Management Accounting Essay

1 - Management Accounting Essay introduction. Introduction

      This paper seeks to answer questions pertaining to Rolls Royce plc.  This will involve understanding company’s history and selecting suitable costing and management accounting methods for the company. To accomplish the goal, this will identify and outline what could be important information requirements that could aid the managers of Rolls-Royce, will explain how the company  expects to benefit from the use identified methods and will discuss some of the limitations of techniques identified in relation to designed purposes.

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2. Questions and Answers

2.(a. i)   A brief summary of the company’s business activities, its recent history, and current position.

      Rolls-Royce Group plc is global company with the business providing power systems for use on land, at sea, and in the air to different customers (Rolls-Royce, 2009a).  Currently, it is operating in four segments. One of this is Civil aerospace which is into aerospace, which develops, manufactures, markets and sells commercial aero engines and aftermarket services to customers. The second one is in Defense aerospace where the company develops, manufactures, markets and sells military aero engines and aftermarket services. The third one is Marine where it also develops, manufactures, market and sells marine propulsion systems and aftermarket services. The last segment is in Energy where Rolls-Royce develops, manufactures, markets and sells power systems for its customers in the offshore oil and gas industry, electrical power generation and aftermarket services.  In October 2007, the Company was noted to have acquire Seaworthy Systems Inc.,  which is a United States-based naval architecture and engineering firm, thus making the bigger still bigger (MSN, 2009, Rolls-Royce , 2009b)).

 2.(a.ii)  Identify and outline what you consider to be examples of important information requirements which could aid the managers of this business. 25% ( 500 words)

      The issues of maintaining day to day control, product costing and pricing, planning and decision making, monitoring the business performance, building and maintaining a competitive advantage are considered  by this  researcher important to Rolls-Royce because on the effect to the bottom line or profitability of the business.

       This researcher believes nothing is unimportant when it comes to accounting information if the company has to attain its goal of providing, accurate, reliable and timely information for decision making (Meigs and Meigs, 1995).  An organization like Rolls Royce will have to use assets which must be utilized to produce output or returns to compensate what could have been earned if the resources are used in other ways. There is economic cost to every use of resources.

      Product costing is an important information requirement for Roll-Royce.  Like any other kind of business, the company will have to sell its products above cost. Since its products could be varied, it cannot be assumed that each is given a cost arbitrarily. Its product cost is important in terms of competing in the market. Although it wants to have revenues above cost, it cannot just sell at any amount above cost as competitors could be selling at lower price and this would leave the company unable to sell. If this happens, inventory loss comes out as a result.
Planning and decision making is part of every business as none could be successful without passing through this process with care and skills by its management  (Helfert, 1994; Massie,1987).   It cannot  just produce any volume of product that is not demanded by the market; thus  a business involves looking at the future and trying to approximate the best volume of production  by planning.  In the implementation phase however, changes could happen and decision must be done that should be in accordance with plan if still applicable or make some modifications if conditions demand them.

      Monitoring the business performance is also relevant to the company.  As stated earlier, planning is important to set a target where the company could safely choose some courses of action.  Since there are decisions that must be made, the same must be integrated or combined with monitoring business performance to be able to be guided properly by the proper amount of resources allocated for each activity and to make it sure that managers are doing their assigned duties as expected and in accordance with plans.

       Maintaining a competitive advantage is critical to the company. A business seldom exists outside competition. There are competing uses of funds and there are competing opportunities on what will maximize return of investors.  Depending on how each organization sees the future or market, each will make preparations to get their fair share of the market that would give them needed amount of revenues and that would match planned level of outputs or production. A company therefore like Rolls-Royce could just realize that it competitors are coming from many directions include from the US and the Asian counterparts in many of its products.  A competitive advantage like its capacity to produce a minimal cost for a certain product category in the market would afford the company the resources not only to survive competition but even to generate superior returns.

 2.b. Considering the company’s information needs, identified in (aii) above, select four suitable costing and management accounting methods/techniques from those covered on the Management Accounting 2 course.   For each method or technique chosen: (b) show how it would be applied within this company, including a specific illustrative example. 25% (@ 500 words).

