Costing Methods Table of Contents Term Paper

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Even the lowest-level managers and employees are empowered to make decisions and have that valued democratic voice.

ADVANTAGES:

An advantage of this form of measurement is that it tends to be more encompassing, since it accounts for all uses of capital. It is susceptible to manipulation by managers with a short-term focus, or by manipulating the hurdle rate used to evaluate divisions. The frequently occurring problem, in concern to a lack of coordination among autonomous managers, can be quickly reduced by clearly redefining the company's strategy and communicating it effectively throughout the organization; accordingly, problems will occur, but Investment Centre Management has discovered a quicker means to establish resolution.

An investment center is a classification used for business units within an enterprise. The essential element of an investment center is that it is treated as a unit which is measured against its use of capital, as opposed to a cost or profit center, which are measured against raw costs or profits. The advantage of this form of measurement is that it tends to be more encompassing, since it accounts for all uses of capital. It is susceptible to manipulation by managers with a short-term focus, or by manipulating the hurdle rate used to evaluate divisions.

DISADVANTAGES:

Lower-level managers without a full grasp of the overall situation are still allowed to make crucial decisions; along with this, comes animosity, angst, and hostility.

Moreover, top level managers frequently receive insufficient of inadequately detailed information concerning local operations than the lower level managers. In accordance, Investment Centre managers usually have more information concerning the company as a whole when they should have a better grasp of the company's current strategies.

Within Investment Centre management systems, a lack of coordination among autonomous managers frequently occurs. Lower-level managers frequently have objectives that are quite dissimilar to the overall objectives of the organizational management as a whole. Commonly, rather than holding focus in increasing the profits of the company, these managers become more interested in building the proportional magnitude of their individual departments. Though this problem can be overcome by establishing a performance evaluation system to motivate managers to make decisions that are in the best interests of the organization, more often than not any attempt to gain acceptance of every managerial opinion cast.

Likewise, in many instances this becomes more difficult to effectively share and further develop innovative ideas. When one employee or lower-level manager from one part of the organization develops a traffic idea to benefit other parts of the organizations, then without strong central direction the idea may not be shared, and adopted, and utilized by other sections of the organization. Apparently, this is only great in theory, but overwhelming and continually problematic in practical use.

Part B.

Organizations need to know the cost of products or services they provide for a variety of decision making situations. Critically evaluate the following three approaches to costing products or services:

1. Marginal or variable costing;

2. Full or absorption costing;

3. Activity-Based costing (ABC).

For each approach, identify two managerial decision making situations where that approach is more appropriate than the other two and justify why you have chosen that approach over the other two approaches in a particular decision making situation.

1) Marginal or variable costing:

Also in Wikipedia, Principles in Action (2003) by Arthur Sullivan and Steven M. Sheffrin clearly details these differences in Marginal Costing:

In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good. Mathematically, the marginal cost (MC) function is expressed as the first derivative of the total cost (TC) function with respect to quantity (Q).

Note that the marginal cost may change with volume, and so at each level of production, the marginal cost is the cost of the next unit produced.

In general terms, marginal cost at each level of production includes any additional costs required to produce the next unit. If producing additional vehicles requires, for example, building a new factory, the marginal cost of those extra vehicles includes the cost of the new factory. In practice, the analysis is segregated into short and long-run cases, and over the longest run, all costs are marginal. At each level of production and time period being considered, marginal costs include all costs which vary with the level of production, and other costs are considered fixed costs.

A number of other factors can affect marginal cost and its applicability to real world problems. Some of these may be considered market failures. These may include information asymmetries, the presence of negative or positive externalities, transaction costs, price discrimination and others.

QUESTIONS:

By not charging fixed overhead to cost of production, how can the effect of varying charges per unit be avoided?

Does the simple and understandably pure nature of Marginal Costing dually eliminate large balances left in overhead control accounts while also indicating the difficulty of ascertaining an accurate overhead recovery rate?

Full or absorption costing:

Absorption costing entails that the units produced incorporates the bulk of the manufacturing costs. Strictly speaking, the cost of a finished unit in inventory will include direct materials, direct labor, and both variable and fixed manufacturing overhead. Consequently, absorption costing may frequently be regarded as full costing or even the full absorption method.

Frequently contrasted with variable costing or direct costing, Absorption costing is vital to all of managerial decision-making. Variable Costing or Direct Costing, however, though also essential to managerial decision making, all established overhead costs in lieu of mass-production are not allocated, assimilated by, or assigned to the products manufactured. Yearly income tax reporting, nonetheless, does require Absorption Costing in regard to external financial reporting.

QUESTIONS:

Does this become very costly to implement and maintain, such as Activity-Based Costing, and encourage activity while weighting heavily on detail yet overlooking accuracy?

Does the separation of costs into fixed and variable become difficult and frequently cast misleading results like Marginal or Variable costing?

Activity-Based Costing:

Activity-Based Costing (ABC) recognizes and then assigns all applicable indirect costs or overhead as direct costs. By distinguishing, establishing, and isolating projects within an organization first, ABC allocates the cost of the particular assets or resources of each activity. All products and services are then measured alongside any withstanding expenditures. Then, concerning the purposes of identifying so as to eliminate all commercial hazards and to lower the costs of any that are overpriced, these systematized ABC procedural ventures both governs and assigns an organization's resource costs through activities to the products and services provided to its customers.

Correspondingly, an organization can then estimate the costs of individual products and services with great accuracy. Nonetheless, this technique becomes progressively imprecise; since the indirect costs are not based identically, the percentages of overhead costs increase, and on a seemingly slippery-slope. A particular product may take longer in one exorbitant device than another product, for instance, but any surplus expense for the use of that device would not be identified when that same non-specific percentage is added to all products. The amount of direct labor and materials may very well be comparable if not identical. As a result, as multiple products share common costs, there is a danger of one product subsidizing another.

QUESTIONS:

Does the volume variance in standard costing also disclose the effect of fluctuating output on fixed overhead, like the way Marginal costing data becomes theoretically logical though impractical and purely idealistic in the case of highly fluctuating levels of production?

Does management discount intuition and place emphasis is on total cost, like Absorption Costing, while the cost volume profit relationship is ignored?

References/Bibliography

Management Accounting for Business, Colin Drury, 4th Ed. 2009 Thomson.

Management Accounting for Decision Makers, Peter Atrill and Eddie McLaney, 6th Ed. 2008 Prentice Hall

Corporate Finance (Principles and Practice), Denzil Watson and Antony Head, 3rd Edition 2006 - Prentice Hall

Sullivan, Arthur; Sheffrin, Steven M. Economics: Principles in Action (2003). Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 111. ISBN 0-13-063085-3.

Kaplan, Robert S. And Bruns, W. Accounting and Management: A Field Study Perspective (Harvard Business School Press, 1987) ISBN 0-87584-186-4

"Oxford University Press. Encyclopedia.com." 2006.http://www.encyclopedia.com/doc/1O18-costcentre.html. Retrieved 9 August 2010.

Sapp, Richard, David Crawford and Steven Rebishcke "Article title?" Journal of Bank Cost and Management Accounting (Volume 3, Number 2), 1990.

Drucker, Peter F. (2002). Managing in the Next Society. New York, New York 10010: St. Martin's Griffin. pp. 84. ISBN 0312320116. http://us.macmillan.com/managinginthenextsociety.

Staubus, George J. Activity Costing and Input-Output Accounting (Richard D. Irwin, Inc.,…

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