABC adoption will be continuous.  As a result, changing the culture of manufacturing will be done gradually and based on integration to human and environmental conditions of the site.  Empowerment is crucial in changing work systems as employees feel that they are important components of a quality product.  In effect, any change in production guidelines and flow charts must be settled with machine operators, quality specialists, scientist and even sweepers.              It is no doubt that James Dyson is one of the most visionary and cunning vacuum cleaner inventors of all time.  However, the passion to produce innovative products must be coupled with collaboration with subordinates.  The move of transferring production sites in Asia is an example of bypassing the role of employees particularly in UK (BBC News 2002).  Although cost-savings are assured with cheap labor and affordable space rental, the skills of former employees are detached with the production processes.  As a result, it is likely that efficiency in operating the machines or assembling parts are lost.  ABC implementation to create budgets must not be all based on financial benefits and short-term savings.  Rather, the experience of employees in setting-up the production lines and their specialization in assuring quality must be on top of Dyson top management.  In this way, ABC adoption is aligned with production culture.             Strategic Control The firm should change its current system and replaced it with ABC technique.  This can especially gain beneficial returns when the firm decided to expand the up-market brands which would reflect the same manufacturing complexity and labor-intensiveness of some products.  If product line expansion is carried in the coming years, much more the significance of ABC is eminent because the manufacturing processes of up-market products are riskier compared to low-cost products.  As a result, proper costing is required for the company to maximize the benefits of the expansion.  Since ABC also allocates indirect costs to the overhead like transportation, the up-market products can provide easy allocation for the firm in distant places such as Asian countries.  The issue here is the transfer of value from normal places (i.e. UK) that may not be recognized by the firm and shipping costs are not included in the current system.  In its current manufacturing situation, its semi-automated process does not make "machine hours" a concrete basis for settling an overhead rate.  Emphasizing the error on a company-wide agenda only aggravates the problem.  Also, current departments such as packing and shipping are done manually and so it is obvious that "machine hours" does not represent the cost driver for general expenses of each department.  Further, the firm is a value-based producer where it presently made success through market position.  However, its profit continued to slump for consecutive years suggesting that demand-side approach to business is lacking.  As a result, supply-side should achieve value the same manner as the demand-side.  Since the current costing had made substantial understatements especially for some product lines, it showed that it cannot reflect measurement of cost-related efficiencies.  ABC can provide such data for the firm to improve its value chain in producing risky and low-volume up-market product line.         The firm should use ABC approach especially in its up-market products.  These products are considered labor-intensive, risky processes and substantial process investment compared to other counterparts.  In effect, costing approach should be more conservative.  In the operational issue, it should acquire new and dedicated machines for up-market products to increase productivity and also revenues.  It should exploit the lucrative market by coupling investment strategy and costing techniques.  Further, it should continue to produce and design up-market products for the next years to maximize the adoption of ABC technique.  When machines are acquired, ABC can assure that the interference of labor in the process is accounted and this claim creates the synergy that exists between ABC adoption and strategy to expand product line. Ultimately, the firm can focus its operations into the up-market demand.  It should close its low-cost product line by transferring the brand name its hand-held products are admired for to the up-market products.  For example, the firm can create discounts in bulk purchases or sell the products in retail markets for ease of discounting promotion.  It should obtain an integrated product portfolio where the up-market is prioritized and brand name retained due to the change in market environment.  This issue is concretized by the fact that the cost of shipping and machine investments will increase once the firm continuously create up-market products.  The rise in such costs may require substantial investment which may affect liquidity of the firm.  As a result, its low-cost business portfolio should be gradually reduced and retire once the brand name transfer is effectively executed.           