Costing Methods Table of Contents

¶ … Costing Methods

Table of Contents (optional)

Comparison of the Types of Responsibility Centers & Evaluation of Costing Methods

Structure of Paper

Abstract- Executive summary-100-200words

Question a- Title -(1300/1400 words approx)

Subtitle 1a- 1b-

Question b -Title-(1300/1400 words approx)

Subtitle 2a- 2b-

Conclusions/recommendations (100/200words)

Appendices -Brief can be placed here

Numerical examples

I am not in this course, so I have no idea how to construct this. However, by what is presented within this detailed seventeen page synopsis, these final subsections (Conclusions / Recommendations, Appendices, and Numerical Examples) should be quite evident.

Abstract

A distinguishing issue to face this multinational corporation, as with any, exists in the back and forth banter between information and communications technology and how an appropriate form of management is not only initially vital in a sink-or-swim demeanor, but also vital in keeping current with the shifting economy. As the finance manager for this large multinational corporation maintaining business in roughly 20 different countries, deciding which of the three managerial types maintaining undivided focus here -- Cost Centre Managers, Profit Centre Managers, and Investment Centre Managers -- can best assist in promoting innovation and creativity, shepherding ideas from concept through reality.

Some of the businesses within the group buy from one another. By investigating these various ways to measure the performance of individual managers who each have responsibility for one part of the portfolio, we will explore ways to maximize profits for the corporation as a whole. This paper isolates each of these three types before comparing and contrasting, before ultimately deciding which to apply in order to further the development that is designed to promote continued competitiveness in an increasingly interlinked and interdependent global marketplace.

Introduction:

Within this paper I will detail the advantages alongside the disadvantages of these three types of managerial costing (Cost Centre, Managerial Centre, and Investment Centre).

Part A.

You have just been appointed to the position of Finance Director for a large multinational corporation. The business operates in about 20 countries around the world and has a very diverse product, service, and business portfolio. Some of the businesses within the group buy from one another. You are looking at ways to maximize profits for the corporation as a whole and as such you are investigating different ways to measure the performance of individual managers who each have responsibility for one part of the portfolio. What are the advantages and disadvantages of making individual managers either:

Cost Centre managers:

A cost centre manager, or cost center manager, consists of the business segment which allocates a cost for the functionality of strategic planning. These can be large divisions of a business, departments, small teams, or individuals. Since the cost centre negatively impacts profit, at the surface, it is a likely target for rollbacks and layoffs when budgets are cut. Operational decisions in a contact centre, for example, are typically driven by cost considerations. Investments in new equipment, technology and staff are often difficult to justify to management because indirect profitability is hard to translate to bottom-line figures.

Business metrics are sometimes employed to quantify the benefits of a cost centre and relate costs and benefits to those of the organization as a whole. In a contact centre, for example, metrics such as average handle time, service level and cost per call are used in conjunction with other calculations to justify current or improved funding.

ADVANTAGES:

Service departments housing manpower such as general administration, finance, legal administration, legal placement and arrangement, personnel, accounting, et cetera / et al., are typically considered to be cost centers. Moreover, manufacturing facilities are frequently considered to be cost centers. While the managers of cost centers, to meet the standard, must underrate or minimize costs, they still must determine a means to provide the level of services or the amount of products demanded by the other parts of the organization.

For one common instance, imagine that the manager of a production facility has been evaluated at least in part by comparing the substantiated costs to the speculative costs at what they should have been for the genuine number of productive units produced during the period. Standard costing and variance analysis page deals this evaluation of the performance of cost centers in detail.

Therefore, even though a cost center, as based on the Cost Centre Management pinnacle here, is a division of business management whose manager has control over costs, Cost Centre Management does not maintain control over revenue or investment funds.

DISADVANTAGES:

Faulty distribution of overheads ultimately undermine estimates and mislead any analysis of profitability. Also, management through the means of a profit centre intensifies monotonous administrative duties.

2) Profit Centre managers:

Found on Wikipedia, Peter Drucker displays quite a concise explanation of the duties of a Profit Centre Manager within Managing in the Next Society (2002):

A profit center is a section of a company treated as a separate business. Thus, profit or loss for profit center are calculated separately. A profit center manager is accountable for revenues and expenses, and, therefore, profits. What this means for managerial responsibilities is that the manager has to drive the sales revenue generating activities which leads to cash inflows and at the same time control the cost (cash outflows) causing activities. This makes the profit center management more challenging than cost centre management. Profit center management is equivalent to running an independent business because a profit center business unit or department is treated as a distinct entity enabling revenues and expenses to be determined and its profitability to be measured.

Business organizations may be organized in terms of profit centers where the profit center's revenues and expenses are held separate from the main company's in order to determine their profitability. Usually different profit centers are separated for accounting purposes so that the management can follow how much profit each center makes and compare their relative efficiency and profit. Examples of typical profit centers are a store, a sales organization and a consulting organization whose profitability can be measured.

Peter Drucker originally coined the term profit center around 1945. He later recanted, calling it "One of the biggest mistakes I have made." He now asserts there are only cost centers within a business, and "The only profit center is a customer whose cheque hasn't bounced."

ADVANTAGES:

The profit management option is a frequently employed method used to evaluate a division's financial success as well as the functionality of the current manager. A profit centre monitors and distributes responsibility as well as measures the performance of a division, additional and various measurable units, product line, and the geographic area. Profit Centre Management also allows greater and more expeditious resolution adaptability, decisive option lucidity, decision making abilities, and localized clarity within smaller businesses.

Divisional profit figures are best obtained by subtracting from revenue only the costs the division manager can control (direct division costs) and eliminating allocated costs common to all divisions (e.g., an allocated share of company image advertising that benefits all divisions but is not controlled by division managers). In determining divisional profit, a Transfer Price may have to be derived. The divisional profit center allows for decentralization. As each division is treated as a separate business entity with responsibility for making its own profit.

The optimal advantage is that the company can easily oversee which segments of the business are profitable and which are not; this accessibility makes Profit Centre Management see, as more of a black-or-white option.

DISADVANTAGES:

The isolated effect of a profit center management system is that it is truly nothing greater than an accounting and operating structure that allows management to track revenue, costs, and overhead (expenses) unique to each product or service offered. Frequent misplacement of comprehensive control and distorted sense of unity due to imbalanced perceptions of profits within each Cost Centre.

Investment Centre managers:

Investment centre is a sort of autonomous unit and is gauged in accordance with Return on Investment (ROI). It motivates management to diligently hold rigid focus and promotes efficiency. According to J.P. Morgan, Investment Centre initiated in Hong Kong. Within the bounds of an enterprise, the classification regarded as an investment centre, or investment center, is used for Strategic Business Units (SBU); also according to Wikipedia, since it serves as a defined external market where management can conduct strategic planning, a SBU is understood as a business unit, in relation to products and markets, within the overall corporate identity which is distinguishable from other business. 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.

Essentially, any division of an organization whose manager perpetuates the ultimate control over costs, revenue and investment funds remain democratic (and hopefully untainted). This creates a unit in which decision-making is not confined to a few top executives, but instead shared throughout the organization. This puts managers at various levels; key operating decisions, in relation to their sphere of responsibility, causes much less unwarranted delegation and leaves the decentralized structures to be created purely out necessity. 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.