Being Aware Of Future Environmental Context Accounting Essay

Category: Accounting

As per (Norton and Hughes, 2009:p.3) strategy can be defined as a course of action, set to achieve a specific objective which includes specification of resources required. In a very raw sense, the strategy could be identified as how a person, a company, a group or even a country would get its objectives fulfilled. Strategic management is about understanding the nature of the competitive environment, stakeholder management strategies and taking relevant actions to,

Achieve strategy essentials : Which include a clear objective for the company.

Future : Being aware of future environmental context.

Direction : Focusing on the path company is going into.

Environment : Understanding the position of government, customers, suppliers and competitors.

Resources : Understanding the resources the company has with itself.

Strategic fit : deciding on how to use the resources to meet current and future challenges.

Competitive advantage : How the organisation would gain a better position in the minds of the customers and market compared to competitors (Kazmi, 2008:p.333).

Strategic management accounting is an extension of traditional management accounting where analyse both internal and external information in order to achieve a desired strategic position by the use of competitive advantages that the company is having (Smith, 2007:p.11). Strategic management is there to provide relevant information required for the management of the company for decision making. Generally companies appoint a strategic management accountant to carry out the various activity analysis needed in order to take most accurate and suitable decision making.

To : Directors of Jessup Ltd

From: Consultant management accountant

Subject: To describe the key roles of which a strategic management accountant would undertake in an organisation, To define the meanings of relevant and irrelevant costs and revenue in strategic management decision making, To state the benefits and problems associated with activity based costing in an organisation.

Date : 20/09/2012

To carry out operations under strategic management accounting, Jessup Ltd will require a strategic management accountant and it will provide several strategic benefits for Jessup Ltd.

Key roles which a strategic management accountant would undertake in an organisation.

The strategic management accountant is responsible for providing all the relevant information in a the suitable format as it can be used for the decision making process of the organization. This information would be useful in the planning process, controlling processes, objective identification process, the process of identifying appropriate decisions and etc (Belkoui, 2002:p.36). But the role of strategic management accountant differs from the role of other general accountants. Generally the duty is to present the financial numbers in a manner it is useful for decision makers and as it can be directly used for decision making process. But the strategic management accountant is responsible for placing all the relevant financial numbers into a wider context and relate all those financial factors to the key non financial factors. This will integrate the financial factors and non financial factors of the organisation and it will enable the managers obtain a proper understanding about financial results, operating performance and the strategic direction of the company (Botten, 2009:p.390).

In order to perform the expected role of the strategic management accountant, the strategic management accountant must develop financial knowledge like other management accountant and further, he will need to have a broad personal skills ans commercial capabilities. This is because of the extra role that strategic management accountant have to perform by relating the financial factors of the company with the non financial factors which include tackling the external environment information such as information on customers, competitors and marketplace and etc. This is what make the role of strategic management accountant this much important because, currently it is impossible to perform a leading part in the industry without relating the financial information of the company with the non financial information (Ward, 2012:p.10).

When a person gets to hold the position as the strategic management accountant of the Jessup Ltd, he will be responsible identifying, relating, analysing and achieving following.

Providing all the relevant information needed : Here the strategic management account of Jessup Ltd will provide the information needed for evaluating each situation and guide the directors of Jessup Ltd to get the most suitable and accurate decisions for each situation arise. And here, the information he provide will be useful to identify the level of performance Jessup Ltd is performing when compared to the the other players in the advertising field, who can be identified as the competitors of Jessup Ltd (Blocher, 2006:p.23).

Facilitate the communication between manager and accountants : Managers are responsible for decision making of the Jessup Ltd and they will get the use of financial information provided by the accountants of the Jessup Ltd when making the decisions. But it is the strategic management accountant who performs the role between them by enabling a proper information flow between managers and accountants of Jessup Ltd (Hirsch, 2000:p.4).

Identifying the most suitable type of decision matches for each situation arise. There are 3 main strategic decisions that can be made. One of them is changing the amount of resources allocated for the activity. For example, if the amount of quality checkers allocated per a center, the the management of Jessup can consider appointing some more in order to achieve the target quality level. Another type of decisions that can be used is entering into a new business area (Khan and Jain, 2006:p.10). For example, Jessup can consider entering into 3D creations in line with the general advertising activities they are carrying out. Another strategic decision that can be taken is exit decision. For example, if it is clear that the advertising on newspapers does not generate a turnover at a satisfactory level which is enough for the effort made, then the management of Jessup Ltd can consider exiting from newspaper advertising.

Setting the appropriate financial indicators : Here the performance indicators of the internal factors of the organization should be set along with the monitoring the performance of customers and competitors as well. Those are they 2 parties who can make the most significant impact on the company. So the strategic manager should collect information about the other advertising firms as well in order to compare the performance of Jessup with the performance of them (Drury, 2007:p.570).