Strategic Planning             Initially, there is an understatement for the cost of producing some products because they are machine-based units.  At the strategic side, abrupt adoption of ABC which necessarily leads to increase in market price especially of the some products can reduce competitiveness of the firm.  This is true especially when there are similar products in the market where up-market producers have lower prices.  Thus, ABC has the weakness of infusing its findings instantly and directly in the market and even investment strategies of the firm in the case of purchasing new assets.  Even if the firm has the information and measurement of performance, it has limited use of them because of the stakeholders involved.  The recommendations above also are not recourses that can be executed immediately.  Time, money and effort are elements necessary to make them reality but the firm is not a low-cost producer and substantial investment in assets, processes and change in strategy is possible due to financial depth and experience curve.                 In general, ABC is incompatible with mass production processes and machine-intensive products because activities are minimal.  This is why some products are understated under ABC because human intervention is very small.  Second, collecting data such as activities and “levels” can be tedious and costly.  A small manufacturing company may not afford the requirements of implementing a company-wide ABC adoption.  Computer systems, trained personnel and continuous evaluation in the manufacturing and non-manufacturing activities should be applied which can be impractical for small manufacturers.  In the behavioral side, ABC can create managerial resistance because it can show the inefficiencies of the processes where their departments are link.  Without support from managers, ABC adoption would be futile.    Table 1: ABC Method versus Traditional Costing Activity Overhead Cost # of times in G-Force Overhead Allocation # of times in DC-1 Overhead Allocation prototyping $900 once $300 2 $600 machining $500 2 times $200 3 times $300 packing $300 once $100 2 times $200 TOTAL     $600   $1,100 Per Unit Overhead     $600/ 100 units = $6   $1,100/ 110 units = $10 Total Cost (ABC Method) G-force: Overhead + Direct Labor = $6 + $20 = $26 DC-1: Overhead + Direct Labor = $10 + $40 = $50 Total Cost (Traditional Costing) G-force: Overhead + Direct Labor = $100 + $20 = $120 DC-1: Overhead + Direct Labor = $200 + $40 = $240   Books   Young, S 2000, Readings on Management Accounting, 3rd edition, Prentice Hall, NJ.      Lewis, R 1993, Activity-Based Costing for Marketing and Manufacturing, Quorum Books, Westport, CT.   Electronic Sources BBC News 2002, viewed on 4 January 2008 <http://news.bbc.co.uk/1/hi/business/1801909.stm>   Dyson Website 2008, viewed on 4 January 2008 <www.dyson.co.uk>   MT Program 2006, viewed on 4 January 2008 <http://www.mtprog.com/ApprovedBriefingNotes/PDF/MTP_BNXS30_2007November15.pdf>

Application of ABC method for a vacuum cleaner firm : A case study of manufacturing and costing

Introduction Although not as stylish and elegant as the automobile sector, the UK vacuum cleaner industry has over 93% forecasted house...

CASE STUDY

To Qualify or Not? 1.                  Recap the major issues in this case. What is/are the ethical dilemma(s) in this case?   The major issues in the case are questions of violations of the fundamental principles of accounting ethics. The primary ethical dilemma experienced by        is the proper course of action in dealing with the actions of her superiors           of covering a discrepancy in the items under audit, which in the point of view of         is inconsistent with standards of good practice and inimical to the long-term interest of the client Models Inc.      2.                  Did         , the staff accountant, have any legitimate choice except to follow the direction of the partner on the job with regard to what happened on the job?         has the option of putting into record her disagreement with the decision of the partner but she has to comply with orders unless she can find an alternative legitimate way of solving the problem.     3.                  Outline your understanding of the cut-off problem that has developed. What issues are involved?   Models Inc. has several suppliers, which the firm scheduled for payment. In auditing the accounts payable, the person in-charge looks into expense reports, invoices and other supporting documents to trace and account for payments. However, there were several missing documents, which may not be found and the person in-charge is faced with the dilemma of deciding on how to reflect the insufficiency of data in the audit report.   4.                  What are the fundamental principles underlying a professional accountant’s code of ethics applicable to this case?   