Strategic Management Accounting Business report for Manac plc.

Management Project Teacher: Mr Given Spencer

My name: Xiaobo Pan

Contents
My name: Xiaobo Pan.................................................................................................1 Contents..................................................................................................................... 2 1. Introduction............................................................................................................. 3 2. Topic 1: The models and concepts affecting the pricing decisions..........................3 2. 1. actors affecting pricing decisions...............................................................3 2. 2. Methods affecting pricing decisions..............................................................! 3. Topic 2: The role of standard costing and "ariance analysis in management accounting.................................................................................................................. # 3.1. $tandard costing and "ariance analysis........................................................# 3.2. %&ample........................................................................................................' 3.3. The "alue and limitations...............................................................................( 3.3.1. )alue...................................................................................................( 3.3.2. *imitations...........................................................................................( +. Topic 3: The ad"antages and disad"antages of introducing an ,cti"ity -ased Costing system to replace the current ,bsorption Costing system............................1. +.1. ,cti"ity -ased Costing system and ,bsorption Costing system...................1. +.2. %&ample......................................................................................................12 +.3. The ad"antages and disad"antages............................................................12 +.3.1. ,d"antages........................................................................................12 +.3.2. /isad"antages...................................................................................13 !. Conclusion............................................................................................................ 1+ 0ord count: 2('#......................................................................................................1+ 1eferences............................................................................................................... 1!

1. Introduction Lately, Manacplc faced some haunting problems: it fails to meet the budgeted target profit. I, the financial director of Manacplc, planed to carefully review the variances, so as to identify the areas failing to meet the budgeted expectation. This report primarily deals with the following three issues. i. The models and concepts which affect the pricing decisions taken by Manac plc. ii. The role of standard costing and variance analysis in the management accounting. iii. The advantages and disadvantages of the introduction of ctivity !ased "osting system to replace the bsorption "osting system. . Topic 1: The models and concepts affecting the pricing decisions #rowing firms come to realise that reasonable product price directly relates to whether a firm can survive in the intensive competition. $roctor %&''() maintained that pricing decision means to determine the most proper product price in a rational and scientific matter for the business targets. . 1. !actors affecting pricing decisions The primary factors affecting pricing decisions include product cost, market demand, and competition from similar products in the market. %*) $roduct cost affects product price as it affects supply. In practice, product price is made based on cost, tax, and profit. "ost can be divided into fixed and variable costs. $roduct price is sometimes determined by total cost and some other times by variable cost. +rom time to time, cost is divided into social average cost and individual corporate cost. ,ith regard to the market price of similar product, it is

mainly affected by social average cost. -nder full competition, whether individual corporate cost is higher or lower than social average cost has no big impact on product price %.rury, &''/). %&) part from cost, product price is also affected by market demand, i.e. it is affected by the supply of and demand for product. ,hen market demand is greater than supply, the price will be relatively high0 while when market demand is less than supply, the price will be relatively low. Meanwhile, price change also affects market demand and thus affects the sales and the attainment of corporate target. 1ence, in pricing decisions a firm must have a good understanding of the influence of price change on market demand. $rice demand elasticity coefficient is an indicator reflecting such influence. +or instance, the sales of $anasonic2s electric iron is sluggish, and the development director invited do3ens of women for their advices, and one woman 4oked that, 5If you can produce an electric iron without wire, then it will be well received.6 The development director immediately organised research and design, and it was not before long that wireless electric iron was launched in the market, which was well received %"ooper, &'''). %7) Market competition is another important factor affecting pricing decisions. +irms make different pricing decisions according to different levels of competition. ccording to competition level, market competition can be divided into perfect competition, imperfect competition, and perfect monopoly. -nder perfect competition, neither the buyer nor the seller can affect product price, while they can only carry out production and transaction at the given market price. -nder imperfect competition, firms2 pricing decisions are relatively flexible while firms mainly consider competitors2 pricing decisions and the influence on competition status. -nder perfect

