Management Accounting For Accurate Information

The Importance of Cost Information for Decision Making

The costing function plays an important role in an organisation. It helps the managers to undertake sound decision making by providing necessary and accurate information. The accuracy of cost information holds great significance for various aspects of business. Without the availability of accurate information, the business has to operate in vague. It is of great importance to record and process all the cost related data correctly with due care so that true information related to cost involved in the business process can be identified and communicated to the managers. Managers use  cost information for various purposes such us undertaking various crucial decisions, formulating sound strategies and policies, fixing selling prices, preparation of budgets, controlling and reducing the excessive cost involved and so on. Further, the managers have to sometimes determine as to whether the products they are dealing in must be manufactured internally or they shall purchase such products from the market. To decide on these matters, the availability of actual cost required for the production process, is quite a necessary thing. Furthermore, a firm has to determine the appropriate product mix which requires ranking of the products on the basis of cost involved in their production. Moreover, the decisions regarding termination of a product unit or introduction of a new product line also requires proper cost analysis so that accurate cost information can lead to effective decision making. A budgetary function is also important for the organisation and for the purpose of preparation of budgets a company must have the information in regards to the cost so that proper allocation of economic resources can be undertaken to the necessary areas. There are various methods of cost determination such conventional cost accounting, activity based accounting etc. Under traditional costing approach the overhead cost is assigned to the products on the basis of pre-determined overhead recovery rate (Molis, 2018). However, in activity based costing, overhead cost is apportioned to the different products and activities on the reasonable basis. The cost determined under activity based costing is more accurate than the cost determined under conventional costing methods as ABC  system is an advanced technique of management accounting which is introduced to deal with the limitations of traditional costing methods. In the present case of Beztec Ltd also, the company is presently using traditional costing as a method of cost allocation to the two different types of printers manufactured by the company. One of the printers, viz. Lexon is in the product line of company since three years back and the other product viz. Protox was a newer model which was introduced last year only. The income statement of the company shows that Protox printers entail higher profitability as compared to the older model Lexon. These results have been identified using traditional costing methodology. The management of the company is therefore looking forward to the shut the product line of Lexon printers so that the spare resources could be used for the production of Protox printers. However, it would not be a prudent decision to phase out the Lexon model merely on the basis of cost results produced under traditional costing method as the total overheads of the products are distributed among both the models on the basis of the common recovery rate based on the machines hours utilised in their respective manufacturing processes (Drury, 2013). The manufacturing of printer involves various activities such as soldering, shipments, quality testing, purchasing, machining and so on. All these activities have different cost drivers and hence it is not practically feasible to allocate the overall production overheads to both the printing models merely on the basis of common overhead recovery rate. Rather, the cost related to each activity must be allocated to Lexon and Protox printers in the proportion of usage of activity or any basis that is reasonably suitable to such activities (Horngren, 2002). Machine hours are only consumed for the activity related to the machine power and hence the cost of machining could be only allocated on the basis of machine hours rest other activities are not at all related to the machine hours as no machine hours are consumed for such activities. The allocation of such activities must not be done by applying the pre-determined overhead rate to the total hours consumed in the manufacturing both the printing models. Hence, it can be said that the allocation method adopted by the company is not correct and thus it is not producing accurate results of the cost involved in their production. If the decision of termination of production of Lexon model is taken by the company, it will lead incorrect decisions which may convert the profitability into loss or high profitability into little or low profitability of the overall business of manufacturing. The decision of shutting down of a particular product line which is in existence since long time is crucial enough as it involves considerable amount of investment and also it has a well-established market base which will be lost if production is abandoned without conducting the critical analysis of the true cost involved in its production process. Though, management of Beztec Limited might find it convenient to apply traditional costing, they must consider the problems associated with such system. As Beztec Limited is the manufacturing the printers, it will require the accurate cost information to set the prices of such printers for their sale in the external market. Generally, a desirable margin of profit is added to the total cost incurred in the production of the printers to arrive at the selling price of such products. If incorrect cost is determined, it would lead to incorrect product valuation which will affect the profitability as well as the competitive advantage of the entity.

Limitations of Traditional Costing Methods

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Activity based costing is the one of the key advanced techniques of management costing which is used to determine the cost of the product unit. This technique has gained huge importance in today’s world where the complexities of the business has increased due to involvement of multiple product lines in the business portfolio of the firms specially the manufacturing concerns (Dickinson & Lere, 2003). In the present case, the management accountant of Beztec Limited is considering the application of activity based costing method to allocate the production overhead related to the printing machines in place of traditional costing method so as to achieve the accuracy in the cost results. The basic motive behind the adoption of ABC system is to provide the top management valuable correct information so that they can undertake informed decision making in relation to the production continuance and termination. The application of activity based costing has allowed the management accountant to reach at the conclusion which is absolutely opposite to the results shown under the traditional costing method. As per the results of activity based costing, Lexon model of the printing machine is offering more profit per unit than the Protox model even though its selling price is less than the Protox printers because of involvement of less production overheads as well as other costs. The present case of Bezlec Limited involves an ethical issue as there is conflict of interest between the management and the management accountant. Being a professional body, management accountant has a professional obligation to perform the professional services in the most professional and ethical manner. The profession of accounting requires the accountants to act in the general interest of the public and not only in the interest of their client or employers. In this respect, Accounting Professional & Ethical Standards Board Limited has issued a code for the professional accountants i.e. APES 110. This code of ethics is applicable on all the members of accounting institute and each member must strictly follow each principle in the strict sense so as to avoid bringing disrepute to the accounting profession (APESB, 2010). It sets out various fundamental principles on which the accounting professionals must work. There principles are integrity, objectivity, professional behaviour, professional knowledge, competence and due care and confidentiality. The principle of integrity seeks that accountant to behave in the most honest manner while maintaining professional relations with the clients. The principle of confidentiality suggests that the accountant to not entertain any situations involving biasness or conflict of interest by avoiding overriding of professional judgements for the personal interests. The principle of professional behaviour seeks the accountant to undertake professional practices in compliance with the rules and regulations applicable to the entity. The principle of professional competence will require the accountant to apply all the knowledge and competence that is normally expected from the professional members of the institute so as to ensure that the client or employer of the accountant receives the competent professional services on the basis of current development in the professional practices (Smith, 2003.