There are five fundamental principles forming the foundations of the accountant’s code of ethics, which are: 1) integrity—being straightforward and honest; 2) objectivity—freedom from prejudice or bias and conflict of interest; 3) professional competence and due care—maintaining standards for professional knowledge and skills; 4) confidentiality—preservation of the privacy of clients and non-disclosure of sensitive information; and 5) professional behaviour—compliance with law and professional standards.   5.      What, if anything, should           do under the circumstances?          may voice her opinion on the decision of the partner to her senior or to the partner. She should look for legitimate ways of resolving the lack of documentation and suggest this to the partner. If there is no way to find the missing documents, the she can find guidance in the company policies and accountant’s code of ethics. To Resign or Serve? 1.      What is/are the ethical dilemma(s) in this case?   The initial ethical dilemma of          revolves around integrity and professional competence on whether or not to report the risky and inimical practices of their client and the succeeding ethical dilemma revolves around objectivity and confidentiality on whether or not          should apprise concerned parties of the business practices of Prairieland.      2.      Was the renegotiation of overdue loans to current correct? If not, are there any conditions under which a “current” classification would be warranted?   Renegotiation to report the overdue loans as current loans is practiced but it is a risky move because the bank’s non-recognition of the possibility that a debtor may not be able to pay decreases its credibility to declare the loan later on as non-performing and invoke security nets in claiming payment.      3.      Was the arrangement for insurance against non-payment of loans and/or Prairieland’s (non)disclosure of the insurance arrangement acceptable? If not, how should it have been handled?   Even with an insurance against non-payment of loans obtained by the bank, the risk is still high because insurance companies conduct thorough investigation to ensure that the bank is not deliberately lax on their demands for payment since the payment of loans is insured. The non-disclosure of the insurance arrangement is also not acceptable because this is an important information to the accounting firm. The bank should practice reasonable loan assessments and disclose valuable information.   4.      As          , what would you have done? What (if any) other options were available to       beside resignation?   If I were        , I would have supported the resignation. This is because when         expressed his concern over the banking practices of the client, the representatives of the bank were adamant. Provided               and       explained the risks thoroughly but the bank still refused to budge, then there is no other option for         but to resign.   5.      In this situation, what responsibilities does               have to various stakeholders?   The responsibility of          to inform stakeholders is subject to the confidentiality of information. Unless the bank and its representatives permit the disclosure or the disclosure is called for in a legal proceedings or in other authorized venues of disclosure, both            are barred from disclosing sensitive information to stakeholders who are not a party to their previous business dealings. What are your thoughts on this situation? 1.      What do you think are his concerns? 's primary concern is the possibility that the judgment of Trevor regarding their client’s billing practices may have been clouded by Trevor’s personal relationship with the accounts receivable supervisor of their client company. The development of the personal relationship between the auditor and client gives rise to questions of conflict of interest of Trevor because he could have made a favourable report on the client company to be on the positive side of           or his objective judgment may have been overpowered by his personal emotions towards a representative of the client company. In this cases, the integrity of Trevor’s report becomes questionable and unreliable. 2.      What actions can be taken to address his concerns?  has to make sure that the report passed by           on the practices of the client are accurate and supported by sufficient documentary evidence to ensure the integrity of the entire audit report. During the remaining days before the report presentation,       should remove       as part of the audit team working with the client company to prevent further issues on the validity of the report.        should also have    ’s report validated before the final report to ensure the accuracy of the favorable recommendations to the client. As a preventive measure,          should also remind his employees or staff of their duties provided by the accountant’s code of ethics and the importance of practicing objectivity to the profession.

CASE STUDY

To Qualify or Not? 1. Recap the major issues in this case. What is/are the ethical dilemma(s) in this case? The ...