2.b.1 Job Order Costing

      The use of the job order costing, where products are manufactured individually or by batch, is very much applicable in the manufacture of engines by the company.  It may be noted that Rolls-Royce is into different segments such as defence, aerospace, marine and energy and the company would need to make product in accordance with specific customer requirements.  . For planning and decision, making the company need to know the cost of each product before it will accept and process orders.

2.b.2  Batch costing

     If there are similar jobs to be done because customers order in greater number, then Rolls-Royce could apply batch costing. This is a variant of job order costing.

2.b.3. Marginal Costing

         Another alternative that could be used by Rolls-Royce is marginal costing, a technique where only variable cost or direct will be charged to cost unit produced.  This kind of costing shows the effect on profit of changes in volume/type of output by differentiating between fixed cost and variable cost. In times of competitive situations, the company can use this instead of traditional costing.  This very much applicable in term of monitoring performance where there are short-term objectives that must be met.

2.b.4 Activity-based costing  (ABC)

       Job order costing and batch costing are rather a traditional ways of costing where there could be over some limitations. For this reason, the company can adopt ABC as alternative costing.  It is asserted that ABC is better than traditional costing as the former assigns cost to activities instead to cost pools. Under ABC, the appropriate activities are defined after carefully analyzing the same and a cost driver rate is derived for each kind of appropriate activity by dividing estimated unallocated overhead costs to cost drivers that are properly identified.   ABC impacts by bringing unallocated fixed cost with the activities that consume resources, thus in effect redefining the behaviour of the fixed cost into variable cost. It is in effect expanding to more variable costing to afford the decision make to know what are controllable and in effect helps the company in implementing responsibility accounting that could hold managers responsible for their decisions.  However present practice of management accounting may not find the very wide users of ABC because of complexity and cost issues as would be explained further latter in the other parts of this paper. Complexity is taken in the sense that it is simpler to prepare costing under the traditional way and hence it costs fewer to do the same.  As a general rule, no matter how could a practice or technique may if cost exceeds the benefits, then usefulness is necessarily reduced.

       In regard therefore to adopting either traditional costing or activity based costing method by management additional cost will be incurred. Adopting management accounting is an investment decision that will have to be weighed by management along with other options and this will also need a separate study of how much will it cost management to adopt management accounting and how much he stands to gain for management to clearly make a position in the issue.  Since the case facts do not provide cost information for this, analysis could not be further be expanded to reach that level in order to complete the recommendation made to management.  It is therefore suggested that management will have to gather cost data for this purpose and make a cost benefit analysis as basis of his decision whether to adopt management accounting and whether the method adopted should be traditional or ABC costing.

2. (c)  Explain how you would expect the company to benefit from the use identified above and explain how your suggestions could assist the business performance.  25%.  (@ 500 words)

         This researcher would expect the company to benefit from the use of the above identified costing methods by the company’s being able to know how to manage its cost that could improve its business performance.

       In general, Rolls-Royce can have the specific benefits of employing management accounting, which could either be using traditional or activity based costing or the other methods.  Every company need to know how much it should sell it product by knowing first how much it has cost the company. To determine the profit of each product is a function of revenue per unit and unit cost per product produced and additional selling and administrative expense cost per unit.  Revenue or price per unit is theoretically determined after knowledge of unit cost per product while product unit cost includes direct materials, direct labour, and factory overhead.  Even at the production level, it is advisable to know the gross profit or contribution margin per unit for each product in order to assist the company on which product to produce more, or less or whether there is basis of using another product that would yield greater amount of profits.  The determined contribution margin per unit enables the decision to proceed whether the same would be able to cover operating expenses per unit.

        To identify the different various variable elements in traditional product costing would not pose a problem. There is ease in identifying direct materials, direct labour and the variable manufacturing overhead of the product. It is in the application of fixed overhead to product that will create the problem since fixed cost are supposed to remain fixed regardless of the level of production. But by including a portion of fixed cost to the product, a unitizing fixed cost is created.   This practice of unitizing fixed as required by the generally accepted accounting principles of financial accounting has the effect of making fixed cost variable despite these cost are clearly fixed cost. This will therefore create an assumption that changing the level of activity will change the amount of fixed cost also despite the fact that there should be no change. The result is to produce erroneous contribution margin which is important in decision making.  The resulting decision would most likely be distorted since the premises are faulty. It could thus inferred that under traditional product costing, accountants arbitrarily decide to allocate fixed overhead to product using direct labour hours or other observed relationship.