Distinguish the managerial and economic performance : The administrative cost of Jessup Ltd is something controllable. But the government tax amount is out of control of Jessup Ltd. So strategic management accountant will ensure to provide the real performance of the company by only considering the controllable costs.

Providing relevant information : The main duty of strategic management accountant is to provide information required for decision making. But the issue here is the content of irrelevant information in the statements preparing by the accountants as it wastes the time of decision makers. But the strategic management accountant will ensure to provide only the relevant information needed (Barnwell, 2009:p.199).

Separately identify and present the committed costs, discretionary costs and engineered costs.

Identifying the possible change over options : the needs and wants of customers are dynamic. So in order to keep the customers with the Jessup Ltd, it is important to analyse and identify possible change over options and following the suitable options (Clarke, 2002:p.202).

Relevant and irrelevant costs and revenues in strategic management accounting decision making

Relevant Costs

Relevant costs are the costs appropriate to a specific management decision. These are represented by future cash flows whose magnitude will vary depending on the outcome resulted from the decisions made by the management. When a cost to be classified as a relevant cost, it should fulfill 3 factors.

Relevant costs are future costs : if the cost amount is already incurred before start the operations of a specific activity, those costs are called as sunk costs and they can not classify as a relevant cost. For example, if Jessup Ltd is considering the 3D video visual making, they may need to investigate and identify the possible ways to perform. In this matter, Jessup Ltd needs to maintain a research and development process and spend on that. But even Jessup spends on research and development of 3D visual making, the cost of research and development can not classify as a relevant cost of the project as it is not a future cost, instead it is a sunk cost which has been already incurred (Lucey, 2003:p.326).

Relevant costs are cash flows : There are 2 types of transactions as cash flow transactions and non cash flow transactions. If Jessup Ltd makes payments for its employees, it is a cash flow transaction. But the costs that are accounted as depreciation of the computers that are used in the advertising firm, in reality, a cash flow didn't take place. So they are called as non cash flow transactions which cannot include as a relevant cost of the production.

Relevant costs are incremental : If the Jessup Ltd expands its premises which currently costs $50million of rent and set up a new center which needs extra $20million rent, the incremental cost of setting new center is $20million (Lal, 2009:p.723).

There are other terms that can be used to describe relevant costs. One of them is 'avoidable costs', which includes the costs that can be avoided if the decision is not made. This is the reciprocal of incremental cost. If the same example is considered where Jessup Ltd expand its premises, the avoidable cost of that decision is $20million because Jessup Ltd does not need to pay it if the expansion did not take place. But still $50million is unavoidable as Jessup has to incur it no matter what the decision is. Another term that can be used to describe relevant costs is 'differential cost' (Young, 2003:p.65). This is the cost difference between different alternatives.For example, if Jessup has 2 options to expand its premises as one costs $15million and the other costs $20million, the differential cost is $5million. 'Opportunity cost' is another term that describes the relevant cost. Opportunity cost is the value of next best alternative forgone. In other words, the opportunity cost is the benefit which could have been earned, but which has been given up by choosing one option instead of another. Therefore they will represent future lost cash flows (Mankiw, 2011:p.55).

Non relevant costs

Non relevant costs are the costs which are not appropriate for a specific management decision. There are 3 main types of non relevant costs as sunk costs, committed costs and notional or imputed costs (Burke and Wilks, 2006:p.54).

Sunk costs : these are the costs that have been irreversibly incurred or committed prior to a decision point and which cannot therefore be considered relevant to subsequent decisions. Sunk costs may also be termed irrecoverable costs.

Committed costs : these are the costs arising from prior decisions, which cannot be changed in the short run. Committed cost incurrence often stems from strategic decisions concerning capacity, with resulting expenditure on plant and facilities. This includes the future costs that are to be incurred as a result of past decision such as lease payment (Jagels, 2006:p.299).

Notional or Imputed costs : These are the costs used to represent the cost of using resources which have no conventional actual cost. In simple, these costs are not real, just imagined costs. This includes costs such as fixed overhead absorbed, depreciation, provisions and etc. Notional costs will be relevant only if they represent opportunity costs.

Identifying relevant costs

The relevant cost of material

Carrying out operations of Jessup Ltd, the management needs to get the use of different materials such as stationary. Especially when deciding on the price of the product, it is important to accurately calculate the relevant cost of material used. For this matter following flowchart can be used to identify the relevant costs of materials.

Figure Relevant cost of material

(Source: Bowhill, 2008:p.71)

Relevant cost of overhead costs

Overhead costs are another major cost producer in the financial statements of a company. The cost of using the machines and etc includes for this cost category. To identify the relevant cost of overheads, following chart can be used.

