Management accounting involves using information regarding the financial spending on the production process. It estimates the cost of a future project and compares it with the real cost when production begins. Management accounting is essential in businesses because it analyses the production costs and tries to maximize efficiency while controlling spending costs. Cost analysis, budgeting, internal financial reporting, and monitoring of internal controls are some of the activities that revolve around management accounting. In the case below, the management department compares the profitability of a project they are running at the current value with the future value. It helps in risk management by evaluating the future cost of risk. In the example below, the following would be the budget if the management canceled the project immediately:
- £ Costs incurred to date 52, 000
- Staff costs (28, 000 – 25, 000) = 3, 000
- Fixed rent and premises costs allocated to the project 7, 000
- Suppliers (8,000 – 2, 000) = 6, 000
- Returns to customers 40, 000
- Less: sale of surplus equipment at current cost (5, 000)
- Total Net cost of the project if stopped today 103, 000
After comparing the project’s current cost with the future one, I would advise the management to stop the project immediately because the current value of the loss that it would make is less than the one expected in the future if the project proceeds until completion. The project would amount to a loss of £103 000 if the management canceled its continuity from the calculations. However, if the project preceded, it would lead to a greater loss than the current one of £177 500 in the long run. Hence, the management should cancel the project’s progress. Using the information provided in the report to analyze a project’s performance aids in selecting the most efficient investment options for the investors. Cost management is the process of collecting, analyzing, and reporting cost information to budget effectively, forecast the future, and monitor costs in businesses. The process plans and controls the costs associated with a business. It should be simple to understand and carry out and sustainable for the business. Cost management should be accurate and elastic to accommodate all the costs incurred by a business.
Relevant Costs and Income would be, to Enable the Manager to Reach a Decision
Marginal analysis is essential for businesses since it helps compare the benefits obtained from an item with the product’s cost. The marginal cost is the difference between the benefits gained from creating an item and the profits gained from the product’s sale in the production process (Rounaghi, 2019). Marginal analysis helps the management compare the value they spend on production with the value they obtain from selling the product, thus influencing major decisions on the amount of production they should conduct. The marginal analysis also evaluates the business’s benefit by producing an extra quantity of goods and contrasts it with the marginal cost of producing the extra unit. Marginal cost is the business’s amount of money to produce an extra product unit. Hence, marginal cost equals the total cost divided by the change in the number of units the business produces. The total cost is the total amount of money that the business spends on the production process, and it increases with an upgrade in the amount of production.
There are different types of costs that are involved in the production process. They comprise direct, indirect, fixed, variable, operating, opportunity, and implicit and explicit costs, as well as many others (Rounaghi, 2019). All these costs are involved in management accounting to determine the actual cost of a product and assist the management in determining whether production should continue or should not proceed. All these costs are attributable to the production process and vary based on their functions. Direct costs are the costs that the management can straightly attribute to the production process. They include direct labor, direct materials, wages for the production staff, manufacturing supplies, and power or fuel consumption costs. The management can directly link these costs to the production process, greatly impacting the process.
On the other hand, indirect costs are the costs that are incurred in the production process, but the management cannot directly link them to the activities. They cannot be identified with a specific production activity but are involved in the general production process. They include factory overheads, rent, office costs, administrative salaries, security expenses, accounting, legal expenses, and others. These costs are for the general running of the organization and are important in accounting since they draw a real image of the net profit that the firm makes.
Additionally, other costs in strategic management accounting are variable and fixed costs. Variable costs are those that keep changing based on the amount of output. Variable cost increases or decreases based on the amount of production in an organization. An increase in the number of goods produced increases the value of the variable costs (Rounaghi, 2019). For example, an increase in the number of goods being produced increases the amount the organization spends on raw materials. Therefore, the cost of raw materials is an excellent example of variable costs. Sales commissions, direct labor costs, and utility costs are exemplary examples of variable costs since they are expenses whose proportion alters based on the company’s production quantity.
Conversely, fixed costs are those whose value does not change based on the amount of the company’s production levels. They are always constant regardless of the number of products the firm creates. Whether the company creates items or not, the fixed costs are always present and stagnant over a given period. They include rent, salaries, loan payments, and insurance premiums. The direct and indirect costs discussed before are further separable into fixed or variable costs based on how they behave during an increase or decrease in the quantity the company makes. Summing together variable costs with fixed costs creates total costs. Total costs are the costs a company incurs in its production process in a specific period after combining variable and fixed costs. Other costs that affect the manager’s decision-making processes are operating costs, opportunity costs, and controllable costs. These costs play a critical role in influencing decisions that managers make.