Strategic Management Accounting for Decision Making

Part A   Introduction Almost all firms recognize that they face major uncertainties about the future, yet most firms' strategic investment decisions are primarily based on a single projection of future events. Although managers do recognize that the failure to include a consideration of uncertainty can lead to costly errors, the difficulty of such planning leads many to ignore the potential costs and hope that serious problems will not arise (Trigeorgis 1995). Suppose a company is considering a strategic decision, such as building a large now plant or embarking on a large research project. Major projects such as these require significant commitments of both capital and managerial attention. The reward from the project depends not only on its technical success, but also on the market conditions and industry structure at the time of completion. Uncertain future developments and the firm's response to these developments can turn such projects into either resounding successes or abysmal failures. However, managers are often baffled by the question of how to include uncertain future outcomes and potential future strategic responses in a prospective analysis of a capital investment project. The actual staging of capital investment as a series of outlays over time creates valuable options to default at any given stage (Trigeorgis 1995). Engaging in investment projects is vital for the growth of the firm.  This part of the paper discusses the usefulness of investment appraisal techniques. This part of the paper analyzes how the methods of investment appraisal are as relevant and appropriate as the others when making investment decisions.   Investment Appraisal Techniques From the firm’s perspective the objective of the investment appraisal process is to determine how the value of an investment is likely to affect the value of the firm. The goal is to increase the wealth of the firm by making investments which are expected to yield returns greater than their costs (Mcmenamin 1999). The investment appraisal process involves the evaluation of a prospective investment’s relevant cash flows which will occur over different time periods. In order to make a valid comparison of cash flows occurring over different time periods, it is necessary to convert them to a common base, or time period. People do this by either converting future cash flows back to their present day values, or by moving present cash flows out to a future date. The judicious application of investment appraisal techniques will enable management to select projects that will advance the organization’s objectives and plans and add to shareholder wealth. The financial techniques most commonly used to evaluate investment appraisal projects are payback method; accounting rate of return (ARR), or return on investment (ROI) and discounted cash flow (DCF) methods (Mcmenamin 1999).    In applying Discounted Cash Flow (DCF) the following techniques are commonly used: net present value (NPV); profitability index (PI); and internal rate of return (IRR). The payback method is the most popular and the most easily understood of the main appraisal techniques. It is essentially an expression of how long it will take to recover the initial cash outlay on an investment from the investment’s cash flow returns. The ARR is an unsophisticated technique. It is calculated by dividing a project’s average accounting profits by its average investment. The average profits figure is found by adding up the profits for each year of the investment and dividing by the number of years. The average investment is the sum of the initial investment or outlay plus the expected residual or realizable value of the asset, divided by two. The DCF is the incremental operating after-tax cash inflows which people use to measure the expected benefits from the project. The net present value (NPV) is the difference between the present value of future cash inflows and the present value of the initial outlay, discounted at the firm’s cost of capital. The profitability index (PI) is the ratio of the present value of all future net cash flows to the initial costs. While the NPV is an absolute measure of a project’s acceptability, the profitability index is a relative measure as it relates the benefits to the initial investment. The internal rate of return (IRR) or yield can be defined as: the discount rate which equates the present value of the expected initial cash investment, with the present value of the expected cash inflows (Mcmenamin 1999). The aim of investment appraisal techniques is not to replace the brilliant business tycoon or even to eliminate all elements of luck. Rather, it is to quantify all those factors that can be measured in order to provide management with as much information as possible about whether a project looks like adding value to the firm (Chrystal 1997). The investment appraisal techniques help in determining how the investments will create benefits or problems to a firm.   The investment appraisal techniques ensure that the value of an investment will reflect on the firm’s value.   