monopoly, the volume and price of transaction are determined by the monopolist %!irchard and 8pstein, &'''). part from cost, demand, and competition, firms2 pricing decisions are also affected by other factors, such as government or industrial organisation intervention, consumer psychology and habit, and firm or product image %"ooper, *((9). . . Methods affecting pricing decisions $ricing method refers to a firm2s method to calculate product price by using pricing decision theory based on studies of cost, demand, and competition under the guidance of specific pricing targets, while ma4or pricing methods include cost:, demand:, and competition:based pricing. Meigs, et al. %&'';) argued that cost:based pricing is a top choice for firms. "ost refers to the real spending in a firm2s production and operation, and it is ob4ectively re<uired that cost should be made up through product sales while the return must be higher than the expenditure, and the exceeding part is shown as business profit. ,ith unit product cost as basis and determining the price by adding expected profit, cost:based pricing is a most commonly used and most fundamental pricing method for firms. "ompetition: and customer:based pricing are often used as supplement to cost:based pricing. most representative cost:plus pricing formula is: -nit product price= Total unit product cost> %*?Target profit margin). 8xample:*: ssume that Manacplc produces an electric product of which the fixed cost is @ A'',''', variable cost @ &'Bpc, and expected sales volume /',''' pc %-nit @). -nit cost= Cariable cost? %+ixed costBDales volume) = &'? A'','''B/','''= 7& If the firm wants to realise the profit of &'E cost, then the unit price will be:

-nit price= -nit cost> %*? 8xpected profit margin) = 7&> %*? &'E)= 7;.F If the firm wants to realise the profit of &'E selling price, then the unit price will be: -nit price= -nit cost> %*:8xpected profit margin) = 7&> %*: &'E)= F' This method simplifies pricing, facilitates economic accounting, and is relatively fair to both the seller and buyer, while the prices tend to be similar, and the price competition will reduce. 1owever, it should be noted that when cost:based pricing is used, the identification of cost is based on the assumption that the sales volume reaches a certain level %Thomas, and Geed, &''&). In short, the ma4or factors affecting pricing include product cost, market demand, and market competition. ,ith unit product cost as basis and determining the price by adding expected profit, cost:based pricing is a most commonly used and most fundamental pricing method for firms. Manacplc can use competition: and customer:based pricing as supplement to cost:based pricing. ". Topic : The role of standard costing and variance anal#sis in management accounting ".1. Standard costing and variance anal#sis Dtandard costing is an important method to overcome the disadvantages of actual cost accounting method, while it takes preset standard cost as basis, compares standard cost and actual cost, calculates and analyses standard variance, evaluates cost control performance, and conducts direct control and management of product cost. ,ith regard to the operation procedures, standard costing firstly sets unit standard cost and calculates standard cost of product, and then calculates actual cost and standard cost variance, and at last analyses cost variance and hands in cost control report %+leischman and Tyson, *((;). Dtandard cost is the

expected cost of unit manufacturing cost under normal production condition, which is set based on product consumption standard and standard price of consumption. The setting of standard cost is carried out based on cost items, including the standard cost setting of direct material, direct pay, variable and fixed manufacturing overhead. In standard costing control system, cost variance refers to the total discrepancy between the total actual cost and total standard cost in the production of certain <uantity of products in a specific period. ccording to different classifications, cost variance can be divided into price and <uantity variances, pure and mixed variances, favourable %H') and unfavourable variances %I'), and controllable and uncontrollable variances %1all, &'*&). Dtandard costing facilitates firms to realise the budget, conduct control and performance appraisal, implement decisions, and realise improvement and change through variance analysis. Dtandards are suitable for the firms of which the activities involve repetitive or common operations and in which the component parts and material of product could be specified. Dtandards are usually set at an ideal level and reflect the perfect performance, or at an attainable level to reflect the performance under the efficient operation condition. Therefore, standards play a critical role in management accounting %!erger, &'**). ". . $%ample In this section, fixed manufacturing overhead variance analysis is taken as an example. .ifferent from variable cost variance analysis, fixed manufacturing overhead variance analysis mainly has two analytic methods: two: and three:factor analysis. Three:factor analysis divides fixed manufacturing overhead cost variance into three factors: expenditure variance, efficiency variance, and idle capacity variance. 8xpenditure variance further divides the capacity variance in two:factor

