The following essay explains the importance of cost accounting for stakeholders of Multinational Companies, particularly the shareholders & the customers. Who are the stakeholders of an organization? according to (Freeman 1984) stakeholder is “any group or individual who can affect or is affected by the achievement of the firm’s objectives” going by this definition stakeholders of a company would include lenders, creditors, customers, shareholders, government, media, political groups, local charities etc. The main focus of this essay will be on shareholders and customers.
A company cannot plan a strategy on to just focus on increasing shareholder value or just focus on customers, neither one leads to the other automatically. Customers want best product for the cheapest price, while shareholders look for value of their investment and the income that is derived from their holding of shares. Shareholder value or customer value cannot be measured simply by numbers; Earnings per share, Return on investments or other ratios are not sufficient which is why financial accounting is not enough. Langfield): Management Accounting provides managers with essential information for the effective and efficient use of financial and non-financial resources in creating value for shareholders and customers. Focus of management accounting is to effectively achieve shareholder value or customer value with the least possible consumption of the company’s resources. Highlight of modern cost accounting is how costs can be analysed in different ways to meet different information needs of the organisation in its decision making.
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Identification and tracking of individual costs helps managers in forecasting profits & setting product prices which are key elements in creation and enhancement of both customer and shareholder value. Cost accounting also focuses on what drives value, which costs and which activities have a positive or negative effect in the creation of value for stakeholders. The most important thing cost accounting provides the management is the information in making proper, efficient and sustainable business decisions.
Without proper awareness and lack of information managers tend to make poor business decisions, as seen in this classic case of shareholder value verses customer value: (Cleland, Alan S )Schiltz Beer was second best beer maker during 1970s in North America, until management decided that it was dissatisfied with the stock market price, on purely financial basis management looking at income statement, decided to cut on expenses and thus started using less expensive hops in its beer. Looking at the balance sheet they decided to reduce assets tied up in the business so the time used to age the beer was cut.
As a result profit margins, asset turnover and stock price all went up, but the beer did not taste the same anymore and masses stopped buying the beer which eventually led both shareholder & customer value down the drain. This shows that there is a fine line between enhancing shareholder and customer value and it’s very critical to maintain a balance between both. In the light of the importance of Shareholder and Customer value mangers rely highly on the tools of management accounting in their decision making. Words: 510) Question no. 2 The following essay looks to define cost allocation, cost apportionment, and cost absorption of products, and will compare and contrast activity based costing (ABC) & traditional methods of costing. (Horngren, Datar, Foster… ) ‘Cost’ as defined by accountants refers to a resource that is sacrificed or used in purpose to achieve a specific objective. Management or Cost accouting focuses a great deal on establishing what direct & indirect costs are and assigning them to a cost object.
Cost accounting focuses on determining the different components of the total cost of manufacturing a product, for e. g. : how much of the total cost were raw materials? How much was the cost of labor etc, determining these individual costs would help in finding out for e. g. : if the cost of raw materials is too high then maybe management should consider a cheaper option that might be available, similarly if the cost of labor is too high or low maybe a cut in labor is needed. Determining individual costs is very essential to the running of all kinds of businesses.
The term allocation and apportionment of costs are sometimes used interchangeably in some countries but according to (CIMA) assigning of a cost to a single cost unit or cost centre is known as cost allocation and assigning of indirect cost or overheads to two or more units of costs is known as cost apportionment. Various methods of determining and allocating costs are used by businesses some of which are referred as traditional costing systems which include direct costing & absorption costing. Drury)’ traditional costing systems were developed in the early 1900s and are still in use businesses today. ’ In direct costing method only direct costs are assigned to cost objects, supporters of direct costing argue that only direct costs can be traced accurately to a cost object and hence they provide a true assessment of the cost since indirect costs cannot be exclusively traced to a cost object therefore should not be assigned to a cost object. Drury): Another traditional method used is known as absorption costing which takes in to account both direct & indirect costs when assigning costs to cost objects, Supporters of absorption costing say that indirect costs should not be ignored because when determining costs, all the resources used should be taken into account as it will help in better and efficient decision making.
Indirect costs which are also known as overheads are common to several cost objects therefore it is difficult to directly trace these costs. A modern method of costing introduced in the 1980s is Activity Based Costing. (Chutchian-Ferranti, Joyce) “Activity-based costing is a costing model that identifies the cost pools, or activity centres, in an organisation and assigns costs to products and services(cost drivers) based on the number of events or transactions involved in the process of providing a product or service. (CIMA)The main aim of ABC is to identify business activities to increase efficiency, lower costs and improve utilisation of assets. Chutchian-Ferranti further describes that activity based costing analyses and evaluates indirect costs or overheads along with other operating expenses linking them to the costs of such as customers, services and production etc. This allows management to determine which services or activities are profitable or whether are losing money. Drury)Supporters of ABC argue that traditional cost systems were designed decades ago when most companies were marketing a narrow range of products thus overheads were relatively small and problems arising from inappropriate allocations were negligible hence use of sophisticated methods was not beneficial. Since 1980s companies not only started making a wide product mix but production was in more than one country and in a race for profit maximisation companies realised that indirect costs could not be ignored.
Due to intense global competition errors due to poor cost information became costly. Companies could not afford to lose competition so better and more sophisticated systems of costing were needed. (Drury) Since traditional methods rely extensively on volume based cost allocation which is a main weakness, they tend to over cost high volume products and under cost those with a low volume of production, whereas ABC takes in to account that many indirect cost vary due to factors other than production volume.
Hence ABC is able to assign costs based on particular activities which give a more accurate trace of costs. Even though GAAP does not recognize activity based costing system and despite of additional costs acquired of ABC, companies continue to use it because it provides a clear picture of fixed and variable costs and hence which costs are profitable to run and which aren’t. Technological advancements and fierce competition is forcing companies especially manufacturing and also accounting bodies to look into adopting ABC.
ABC generates more accurate costs than traditional costing methods and thus gives a proper reflection of desired mark-up for each individual product and or activity. ABC is evolving as we speak (Bellis-Jones Hill Group) DHL which is a multinational company with current revenues of approx €51 million, has been using ABC since 1988. even though ABC did not prove to be successful initially due to the size and volume of its business, in early 2000s after developing different models of ABC DHL did not only develop a reliable system of costing but also a set of tools that could support the pricing of large global tenders.
Companies have to examine their overhead levels to decide if ABC is applicable or not, ABC is usually suitable for companies with high levels of overheads but even at low overhead levels a company with a wide product mix should consider ABC. (Words: 940) Bibliography 1. Bellis-Jones Hill Group, customer case:’DHL-customer profitability in action’ (www. bellisjoneshill. com). 2. CIMA Official Terminology 2005 edition; CIMA publishing. 3. Chutchian-Ferranti, Joyce: Activity based Costing, Journal: Computerworld; (AUT database). . Cleland, Alan S :Balancing customer and shareholder value; Financial Executive 1987(AUT database) 5. Colin Drury :Management Accounting for Business (4th edition;) pages 162,163,164 & 202. 6. Criag Deegan/Grant Samkin: New Zealand Financial Accounting 5E pg 47 7. DHL Annual Report; 2007, 2010. (www. dhl. com) 8. Horngren, Datar, Foster, Rajan, Ittner, Wynder, Maguire, Tan: Cost Accounting (1st Australian edition. ) 9. Kim Langfield-Smith, Helen Thorne, Ronald Hilton: Management Accounting 5E, pages 6, 7.