Besides costs, another factor affecting a manager’s management accounting decision is income. Income is the money that a business generates from making running an activity. There are different types of incomes that firms can make from their operations. They include sales, rental revenue, dividend revenue, interest revenue, and contra revenue. Sales revenue is the income that a business makes after selling the products it manufactures. Rent revenue is the money a business raises from renting out its premises to other people and businesses. Dividends and interests are a business’s earnings due to ownership of shares and capital investment. At the same time, contra revenue is the money that a business regains from acts such as sales returns and sales discounts. All these forms of income affect the manager’s decision on whether to invest in the project or not.
Qualitative, Non-Financial, Factors That Might Need to be Taken into Account, Before Reaching a Decision
Businesses must consider qualitative non-financial factors that affect their operations and success in their field while deciding whether to proceed with the planned investment. Managers have to weigh the benefits and risks of these factors since they significantly influence the business’ rate of income. Qualitative non-financial factors affecting businesses include customers, suppliers, community, employee morale, investors, and product quality. These factors affect the number of sales the organization makes, thus translating to profits. If these factors do not favor the business, the manager must decide not to implement the planned project since doing so increases the risks guaranteeing low profits. Qualitative factors are difficult to value in numerical form since they comprise human emotions and behaviors. If any of the contributors change their perception of the business, the firm makes losses. For example, if an investor changes their plans to support the business financially, the project comes to a standstill leading to losses. Therefore, the manager must critically analyze these factors to evaluate their reliability and commitment to the firm’s success.
Fundamental Characteristics of Strategic Management Accounting in Comparison to the Traditional Approach
Strategic management accounting is how the management identifies, collects, analyzes, and records accounting data to retrieve information useful in decision-making on the production process and its effectiveness. It deals with the collection and interpretation of non-financial information within and outside the business to aid in making general decisions concerning the daily management of resources in an organization. In modern-day, strategic management is critical for all businesses since it evaluates the likely conditions that the firm may face in the industry. Every business has a set of strategies to meet its objectives during a financial period. The firm must integrate strategic management accounting with the original business plans to understand the firm’s sense of direction and motive. Integrating the strategies creates a positive approach to the business’s attitude toward meeting its objectives (Lakshan et al., 2021). Strategic management is attached to specific characteristics fundamental for its definition and development. These characteristics include it focuses on both internal and external information concerning the organization. It must be integrated into the organization’s strategy and linked to the value-adding process of the firm’s products.
Additionally, strategic management accounting must link to the value-adding process through value chain analysis that attains and utilizes the competitors’ information. The overall goal of linking strategic management accounting to the value-adding process is to identify activities that add value to the products and utilize them by reducing the production cost. The process improves the cost management process within an organization and creates a unique method of handling production, thus giving the business a competitive advantage. Strategic management accounting uses the information it obtains from competitors to execute a market share control plan by improvising the production process to standards that can compete with other brands.
Strategic management accounting focuses on achieving organizational goals while achieving profitability as formulated at the beginning of a period. The process engages all players in the plan and acknowledges the contribution of each member to achieving the company’s objectives. Strategic management targets to engage all stakeholders appropriately to enhance participation in the planned process. Strategic management is influential since it ensures that all participants play their role in ensuring that the organization prospers in achieving its goals and making a profit (Lakshan et al., 2021). On the other hand, traditional accounting solidly focuses on calculating the profits and determining the deviation of the real profits from the projected amount. Therefore, the traditional management accounting system only commits to calculating profits and other activities such as cost control, budget preparation, internal control, and position.
Whereas traditional management accounting practices focus on variance analysis, cost analysis, and cost control strategies, strategic management accounting aims at advanced internal management structures and organizational sustainability. Strategic management is activity-based, meaning that it deeply researches the factors that lead to incurring costs. Strategic management accounting challenges traditional management accounting by accommodating more flexible methods of calculating a company’s profitability. Thus, the approach is better than the traditional management one that sticks to strict procedures of evaluating the costs associated with the production of new materials.