analysis into two parts: idle capacity variance caused by the failure to attain production capacity by actual man hour0 and efficiency variance caused by actual man hour2s deviation from standard man hour. nd the calculation formulas are: +ixed manufacturing overhead expenditure variance= ctual allocation ratioJ ctual man hour: Dtandard allocation ratioJ !udgeted man hour +ixed manufacturing overhead efficiency variance= Dtandard allocation ratioJ% ctual man hour: Dtandard man hour) +ixed manufacturing overhead capacity variance= Dtandard allocation ratioJ %!udgeted man hour: ctual man hour) 8xample:&: Manacplc2s budgeted fixed manufacturing overhead in this period is @ &,F'', budgeted man hour is *,''' h, and actual man hour is *,&'' h, while actual fixed manufacturing overhead is @ &,A'', and standard man hour is *,*'' h %-nit @). "alculation and analysis of fixed manufacturing overhead: +ixed manufacturing overhead standard allocation ratio= &,F''B*''= @ &.FBh +ixed manufacturing overhead actual allocation ratio= &,A''B*,&''= @ &.*9Bh +ixed manufacturing overhead expenditure variance= &,A'':&,F''= &'' +ixed manufacturing overhead capacity variance= &,F'':&.FJ*,*''= :&F' +ixed manufacturing overhead efficiency variance= &.FJ%*,&'':*,*'')= &F' +ixed manufacturing overhead capacity variance= &.FJ %*,''':*,&'')= :F;' Dtandard fixed manufacturing overhead= &.FJ*,*''= &,AF' +ixed manufacturing overhead variance= &,A'':&,F''= :F'

".". The value and limitations ".".1. &alue There are some advantages about the standard costing and variance analysis. %*) The classification of cost variance is relatively scientific and comprehensive. ccording to cost nature, manufacturing overhead is divided into variable and fixed costs, which facilitates budget control and analysis % rnold et al., *(;*). In 8xample:&, the factors affecting budget variance include resource price change, and resource <uantity change0 while capacity variance reflects the utilisation ratio of planned productivity, which may be caused by the failure of output to reach a certain scale. %&) The variances in standard costing provide the information needed to management by exception, stimulate the management department to look into the causes of variance and liability, and fall in line with the principle of management by exception. In addition, standard costing simplifies financing accounting and facilitates management accounting to play its maximum utility. ".". . 'imitations Kevertheless, standard costing also has some limitations. %*) In variable manufacturing overhead standard cost, the price indicators and <uantity indicators used to reflect price factor and <uantity factor lack scientific and reasonable basis, so that the price standard and <uantity standard based on these indicators also lack reasonableness. %&) Dtandard costing views variable manufacturing overhead as general expenditure standard in cost accounting and appraisal, so that firms cannot effectively control cost, or ob4ectively conduct performance appraisal or make relevant decisions %+ei, and Isa, &'**). %7) The inaccurate manufacturing overhead allocation results in distorted

cost information, so that the manufacturing overhead standard cost based on cost information itself is unscientific and unreasonable, which is obviously non:conducive to the firms. In short, standard costing facilitates firms2 budgeting, control, performance appraisal, decision execution, and improvement through variance analysis, while it plays a critical role in management accounting. #iven the value and limitations of variance analysis as a method to identify the primary areas contributing to overall profit, Manacplc should ob4ectively view variance analysis and not blindly exaggerate its role in management accounting. (. Topic ": The advantages and disadvantages of introducing an Activit# Based )osting s#stem to replace the current A*sorption )osting s#stem "ost accumulation system is used to account the production, operation, and management expenses and product cost, while it mainly includes direct costing systems, traditional costing systems and activity based costing system%"hris, &''(). (.1. Activit# Based )osting s#stem and A*sorption )osting s#stem bsorption costing system is a traditional costing system which uses inventory estimation to calculate the total product cost. In traditional cost accounting, product cost is primarily made up of direct material, direct labour, and manufacturing overhead, in which manufacturing overhead is an indirect cost and must be allocated to relevant product according to specific criteria. ,ith the great changes in technology and social environment, traditional costing methods gradually show their inherent limitations. +or instance, single criterion is used to allocate overhead to final product or service, while it is assumed that overhead expenditure facilitates production, yet the actual situation has already changed0