Investment decisions and investment appraisal Even in advanced countries, technological developments, where they tend to increase the degree of complementarity between different investment decisions, may have a profound effect on market structure. There exist between the firms in a modern competitive economy complex interrelationships of ownership and control, which are abstracted from in much of more formal analysis; their justification derives, in part, from the need to co-ordinate complementarity activities (Richardson 1997).  And the optimum size of the firm may be determined, not so much by the scale economies associated with any particular operation, but by the number of operations which require planned co-ordination. Nevertheless all the forces do not work in the direction of integration. The inevitable imperfection of the entrepreneur's knowledge, both about technical conditions and about the prospects of other firms, checks his willingness both to make long-term binding commitments and to throw in his lot with that of others (Richardson 1997). A company's internal context, competitive position, external opportunities, business concept, and stock of resources and capabilities available define some options or opportunities that a company has before it at any particular time. However, neither this company's growth path nor its growth rate is completely determined by such scenarios (Canals 2000).    It is the decisions as to what growth alternatives are chosen and the processes by which these decisions are made and implemented that eventually trigger the company's future growth. Of course, these decisions are closely related with the prior development of a business concept and depend upon the firm's internal and external context, and its resources and capabilities. Strategic investment decisions are often related to the development of the company's capabilities. In accordance with the resource-based view of the firm, achieving a certain market position is not only to be attributed to a lower cost structure or a better differentiation. Behind these and other qualities, there are some resources and capabilities that, when adequately combined, enable the company to achieve that competitive position. Consequently, the creation of a business concept implies a definition of what capabilities will be crucial for the company in the future and a program for developing or acquiring such capabilities. In turn, this program requires a strategic decision, and an investment of resources in a certain direction, which excludes other alternative directions (Canals 2000).   The unique nature of certain strategic investment decisions is that, in one way or another, they commit the company's future and define its growth possibilities. These decisions provide new business opportunities or give new life to existing businesses. These investments tend to be irreversible. Thus, if the project is not successful, the resources invested tend to lose value. Therefore, it would be just as bad to invest in projects without a hope of success as not to invest and let opportunities pass by. Investment decisions play an essential part in accounting for the growth process and in the continued pursuit of a certain strategy throughout a company's life. These decisions also help explain some of the difficulties faced by a company when it attempts to implement an organizational change process (Canals 2000). Economic growth and structural change come about as a consequence of innovation being injected into the productive system through investment decisions. However, the economic effects of innovation depend on how it is diffused throughout the productive fabric and what technological strategy firms employ to sustain and improve the results of their activity (Vázquez-Barquero 2002). Investment decisions are made to create a better future for a firm or any organization that wants to take it. The use of investment appraisal techniques in making investment decisions increase the chance of making appropriate decisions that results to wanted effects. Investment appraisals provide a clear financial and statistical data on what will happen to the firm’s status once it undergoes an investment decision.  Investment appraisal techniques provide an outlook on what should be the main focus of an investment decision.   Conclusion Engaging in investment projects is vital for the growth of the firm.  The investment appraisal techniques help in determining how the investments will create benefits or problems to a firm.   The investment appraisal techniques ensure that the value of an investment will reflect on the firm’s value. Investment appraisals provide a clear financial and statistical data on what will happen to the firm’s status once it undergoes an investment decision.  Investment appraisal techniques provide an outlook on what should be the main focus of an investment decision.   Part B Introduction In recent times, numerous academics and practitioners have begun to question the usefulness of traditional managerial costing systems. Their arguments range from the irrelevance of traditional costing techniques in a flexible manufacturing environment to almost complete exclusion of meaningful cost data for marketing, distribution, and customer service functions. Corporate management accounting systems are inadequate for today's environment. In this time of rapid technological change, vigorous global and domestic competition, and enormously expanding information processing capabilities, management accounting systems are not providing useful, timely information for the process control, product costing, and performance evaluation activities of managers (Madu 1993).  