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TABLE OF CONTENTS
Page
Task 1
Introduction
Cost centre manager
2-3
Profit centre manager
4-5
Investment centre manager
6-7
Task 2
Marginal or Variable Costing
8-11
Full or Absorption Costing
12-14
Activity Based Costing
15-17
Conclusion
18
Bibliography
Appendices
INTRODUCTION
I was appointed to the position of Finance Director this job has enormous responsibilities
which play a vital role within the corporation
...
The responsibility centre is defined by Drury
(2008 pp
...
’ It plays a crucial role in the organisation’s accounting systems
...
It is also used to establish how
much authority managers are given with regards to the financial goals and objectives
...
These three
centres stem initially from responsibility centres
...
(See appendix 1)
This section looks decentralising the organisation by making individual managers: Cost
centre manager, Profit centre manager or Investment managers
...
All three divisions are based on
lagging indicators and merge with the balance score card
...
The balance score card looks at the internal as well as the external issues regarding the
organisation
...
(see appendix 2)
...
When
the company applies multiple performance measurements it would be easy to identify
flaws within its operations
...
Companies introducing this performance
2
measure for the first time would come across numerous teething problems, however, a
possible solution would be benchmarking with other organisations
...
Cost centre managers
2
...
Investment centre managers
1
...
The main focus of the cost centre
manager is to minimise the expenses while meeting the requirements necessary to
provide quality products and services
...
Based on the profitability of the cost centre,
the corporation can then make informed decisions regarding the product management,
marketing and even investments
...
This section
would produce reports on product and service profitability which will be beneficial to
3
the entire corporation
...
The cost centre manager is able to
better account for expenses and therefore improves the control and decision-making
aspects of the corporation
...
Disadvantages of Cost Centre Manager
Colin Drury (2008) Management and Cost Accounting 7th edition, pp
...
’ Therefore the cost centre manager must always
keep in mind that the quality and quantity of productivity is significantly important to
the other divisions and contributes towards the profits of the organisation
...
The cost centre manager will also have to closely monitor the allocation
of overheads; if it is erroneous it can jeopardise the corporation’s estimated
profitability
...
Another disadvantage is that the manger is in a position
to manipulate the overhead costs
...
Profit Centre Manager
The Profit Centre Manager is responsible for the controllable costs, the quantity of
sales and revenues accomplished by the corporation
...
The manager here is
responsible for reporting the company’s productivity and profitability over a period of
time
...
Profit centres use controllable profit statements when reporting
...
This division relies heavily on the cost centre division
as the profits would be derived from sales
...
5
Disadvantages of Profit Centre Manager
As with any section, this one also comes with its disadvantages
...
The profit centre manager is dependant on the cost centre manager and subsequently
the amount of sales made would affect the company’s revenue
...
Another disadvantage for the profit centre manager is
the ability to trace controllable and uncontrollable in the profit statement, therefore
according to Steve Jay, Performance Measurement, 2004 (www
...
com)
“When assessing the performance of a manager we should only consider costs and
revenues under the control of that manager and hence judge the manager on
controllable profit
...
Investment Centre Manager
The Investment Centre Manager is responsible for income generated by sales and the
costs incurred
...
” Performance Measurement by Steve
Jay, www
...
com, sited on 08
...
2010
...
To measure the
divisional performance the following methods are generally used:
Return on Investment (ROI)
Net Residual Income (NRI)
Economic Value Add (EVA)
The calculations for these techniques can me seen in (Appendix 4) taken from
Strategic Management of Accounting Module
...
This motivates the manager to work harder and it
also promotes efficiency
...
Since
this manager has control over profits and investments, he/she has to be extremely
careful with investment decisions
...
Disadvantages of Investment Centre Manager
Investment centre managers face one major disadvantage, which is the decisionmaking for investments
...
1
...
This method records the variable
8
costs for product costing
...
” When using this method the fixed or sunk costs are
never charged to the production units, only the variable costs
...
This system is used to value inventories or products and
cost production throughout the organisation
...
Marginal Costing vs Absorption Costing
When comparing Marginal Costing to Absorption Costing the most significant
difference is the treatment of fixed cost within each technique
...
However, the marginal costing technique
only accounts for direct and overhead costs
...
” When there is a net change in the stock valuation the two
techniques can actually generate different profits for that particular period
...
Diagram 1 below taken from http://basiccollegeaccounting
...
For instance, the company can determine whether the
price to fabricate a particular item is cost effective as opposed to purchasing the
item externally
...
10
Drury, Management and Cost Accounting (2008) pp 148 states that “with variable
costing, profit is a function of sales volume, whereas, with absorption costing,
profit is a function of both sales and production
...
If
the company experiences a decrease in sales, the company can end up with
surplus stocks in hand
...
However, when using the absorption costing technique, profits
are achieved using both sales and production
...
”
Marginal Costing vs Activity Based Costing
The Marginal system assists managers with pricing decisions as they don’t need
to account for fixed costs
...