overhead is allocated through direct man hour or machine hour, which is unreasonable0 while responsibility accounting and standard costing lack relevancy to cost behaviour when proving systematic appraisal indicators %1all, &'*&). ,ith growing importance attached to activity philosophy in management and the changes in overhead proportion and structure, Gobert Laplan and "ooper %*(;;) put forward !" which allocates the resources consumed by a firm %all manpower, materials, and capital entering activity system) into activities according to resource driver while allocating the activity cost pooled by activity %ob4ective of resource consumption) to cost ob4ects according to cost driver. In general, criteria to identify cost driver mainly include causality, return, and other rational factors. If there is causality between activity and resource, and between activity and product, then it will be most ideal to identify cost driver based on causality. In addition, cost driver can also be chosen based on the proportion of return. +or instance, there are two restaurants and one has much higher return than the other, so that the service sector can identify cost drivers of different returns, number of employees, and number of customers. Dome costs cannot be connected with product through causality or return, while such costs can be allocated based on e<uity or rationality. !" mainly has following characteristics: it takes people as sub4ect and advocates people:oriented activity0 it consumes certain resources, labour, and materials0 it distinguishes different activities according to the purposes0 it divides activities into value:added and non:value:added activities while improving production procedure by reducing non:value: added activities0 the scope can be restricted, and the precision of activity scope can be identified according to management re<uirements % rmitage and Kicholson, *((7).

(. . $%ample Duppose that M and N are two products of Manac plc. M is made in large batch and N in small batch. M consumes F'E of .L12s while N consumes *'E, yet each product consumes &'E of batch:related indirect cost. The traditional costing system uses .L12s as cost driver while !" system uses the number of batch processed. ll overheads %total= @ *m) are batch:related. Traditional system @ .irect costs Overheads llocated $rofitsBlosses Dales M F*',''' F'',''' %F'E) %*',''') ;'',''' N F',''' *',''' %*'E) A',''' &'',''' !" system M 7*',''' &/',''' %&/E) *F',''' ;'',''' N F',''' &/',''' %&/E) %(',''') &'','''

(.". The advantages and disadvantages (.".1. Advantages %*) !" not only extends the cost proportion of certain product but also uses multiple cost drivers as indirect cost allocation basis, so that it facilitates firms to obtain more accurate cost information %"ollins, *((*). "omparing the calculation results using absorption costing and management expense of M is @ F'',''', while when !" in 8xample:7, it can be found that when absorption costing is used, the !" is used, it becomes @ &/','''. !" allocates cost according to cost driver and thus improves reasonableness. More accurate cost information facilitates firms to relatively accurately identify period:end inventory value, evaluate the profitBloss, and improve financial status. !" provides a way to learn about product activity process and facilitates managerial personnel to improve cost control. To identify cost