A competitive advantage can be developed and sustained once a company identifies its value chain and the cost drivers that determine the value of the activities on that value chain. This can be done by controlling and manipulating the drivers better than the competitors. Strategic cost analysis, which is the use of cost data in strategic planning, is a powerful competitive weapon. When combined with other costing methods costing strategic cost analysis can direct managers to take strategic initiatives in product designing, product cost, customer service, pricing, and automation (Madu 1993). Costing a product or service gives a company an opportunity to analyze the value of their product or service so that they can make necessary adjustments. This part of the paper focuses on evaluating the different approaches to costing products or services.   Marginal or Variable Costing The manner in which direct costs are computed may be inconsistent with the regulations' definition of cost of production. In management accounting practices, direct costs are defined as those costs that can be traceable into and are identified specifically with a particular product or process for a particular purpose. However, direct costing, sometimes called variable costing, is a method of product costing that charges only the variable costs of manufacturing to the product. The variable costing method includes only variable manufacturing costs as the cost of a product. Product costs include direct materials, direct labor, and variable manufacturing costs. All fixed manufacturing costs are excluded from the inventoriable costs and expensed during the fiscal year in which they are incurred together with all selling and administrative expenses (Abdallah 2004). The variable or marginal approach to decision making is useful in making short-run decisions, but must be used with caution in situations that require long range commitments. In the long run all costs and expenses must be accounted for, plus a markup or profit in order to continue in business. The variable or marginal costing approach cannot be applied indiscriminately to all situations (Lewis 1993). The marginal costing approach focuses only on short term decisions because it has simplified features.  The marginal costing approach shares the same ideas with break even analysis. In this approach the behavior of both costs and revenues is maintained constant throughout the relevant range of activity. In the marginal costing approach a critical scenario is the point where total revenues equal total costs.   Full or absorption costing The cost of a product influences channel structure directly. The unit cost of a forklift truck is high and may be considered investment spending. These types of products are used over and over again for many years. Financing the purchase may be a deciding factor in influencing when to buy and what brand to buy. Major equipment products, such as forklifts, are generally sold by exclusive retailers for specific brands or by company branch retailers. Because of the high purchase price, the direct incentives offered by the manufacturer to the user are of considerable importance (McCalley 1992). In some instances, special options are offered and must be specified to the manufacturer in advance of product delivery. These market characteristics require a short line of communications, no storage or warehousing for wholesale distribution, and frequent involvement by the manufacturer with its retailers (McCalley 1992). Having different ways to assemble data for different uses is essential, particularly when a full or absorption costing system is used. When using absorption costing, then, it is essential to have available some product cost information other than just the full product cost, which includes a variety of costs that vary as to the plant, process, or batch but are fixed or non incremental at the product level (Cheatham & Cheatham 1993).    When using costs for decision making, it is necessary to be able to assemble costs that are relevant to that particular decision whether it is a decision to accept a special order, discontinue a product line, or outsource a component. Management must be able to distinguish which portions of total costs are sunk costs and are not relevant to the decisions and which are costs that will be created by the new proposal. Only the newly created costs are relevant in most cases (Cheatham & Cheatham 1993). There are costs which are incurred by the organization as a whole, and are usually apportioned to the different cost centers. There is no one method of dividing these costs, but the most simple and common is called absorption costing which is to spread all the cost into the center. Absorption costing makes sure that the full costs of an organization are absorbed at the service level, so that overhead costs are not a drain upon other incomes or reserves (Palmer & Randall 2002).  