Accounting: Management Meeting, Essay Example

This memo is written to explain the intricacies of costing to the CEO of the firm and would detail the different approaches towards costing with specific reference to ABC or Activity Based Costing and the reasons why this should be adopted along with a cautionary note about why the method of ABC fails under certain conditions. Further, the memo also considers the reasons for dip in profitability even when volumes are increasing. The memo is written in such a way that the CEO with minimal exposure to accounting and cost accounting in particular can understand the reasons for the company’s financial situation.

To start with, historically, costs were directly allocated to the production of the units made by a factory meaning that they were included in the list of “variables” that were to be accounted for in the selling price of the units. However, with increases in production volumes, managers found it necessary to maintain a certain amount of machinery and other “fixed” items like the factory space etc in order to be ready whenever production of the units picked up. The costs associated with such items were classified as “fixed costs” meaning that they remained constant at all volumes of units produced. These were later classified as “overheads” and hence the practice of costing was divided into different categories like standard cost accounting, activity based cost accounting etc.

Activity Based Costing can improve the accuracy with which the company reports its financials as in this method; the accountants assign monetary value to the “activities” undertaken in the production of goods and services. For instance, if the activities involved in producing our products are divided along the lines of time spent for each activity by the employees and the portion of the employees’ salary for each hour or unit of time spent is calculated, then the resulting cost of the product is arrived at in a more accurate manner than by standard cost accounting measures that divide the total cost of production by the number of units, ABC apportions the total cost that is required arrived at by means of cost of activities. Hence, with this method it is easier to allocate resources for more profitable products instead of wasting time and money on products that take up much more of the employees’ time and hence contribute to increased costs.

However, ABC has some downsides as well as it can lead to improper identification of fixed costs. For instance, the CEO’s salary cannot be directly attributed to the cost of making units of products as the CEO’ s time cannot be broken down into units of time that go into making the units. This is just a general example and there are other instances as well that include the arbitrary allocation of fixed costs. Further, the time spent by the employees’ might be more for particular units because of stoppages and downtime as well as quality issues. Hence, this results in a bit of confusion as to the real cost per unit of product. This is the reason for the counter intuitive result of profitability being hurt by increased volumes as the differences in units of time spent to achieve “economies of scale” might not necessarily translate into higher profits.

Finally, the way in which classification of fixed and variable costs as well as mixed costs is done is important as the above discussion shows the importance of assigning monetary values to these costs and apportioning the weights to each of these costs is crucial to the identification of the total costs incurred for the product.

References

Accounting Methods and Practices. Journal of Bank Cost and Management Accounting (Volume 4, Number 1), 1991.

Kaplan, Robert S. and Bruns, W. Accounting and Management: A Field Study Perspective (Harvard Business School Press, 1987)