         But since the company can also choose marginal costing, it can assure itself that it is simple to understand. This kind of costing can be a useful short term survival costing technique particularly in a very competitive environment. During this time where there is a recession, margin costing would be timely to use in having competitive advantage as long  in accepting as long as the marginal cost of the business and the excess over the marginal cost contributes towards fixed costs so that loses are kept to a minimum.  There is however some limitations of this option as will be explained next.

2.(d) Outline any limitations of the techniques you have identified and explain how these might adversely impact on the effectiveness of the method/technique for the purpose intended. 25%.    (@ 500 words)

        The limitations of the techniques used will have to consider the disadvantages of each of costing method. Their limitations have something to the validity of assumptions made. To illustrate the following are the disadvantages of each of the method discussed

       Traditional costing or absorption costing is limited in the context of treating total cost as part cost of inventory (Atkinson, Anthony, et al,2005; Meigs and Meigs, Bernstein, 1993) and not classifying what is fixed from variable, thus its use for management purposes may be limited. It is therefore not used in planning and control. Hence managers may be forced to use intuition and which could be inaccurate.  This explanation should cover job order and batch costing.  Assuming now that company has adopted traditional costing, a suboptimal result is believed to be the outcome when fixed manufacturing cost is being included as part of the product or service that rendered, thus affecting the income for the period.  The income for the period is therefore influenced by production and inventory changes. If production is greater than sales, profit under traditional costing would be higher than variable costing and vice versa (Meigs and Meigs, 1995).

        To remedy some limitations of absorption, marginal costing could be adopted. However, the latter has also its limitations. Marginal costing makes use historical data while management decides on the basis of future events thus there could be some disparity of what is assumed that what will happen.  The same costing also regards fixed costs as if they are not important to production by failing to recognize that in the long run, fixed cost may become variable. Thus for long run costing, the method must be regarded with limitations.  Classifying short term and long run objectives is also part of wise business planning since strategies have to be with the timing also of reaching relevant objectives (Brigham  and Houston, 2002; Droms , 1990; Van Horne,1992).  Common sense dictates that management must consider total cost not only the variable portion, in the long run. There is the difficult part of classifying properly variable and fixed cost perfectly, where there stock valuation is possibly distorted by having fixed cost classified as variable.

        To remedy the limitations of marginal costing, the use of ABC may answer some as in expanding or making it that some fixed cost to be treated as variable because of the activity.  However, again activity-based costing is also not perfect and one of reasons is the fact that it is difficult to implement the process and may entail cost to determine the activities that may have influence on cost.   There is therefore a trade-off of cost and benefit that must be balanced by the management of Rolls-Royce.

3.  Conclusion

       It can be therefore concluded that the best costing method depends upon the need of the company with due consideration of the conditions where the company operating right now. Although no theory or method is perfect for each occasion, Rolls-Royce may stand to benefit from the use of a method according to its need.
References:

Atkinson, Anthony, et al (2005), Management Accounting, Person Custom Publishing, New Jersey, USA

Bernstein, L. (1993) Financial Statement Analysis, IRWIN, Sydney, Australia

Brigham, E.  and Houston, J. (2002) Fundamentals of Financial Management, Thomson South-Western, London, UK

Droms (1990) Finance and Accounting for Non Financial Managers, Addison-Wesley Publishing Company, England

Helfert, Erich (1994), Techniques for Financial Analysis,  IRWIN, Sydney, Australia

Massie, (1987) J.  Essentials of Management, Prentice-Hall , Inc

Meigs and Meigs (1995) Financial Accounting,  McGraw-Hill, London, UK

MSN (2009) Rolls-Royce Group PLC: Company Report, {www document} URL,  http://moneycentral.msn.com/companyreport?Symbol=RYCEF, Accessed  February 23, 2009

Rolls-Royce (2009a) Company Website, http://www.rolls-royce.com/, Accessed  February 23, 2009

Rolls-Royce (2009b),  Annual Report, 2007, {www document} URL, http://www1.rolls-royce.com/investors/reports/2007/Downloads/index.htm, Accessed  February 23, 2009

Van Horne, J.C.  (1992), Financial Management Policy, Prentice-Hall, Inc., London, UK

 

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