It ensures that an organization can receive the maximum amount of income to cover its costs.   It can lead to greater accountability of the central services of an organization to the services that are funding them. There are various problems caused by absorption costing. Absorption costing can lead to inefficiency in central services, as they have no incentive to minimize or control their costs.  Competitive edge can be blunted if another company bidding for a contract has leaner costs or is not working on an absorption model.  This approach can cause resentment among service managers who may feel they are supporting the central services to the detriment of their own service (Palmer & Randall 2002).  The absorption costing includes all kinds of manufacturing costs. Under absorption or full costing the variable and fixed manufacturing overhead is included.   This costing method makes sure that the maximum amount of income to cover its costs will be received by a firm.   Activity Based Costing ABC drove costing very deeply into the organization by identifying the actual costs of labor, equipment, and premises associated with each activity performed by the firm rather than relying on arbitrary formulas to allocate overhead. Activity-based profitability analysis is a granular form of costing. It identifies the actual costs of labor, materials, equipment, and premises needed to deliver a product, serve the customer, and sustain the business. ABC practitioners believe that making costs known creates opportunities for savings even though ABC methodology alone does not identify savings targets. Two advantages are claimed for ABC compared to conventional costing methods. First, ABC makes all costs explicit, reducing distortions caused by arbitrary allocations of overhead to products and customers (Meyer 2002). Second, ABC traces costs back to the economic events that cause them, making it possible to judge the reasonableness of costs in light of these events. Activity-based costing is less useful when costing decisions are made without objective information about their consequences (Meyer 2002).   Activity based costing is a strategy wherein a company assigns its resource cost through activities to the products and services provided to the customers. It is used as a way for the business organization to understand and learn about customer cost and profitability. Companies use it to support decisions on pricing, outsourcing and measurement of process improvement initiatives. Activity based costing is good for companies because it makes cost specific and more understandable to the company. ABC provided assistance in helping the company determine what composes its cost and whether such cost is acceptable to the company or not.  ABC is also good for the company because it can help in ascertaining whether the expenses and costs acquired by the company are acceptable or worth it. ABC provided a clearer statement of what composes the product cost thus when it is computed the result was lower rates of overhead costs. The ABC system provided a better chance for companies to reanalyze its focus and financial goals. For a company this means that the use of ABC system can help it lessens the financial worries of the company thus the company can have more chance to try to analyze their goals and achieve the new perceived goal. Another implication for the company is it can make use of such information to create a better image for itself. This will help the company’s desire for a better standing in its competitive environment.   Conclusion The marginal costing approach focuses only on short term decisions because it has simplified features.  The marginal costing approach shares the same ideas with break even analysis. Under absorption costing the variable and fixed manufacturing overhead is included.   This approach makes sure that the maximum amount of income to cover its costs will be received by a firm. ABC provided assistance in helping firms determine what composes its cost and whether such cost is acceptable to the firm.  ABC is good for the firm because it can help in ascertaining whether the expenses acquired by a firm are acceptable.   References Abdallah, WM 2004, Critical concerns in transfer pricing and practice, Praeger, Westport, CT.   Canals, J 2000, Managing corporate growth, Oxford University Press, Oxford, England.   Cheatham, CB & Cheatham, LR 1993, Updating standard cost systems, Quorum Books, Quorum Books, Westport, CT   Chrystal, KA 1997, Economics for business and management, Oxford University Press, Oxford.   Lewis, RJ 1993, Activity-based costing for marketing and manufacturing, Quorum Books, Westport, CT.   Madu, CN 1993, Management of new technologies for global competitiveness, Quorum Books, Westport, CT.   McCalley, RW 1992, Marketing channel development and Management, Quorum Books, Westport, CT.   Meyer, MW 2002, Rethinking performance measurement: beyond the balanced scorecard, Cambridge University Press, Cambridge, England.   Mcmenamin, J 1999, Financial management: An introduction, Routledge, London.   Palmer, P & Randall, A 2002, Financial management in the voluntary sector: New challenges, Routledge, London   Richardson, GB 1997, Information and investment: A study in the working of the competitive economy, Clarendon Press, Oxford, England   Trigeorgis, L (ed.) 1995, Real options in capital investment: Models, strategies, and applications, Praeger Publishers, Westport, CT.   Vázquez-Barquero, A 2002, Endogenous development: Networking, innovation, institutions, and cities, Routledge, London.