Benefits of Activity Based Costing

In the present case of Beztec Limited, the top management of the company is concerned about the bonus and incentives that they receive on the basis of the revenues generated from both the product lines. Hence, they have instructed Sue Smith to alter the product cost information as generated through the application of system of activity based costing. However, the management accountant of the company must not be influenced by the personal interests that his client has in the appointing organisation. Rather, Miss Smith must influence Steve Kay, the CEO of Beztec Limited to adopt the system of activity based costing which will provide them the accurate product cost information in relation to both the models of printing machine. The application of ABC system will prevent the company to undertake wrong decisions would ultimately cause loss to the company (Granof, Platt & Vaysman, 2000). The management accountant must make sufficient efforts to resolve the ethical matter that has arisen between his professional duties and interests of the management. If after applying the principles of integrity, objectivity, professional behaviour and the professional competence the matter remain unresolved, then the accountant must take the advice from the expert body to deal with the matter in the most professional manner. 

The problem of under application or over-application of overhead costs lies with the traditional costing system as this method does not allow the allocation of overhead cost on the reasonable and appropriate basis (Walther & Skousen, 2010). The traditional costing method works on the assumption that the actual total overheads will be in proportion to the actual value of the allocation base used during the period. As under the system of traditional costing the overhead recovery rate is pre-determined before the commencement of the period and is purely based on the estimations, therefore it is quite natural that the applied overhead will differ from the actual overhead. (Cost Accounting, 2010). The problem of under-application of overheads arises when applied overhead is less than the actual overheads and the problem of over-application of overheads arises when the applied overhead is more than the overheads actually incurred during the year (Greenberg & Schneider, 2010). The under- applied and over applied overheads have to be disposed-off in the following ways:

1. Closing out to the account of cost of goods sold and;
2. Allocating the balance between the work in progress, finished goods and the cost of goods sold on the proportionate basis to the total overhead applied during the period to the ending balances of such accounts (Putra, 2008).
3. The third and last method of disposition is allocation of the amount of indirect costs between the closing balances of work in progress, finished goods and the cost of goods sold on the proportionate basis.

The second method of allocation of under applied and over-applied overheads to the ending balances of inventories as well as to the cost of goods sold is considered as more accurate method of disposition of the balanced amount of overheads, than the first way(Garrison, 2010). 

References:  

Accounting Coach, 2018. What is the major weakness of the traditional method of allocating factory overhead? Available at: https://www.accountingcoach.com/blog/traditional-method-allocating-overhead Accessed on 16.09.2018.

APESB, 2010. APES 110 Code of Ethics for Professional Accountants. Available at: https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf Accessed on 16.09.2018.

Cost Accounting, 2010. Disposition of Under-applied or Over-applied Overhead Balances. Available at: https://costaccounting786.blogspot.com/2010/08/disposition-of-underapplied-or.html Accessed on: 16.09.2018.

Dickinson, V. and Lere, J.C., 2003. Problems evaluating sales representative performance?: try activity-based costing. Industrial Marketing Management, 32(4), pp.301-307.

DRURY, C.M., 2013. Management and cost accounting. Springer.

Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial accounting. Issues in Accounting Education, 25(4), pp.792-793.

Granof, M.H., Platt, D.E. and Vaysman, I., 2000. Using activity-based costing to manage more effectively. PricewaterhouseCoopers Endowment for the Business of Government.

Greenberg, R.K. and Schneider, A., 2010. Job Order Costing: A Simulation And Vehicle For Conceptual Discussion. Academy of Educational Leadership Journal, 14(3).

Horngren, C.T., Sundem, G.L., Stratton, W.O., Burgstahler, D. and Schatzberg, J., 2002. Introduction to Management Accounting: Chapters 1-19. Prentice Hall.

Molis, J., 2018. Advantages & Disadvantages of Traditional Costing. Available at: https://bizfluent.com/info-8645304-advantages-disadvantages-traditional-costing.html Accessed on 15.09.2018.

Putra, L.D. 2008. Disposition Of Under-applied And Over-applied Overhead Cost. Available at: https://accounting-financial-tax.com/2008/11/disposition-of-underapplied-and-overapplied-overhead-cost/  Accessed on 15.09.2018.

Smith, L.M., 2003. A fresh look at accounting ethics (or Dr. Smith goes to Washington). Accounting Horizons, 17(1), pp.47-49.

Walther, L.M. and Skousen, C.J., 2010. Job Costing. Bookboon.

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