Figure Relevant cost of overhead costs

(Source:Mowen et al, 2011:p.546)

Relevant cost of labour

For an advertising firm such as Jessup Ltd, labour is something that is essential to be properly maintained because the advertising companies like Jessup Ltd are highly dependent on human capital. So when identifying relevant cost, cost of labour should also consider. The relevant cost of labour can be identified using following diagram.

Figure Relevant cost of labour

(Source:Avis, 2009:p.81)

Benefits and problems of introducing activity based costing into an organization

Activity based costing is an approach to the monitoring and costing activities, which involves tracing resource consumption and costing final outputs (Rajasekaran, 2010:p.271). Activity based costing is another method of costing which is considered as a better method than traditional costing methods. But both traditional absorption costing and activity based costing systems adopt the two stage allocation process which includes following 2 stages.

Allocation of overhead : Activity based costing establishes separate cost pools for support activities. As the cost of these activities is assigned directly to products through cost driver rates, reapportionment of service department costs is avoided.

Absorption of overheads : Absorption costing mostly uses a few absorption bases such as labour hours or machine hours, to charge overheads to products. Activity based costing uses many cost drivers as absorption bases. Absorption rates under activity based costing should therefore be more closely linked to the causes of overhead costs (Lal, 2009:p.323).

In traditional absorption costing overheads are first related to cost centers and then to cost objects . In activity based costing, overheads are first related to activities or grouped into cost pools and then related to cost objects. Just like traditional absorption costing rates, activity based costing rates are calculated in advance which calls as predetermined rates.

The major principles behind activity based costing are as follows.

Activities cause costs.

Producing products creates demand for the activities.

Costs are assigned to a product on the basis of the product's consumption of the activity (Warren, 2010:p.391).

The outline of an activity based costing system

If Jessup Ltd is considering to follow activity based costing system, the outline of an activity based system should be identified. This contains 5 main steps as follows.

Step 1 : Identify the major activities of Jessup Ltd.

Step 2 : Identify the factors which determine the size of the costs of an activity/cause the costs of an activity. These are called as Cost drivers.

Step 3 : Collect the costs associated with each cost driver into what is known as cost pools.

Step 4: Calculate the cost driver rates.

Step 5 : Charge the costs of each cost pool to products on the basis of their usage of the activity (Hansen and Mowen, 2006:p.51).

Analysis of activities

Activity based costing relate the incidence of costs to the level of activities undertaken. A hierarchy of activities has been suggested.

Type of activities

Costs are dependent on

Examples

Unit level

Volume of production

Direct labour, direct materials

Batch level

Number of batches

Inspection, set up costs

Product sustaining

The existence of a product group/line

Product management, equipment maintenance

Facility sustaining

Organisation simply being in business

Rent , building depreciation

Table Activity based costing - analysis of activities

Benefits of using activity based costing system

The complexity of manufacturing has increased its wider product rages, more complex production processes and shorter product life cycle. Activity based costing recognises this complexity in the production process, with its multiple cost drivers. Absorption rates under activity based costing should therefore be more closely linked to the causes of overhead costs (Leitner, 2007:p.5).

Activity based costing facilitates a good understanding of what drives overhead costs which in turn improves the product pricing.

In modern manufacturing systems, overhead functions include a lot of non factory floor activities. Activity based costing takes management accounting beyond its traditional factory floor boundaries.

By controlling the incidence of the cost driver, the level of the cost can be controlled.

The costs of activities not included in the costs of the products an organization makes or the services it provides can be considered to be not contributing to the value of the product/ service. Activity based costing helps to eliminate these non value added activities.

Activity based costing can be used in the service sector as well (Weil and Maher, 2005:p.233).

Criticisms of Activity based costing

Some measure of cost apportionment may still be required at the cost pooling stage for items like rent, rates and building depreciation.

It is questionable whether a single cost driver can explain the cost behaviour of all items in its associated pool.

The number of cost pools and cost drivers cannot be excessive otherwise an Activity based costing system would be too complex and too expensive.

Unless costs are caused by an activity that is measured in quantitative terms and which can be related to production output, cost drivers will not be usable (Kinney and Raiborn, 2012:p.121).

Conclusion

For any company to be successful, a clearly defined suitable strategy is a vital factor. And decision making is a process is another important factor which ensures proper performance of a company. In order to make the most suitable and accurate decision for the various situations arise in a company, proper flow of information with all the relevant information, to the decision makers is essential. This is why the appointment of a strategic management accountant can create a huge impact on any company in any industry. The strategic management accountant will ensure that the decision makers of the company can obtain all the information needed when and where needed. But the most important thing is, he will ensure that the decision makers only obtain the relevant information, in order to eliminate unnecessary complexities in the decision making process. The relevant and non relevant costs identification is useful for pricing decisions of the company as well. But still for companies such as Jessup Ltd, the advertising company, cost allocation would be difficult as they are not in manufacturing products. So to allocate the costs properly, the management of Jessup Ltd can get the use of activity based costing.