Strategic Management Accounting for Decision Making

Part A Introduction Almost all firms recognize that they face major uncertainties about the future, yet most firms' strategic ...

Management Accounting and Financial Reporting

Management Accounting and Financial Reporting Question: A company wants to set up a sinking fund for the repayment of a loan of $100m at the end of four years. It makes equal deposits at the end of each month into a fund that earns interest at 22% p.a compounded monthly. Determine the size of each deposit and construct a sinking fund schedule Computation of the sinking fund: Note:   S = is for the amount   i = is for interest             n = is for the time or years to pay             1 = is constant The business is obliged to pay the loan after its usage. The accumulation of the fund by making periodic deposits is called sinking fund with additional interests.  After computing the amount that is needed for payment, the company should pay the loan with an equal amount of deposits worth $1,318,436.605 monthly within 4 years. Sinking Fund Schedule Period Deposit Interest Increase Amount           1 1,318,436.605 0 1,318,436.605 1,318,436.605 2 1,318,436.605 24127.38987 1,342,563.995 2,661,000.600 3 1,318,436.605 48696.31098 1,391,260.306 4,052,260.906 4 1,318,436.605 74156.37457 1,465,416.680 5,517,677.586 5 1,318,436.605 100973.4998 1,566,390.180 7,084,067.766 6 1,318,436.605 129638.4401 1,696,028.620 8,780,096.387 7 1,318,436.605 160675.7639 1,856,704.384 10,636,800.771 8 1,318,436.605 194653.4541 2,051,357.838 12,688,158.609 9 1,318,436.605 232193.3026 2,283,551.141 14,971,709.750 10 1,318,436.605 273982.2884 2,557,533.429 17,529,243.180 11 1,318,436.605 320785.1502 2,878,318.580 20,407,561.759 12 1,318,436.605 373458.3802 3,251,776.960 23,659,338.719 13 1,318,436.605 432965.8986 3,684,742.858 27,344,081.577 14 1,318,436.605 500396.6929 4,185,139.551 31,529,221.128 15 1,318,436.605 576984.7466 4,762,124.298 36,291,345.426 16 1,318,436.605 664131.6213 5,426,255.919 41,717,601.345 17 1,318,436.605 763432.1046 6,189,688.024 47,907,289.369 18 1,318,436.605 876703.3955 7,066,391.419 54,973,680.788 19 1,318,436.605 1006018.358 8,072,409.778 63,046,090.566 20 1,318,436.605 1153743.457 9,226,153.235 72,272,243.801 21 1,318,436.605 1322582.062 10,548,735.296 82,820,979.097 22 1,318,436.605 1515623.917 12,064,359.214 94,885,338.311 23 1,318,436.605 1736401.691 13,800,760.905 108,686,099.216 24 1,318,436.605 1988955.616 15,789,716.521 124,475,815.737 25 1,318,436.605 2277907.428 18,067,623.949 142,543,439.685 26 1,318,436.605 2608544.946 20,676,168.895 163,219,608.580 27 1,318,436.605 2986918.837 23,663,087.732 186,882,696.312 28 1,318,436.605 3419953.343 27,083,041.074 213,965,737.387 29 1,318,436.605 3915572.994 30,998,614.069 244,964,351.456 30 1,318,436.605 4482847.632 35,481,461.700 280,445,813.156 31 1,318,436.605 5132158.381 40,613,620.081 321,059,433.237 32 1,318,436.605 5875387.628 46,489,007.709 367,548,440.946 33 1,318,436.605 6726136.469 53,215,144.179 420,763,585.125 34 1,318,436.605 7699973.608 60,915,117.786 481,678,702.911 35 1,318,436.605 8814720.263 69,729,838.050 551,408,540.961 36 1,318,436.605 10090776.3 79,820,614.349 631,229,155.310 37 1,318,436.605 11551493.54 91,372,107.891 722,601,263.201 38 1,318,436.605 13223603.12 104,595,711.008 827,196,974.209 39 1,318,436.605 15137704.63 119,733,415.636 946,930,389.845 40 1,318,436.605 17328826.13 137,062,241.770 1,083,992,631.615 41 1,318,436.605 19837065.16 156,899,306.929 1,240,891,938.544 42 1,318,436.605 22708322.48 179,607,629.404 1,420,499,567.948 43 1,318,436.605 25995142.09 205,602,771.498 1,626,102,339.446 44 1,318,436.605 29757672.81 235,360,444.309 1,861,462,783.755 45 1,318,436.605 34064768.94 269,425,213.252 2,130,887,997.007 46 1,318,436.605 38995250.35 308,420,463.597 2,439,308,460.605 47 1,318,436.605 44639344.83 353,059,808.426 2,792,368,269.031 48 1,318,436.605 51100339.32 404,160,147.750 3,196,528,416.781   After the construction of the sinking fund schedule, the company is bound to pay within 4 years monthly. Meaning, the company has a responsibility to pay the amount with the interest for 48 months. The total amount that the company needed to pay is worth $3,196,528,416.781 with the inclusion of the subjected 22% interest. Within the span of 4 years, it is advised that the company should not fail to pay this amount to avoid the accumulation of interest that will definitely invite the negative effect in the company’s financial statement and might diminish the trust from the banks, loaning institutions, and investors.

Management Accounting and Financial Reporting

Management Accounting and Financial Reporting Question: A company wants to set up a sinking fund for the repayment of a loan of $100m a...