Approaches that the management may Use to Manage Costs
Total Quality Management Approach
Total quality management (TQM) is when a business produces the highest quality commodities and eliminates the errors revolving around the production process. It involves supplying customers with the most high-quality products with very limited defective ones. The management pushes the employees to ensure that they produce goods of the most achievable quality and find all the waste revolving around the production process (Bajaj et al., 2018). Alternatively, the process encourages the managers to detect all the defections in their products and create more qualitative products and concurrently cost-efficient. Total quality management is a form of a lean business that strives to eliminate all the waste products while delivering the most desirable quality items to the customers. Thus, businesses maximize their sales while minimizing costs, increasing profits.
The total quality management process is customer-oriented since it focuses on improving the product quality the company supplies to the customers. It puts the customers’ well-being as its priority. It also engages the employees in finding the most appropriate quality for the customers and motivates them to be more innovative in ideas that boost the product’s quality because employees get directly involved in the production process. The strategy is process-oriented and follows specific guidelines to minimize the production cost. Another characteristic of total quality management is that it utilizes mutually dependent systems (Bajaj et al., 2018). It integrates all the internal systems to create a high-quality product and efficiency. It applies a strategic approach towards attaining the objectives and involves continuous improvement of the product from time to time.
Total quality management is advantageous for most organizations because it strengthens the competitive advantage as customers prefer purchasing from the company with the finest products. The method also helps the business adapt to the market’s changing scope and government regulations and laws (Baja et al., 2018). Total quality management is also vital for businesses since it ensures continued huge production and a competitive brand image. Consumers often refer their colleagues to a business that offers superior goods giving more advantages, enhancing consumer loyalty. However, the whole process requires deep commitment from all the parties leading, which is not guaranteed in many companies. Furthermore, the process requires immense resource allocation by the creators; hence may be difficult to achieve.
Total Cost Approach
Another approach that helps to manage the costs is the target costing approach. This approach is where the market conditions regulate the pricing by themselves (Lily, 2018). The market conditions heed the fact that most products in the market are homogenous, there is a specific level of competition existing in the market, and there are low product switching costs for the consumer. The management has no control over these factors and therefore cannot control the prices. They depend on the market forces to regulate the prices and utilize cost control techniques to obtain high-profit margins since they minimize the cost of production. The approach encourages the management to apply other cost control techniques such as proactive cost planning, cost management, and cost reduction practices that estimate the total production costs and find alternative methods to regulate them.
The process is beneficial for most businesses since it creates grounds for negotiations with the suppliers to reduce the cost of raw materials. The presence of raw materials at relatively low prices creates a thriving environment for the business and encourages the firms to engage in the business to widen their profitability (Lily, 2018). The process helps the business to evaluate the need for outsourcing. It provides alternative activities that help it regulate the amount of outsourcing, thus reducing the amount of capital spent on gaining resources by producing them internally (Lily, 2018). Moreover, the business calculates its return on investment and speculates the number of profits it will make during the specific period. Easy methods of calculating the return on investments aid the business in making decisions that enhance its productivity and maximize profits.
Nonetheless, the approach has several shortcomings since it is not fully accurate. It is a complex system that is difficult to implement in many firms, especially large-scale ones. It is not easy to implement in such firms because tracing all the costs and activities within the organization can be overwhelming for the management. It is also a static approach that keeps varying; thus difficult for the management to cannot respond instantly to changes in the internal and external environments that regularly affect the approach, such as maintenance costs (Lily, 2018). Last, the approach relies on uncertain data to make conclusions; hence not reliable for many firms.
Kaizen’s Cost Management Approach
The Kaizen approach aims at cost reduction by maintaining the present cost levels of the product being manufactured after the producer creates its design. The management can reduce the cost by negotiating with the supplier to control the cost of resources or can use better re-designs of the products (Goyal et al., 2019). Alternatively, the firm may reduce costs by recycling waste materials by using waste management practices that encourage reducing, repurposing, reusing, and recycling. Using these means to control the costs helps the business achieve its profit-making goal and reduce the complications of waste deposition into the surroundings.
Kaizen’s cost management approach enhances teamwork among different stakeholders in the business. It has a worthy target and is beneficial to the employees, the customers, and the entire organization since it acknowledges everyone’s effort, thus giving them a sense of worth in the organization (Goyal et al., 2019). It builds leadership skills and improves efficiency in operations. The main disadvantages of applying this method in cost containment for most organizations are training requirements, difficulty in implementation, and the probability of a few bad individuals corrupting others easily.
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