driver, managerial personnel will focus on cost driver rather than only care about output and direct labour. %&) "onsistent with value chain analysis, by evaluating which links in supply chain can be added, !" can increase customer value, reduce cost and expense, and provide exceptional information support to strategic management %"apusneanu and !riciu, &'**). (.". . +isadvantages Gobert and Dteven %&''/) pointed out that disadvantages. %*) In !", cost centres are established according to department, which facilitates responsibility accounting and performance appraisal. .ifferent from organisational structure, in activity cost system the cost pool does not facilitate the provision of management control information. In addition, !" tends to improve operation decision information at the cost of management control information, which reduces the utility of accounting data in management control %.unn, &''F). +urthermore, !" still focuses on the improvement and control of internal production areas while failing to extend cost control to external areas or control the cost from long:term product life cycle perspective. %&) ctivity cost management is of heavy workload, complicated activity process, and a large number of activity centres, while cost driver data collection also means heavy workload and relatively high cost. dditionally, there are more cost drivers in and maintenance expense will be. In short, when calculating ma4or product cost, firms should choose a most appropriate cost accounting method based on production characteristics and production organisation method, yet such cost accounting method may not necessarily meet all re<uirements for cost accounting and cost !" than in absorption costing, while the more the cost drivers are, the higher the development !" also has many

management. Therefore, Manacplc should scientifically and reasonably arrange cost accounting procedures and methods, combine ctivity !ased "osting system and bsorption "osting system, and try to attain optimal cost accounting and optimal cost control. ,. )onclusion The primary factors affecting pricing decisions include product cost, market demand, and competition from similar products in the market. "ost:based pricing is a most commonly used and most fundamental pricing method for firms, so that Manacplc should adopt cost:based pricing at first. Dtandard costing plays a critical role in management accounting, as it not only facilitates firms2 budgeting and performance appraisal but also helps firms to implement efficient decisions. s a method to identify the primary areas contributing to overall profit, variance analysis is of great value, yet Manacplc should ob4ectively view variance analysis and not overlook its limitations. Manacplc is of complicated situation and thus should comprehensively consider its production characteristics and procedures, scientifically and reasonably arrange cost accounting procedures and methods, as well as combine ctivity !ased "osting system and bsorption "osting system.

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-eferences rmitage, 1., and Kicholson, G. %*((7) P ctivity:based costing: a survey of "anadian practice2, Society of Management Accountants of Canada, 7, pp.*&':*&;. rnold, Q., et al %*(;*) Topics in Management Accounting, London: The "amelot $ress Limited. !erger, .%&'**)Dtandard "osting, Cariance nalysis and .ecision:

Making, Danta "ru3:#GIKCerlag. !irchard, !., and 8pstein, M.Q. %&''') Counting What Counts: Turning Corporate Accountability to Competitive Advantage, London: $eruses !ooks. "apusneanu, D., and !riciu, D. %&'**) R"ontrol and nalysis of "osts

based on Gesult of ccount of the !" methodR, International Journal of Academic esearch in !usiness " Social Sciences, *%7), pp. *79:*/F. "ollins, +. %*((*) Implementing Activity !ased Costing, Kew Nork: 8xecutive 8nterprises $ublications. "ooper, G. %*((9) RThe Two Dtage $rocedure in "ost Journal of Cost Management #all, 9, pp. 7(:F/. "ooper, G.%&''') P"ost management:+rom +rederick Taylor to the present2, Journal of Cost Management, &%*), pp. *FF:*/'. .rury, ". %&''/) Management accounting for business. Dingapore: "engage Learning. +leischman, G., and Tyson, T. %*((;) PThe 8volution of Dtandard "osting in the -.L. and -.D.: +rom .ecision Making to "ontrol2, Abacus, 7F%*), pp. (&:**(. ccountingR,

1all, Q. %&'*&) Accounting Information Systems, Dingapore: "engage Learning. Monroe, L., and .ella, . %*(9;) PModels for $ricing .ecisions2,

Journal of Mar$eting esearch, */%7), pp. F*7:F&;. $roctor, G.%&''() Management Accounting for !usiness %ecisions, 1arlow: $rentice 1allB +inancial Times Gobert, L., and Dteven, '!S Wor$ing .%&''/) ethin$ing Activity&!ased Costing & (no)ledge,SOnlineT vailable at:

http:BBhbswk.hbs.eduBitemBF/;9.html % ccessed: .ecember &', &'*&). Thomas, T., and Geed, L.%&''&) The Dtrategy and Tactics of $ricing: a guide to $rofitable .ecision Making, London: nglais.