” He also states that “traditional systems tend to allocate
costs to departments whereas ABC systems allocate costs to activities: (ABC
systems tend to have more cost centres/cost pools) “
The Marginal system combines maintenance and production cost centres, whereas
on the other hand ABC system divides the cost drivers for the maintenance
departments
...
Full or Absorption Costing
Absorption costing is a systematic way of allocating a fair share of the indirect
costs or overhead costs into the actual cost of the production units
...
Apportionment – involves sharing expenses among general cost centres
...
(Appendix 10 shows an example of costs being apportioned)
To justify the use of absorption costing, ACCA P5 Performance Management 3rd
edition (June 2009) pp 5 states that “all production overheads are incurred in the
production of the organisation’s output and so each unit of the product receives
some benefit from these costs
...
” It is also assists management with inventory
valuations and product pricing decisions
...
Drury (2008) shows a “Formula used to model the profit function for an
absorption costing system when unit costs remain the same unchanged throughout
the period
...
Marginal costing has proven to be more useful for decision-making purposes
13
however, absorption costing is recommended for financial reporting purposes in
compliance with accounting standards
...
” However, when using
absorption costing, manufactured goods are priced at their full production costs
...
However, while comparing the two, the ABC
14
method proved to be more efficient and widely used within larger organisations
because of its complexities
...
The Absorption costing technique allocates all overheads to the production units
...
It also
assists management with output and pricing decisions especially if the company
has a standardize product range
...
Under the ABC system, achieving
the final pricing is a more complex task as it requires tracing and allocating all
costs incurred to their respective cost centres
...
3
...
In today’s economic market many
15
companies produce a wide range of products and offer various services, the ABC
is used to capture the total costs incurred by the company as direct labour
represents only a fraction of the total cost, the objective is to capture all costs
related to the production of the manufactured goods
...
Drury
(2008) states that “ABC systems can more accurately measure the resources
consumed by cost objects
...
Identifying the major activities that take place in an organisation
...
’
2
...
At this point
the cost of resources must be assigned to the related activity cost centre,
this will establish how much each activity costs the company
...
Determining the cost drivers for each major activity
...
4
...
Activity Based Costing (ABC) vs Marginal Costing
These two systems employ the ‘two-stage’ allocation process
...
The marginal costing system allocates indirect costs
to cost centres assigned to departments, however, with the ABC system, costs are
apportioned and distributed according to the activity levels within the
departments
...
According to Horgren et al, Cost Management 12th Edition (2006) pp 144, “unlike
simple systems, ABC systems calculate costs of individual activities to cost
products
...
Activity Based Costing (ABC) vs Absorption Costing
The ABC system manages and maintains the profit-generating products, as
opposed to the absorption costing system where these products may actually be
17
discontinued
...
The
ABC costing system can also be used to identify activities which add little to no
value to the company, this is the only costing system that can provide this
information
...
Conclusion
In concluding, it is my option that the Activity Based Costing (ABC) is the ‘best
fit’ system for organisations today, as it gives a more accurate cost of production
18
as opposed to the Marginal or Absorption costing
...
Bibliography
19
Module APC309, Strategic Management Accounting, version1
...
accaglobal
...
07
...
com sited on 05
...
2010
APPENDICES
21
APPENDIX 4
Return on Investment (ROI)
ROI can be calculated on both a primary and a secondary level:
1
...
Secondary level: ROI = Net Profit x
Sales
x 100%
Sales
Net assets
Net Residual Income (NRI)
Divisional Profit - charge for capital invested = Residual income
Economic Value Added (EVA)
EVA=
Conventional divisional profit
+ accounting adjustments
- cost of capital charge on divisional assets
22
APPENDIX 8
Illustration: sited on 05
...
2010 at (http://basiccollegeaccounting
...
The selling price per unit is $75
...
This product consumes
material costing $10 and 2 hours’ direct labour
...
Further Details:
Direct labour rate per hour
$4
...
(c) Explain why the two methods produce different results
...
500
Difference in profit
$15,000
The difference of $15,000 profit between the two methods is a result of the valuation of the net
change in stock during the period
...
e
...
accaglobal
...
08
...
Horngren, S
...
Foster: Cost Accounting 12th edition, Pearson Education
29
APPENDIX 6
SUMMARY OF IAS 2
Objective of IAS 2
The objective of IAS 2 is to prescribe the accounting treatment for inventories
...
It also provides guidance on the cost formulas that are used to assign
costs to inventories
30
APPENDIX 9
Comparison between Absorption and Variable costing
Colin Drury, Management and Cost Accounting, 6th edition (2004)
31
APPENDIX 7
A two-stage allocation process (traditional costing system)
The two-stage allocation process (ABC System)
Colin Drury (2004), Management and Cost Accounting, 6th edition, Thomson
32
APPENDIX 1
Divisionalised organizational structure
Fig 20