Managerial Accounting Strategic Management in Large Multinational

Managerial Accounting

Strategic Management in Large Multinational Corporations

Strategic Sources, Inc. is a multinational organization that operates in 20 countries around the world. They offer a wide variety of products and services to their customers. Their extensive business portfolio includes some portions of the organization that serve as suppliers for other parts the organization. In an effort to increase profit margins, the Chief Financial Officer has been appointed the task of presenting options for cost accounting that will help to maximize profit margins not only in the individual units, but in the organization as a whole.

The following will present the options for achieving this goal. It will address three different approaches to cost accounting including making individual managers cost center managers, profit center managers, or investment center managers. It will also examine three different approaches to costing products or services. It will explore marginal or variable costing, full or absorption costing, and activity-based costing.

Cost Center Management

Companies may choose to classify their divisions as cost centers when the divisions of the company are clear. When costs are easy to measure establishing business units as cost centers makes accounting easy for the unit and for the parent company. However, cost centers can create incentives for managers to reduce operating costs within their unit to benefit themselves. This can have a negative impact on the parent company by creating bad customer experiences, which will ultimately result in lost sales and lost brand equity. The cost center can have a negative impact on profit and cost centers can be easy targets for layoffs and downsizing when budgets are cut.

Operational decisions in the cost center are often driven by cost considerations. Indirect costs are often difficult to translate into their affect on profitability. For instance, new equipment purchases might not realize a profit until sometime in the future. Cost centers may not see the benefit of such long-term purchases and therefore may not make the decision to buy them. Cost centers tend to want to realize profit quickly and in a way that is easily measurable. Cost centers must be able to immediately justify expenditures, which is not always easy to do.

A cost center does not necessarily directly generate revenue, but contributes generation of revenue in the company is a whole. Some cost centers do not generate revenue it all, such as personnel or a customer call center. The services are paid for by the company's sales, but they do not directly create sales themselves. Yet, without them, sales for the entire company would decrease. An IT department is an example of this type of cost center for many companies (Bahel, 2010).

In a cost center profitability is usually determined by subtracting only the costs that that manager can control and can be directly attributed to their unit from the revenues. When costs are shared between several divisions, one unit may receive a disproportionate benefit from the expenditure, but they will still share equally in the expenditures. Cost centers often have disproportionate cost and benefits relative to their use of capital within their unit. This is usually good for companies that are fairly centralized.

The more assets and overhead they can share, the better success they will have with the cost center management approach. For instance, in a manufacturing facility where all of the units are located under a central roof and share utilities and personnel, the cost center approach would be effective. In this case, all of the cost centers share equally in operational costs, but they also receive some benefit from them as well. One of the key disadvantages of the cost center approach is that the manager will have to absorb costs that they could not control and that were handed down to them from above. Yet, they must find ways within their department to absorb them and still remain profitable. Power and control in the cost center approach is weighted towards the company as a whole and often individual cost centers will have to struggle if their unit wishes to meet their goals.

Profit Center Management

A profit center differs from a cost center in that it is treated as if it is an entirely separate business entity. Profits and losses at each center are calculated separately. The manager of the profit center is responsible for both revenues and expenditures. The manager of the profit center must drive sales so that the cash inflows outpace cash outflows. This is similar to running one's own business. This differs from the cost center where the manager is only responsible for keeping down costs and their activities are limited to those activities that will produce tangible results.

Management can easily follow how much each cost center contributes and they can compare it to the contributions of the other cost centers. The profit center has an advantage in that it is easier to track in terms of performance. However, it has a disadvantage in that one manager can have a detrimental effect on the rest of the business in the actions that they take. The profit center approach is much easier from an accounting perspective and from a management perspective because one can easily see which divisions are profitable and which ones are not. It has the advantage of being able to quickly diagnose a problem so that the resolutions can be implemented.

Profit center approaches are typically applied to businesses that are decentralized. They must often attain their own facility and assume their own operational costs such as utilities and personnel. In a cost center, several units may share a centralized administrative staff or perhaps they may use the same main and staff. However, if the units of the business are scattered far away, each center must have its own administrative staff, maintenance staff, electrical service, and they must provide their own physical building. They do not have the advantages of sharing the services as with the cost center approach, but they receive direct benefit from their expenditures. Often managers that are using the profit center approach are under extreme pressure to meet goals because they are directly responsible for them. With the adoption of activities-based costing, the definition of cost and profit centers is changing (Kaplan, 2006). There is a growing trend to transform cost centers into profit centers (Leonard, 2006).

Investment Center Management

The investment center approach is to measure is the unit's performance against its use of capital. This differs significantly from cost or profit centers which are measured against raw costs or profits. One of the advantages of this method is that it accounts for all uses of capital, not just those that are directly associated with profit activities. Divisions are often measured against a set of criteria. A key disadvantage with this method is that managers with a short-term focus my not make the best decisions for the long-term goals of the company.

The investment center is the center that has control over the investment of funds that will benefit the entire company. Many companies have a centralized corporate headquarters that serves as an investment center. The investment center approach is not focused on short-term gains, but rather on the long-term goals of the entire organization. Some organizations may have smaller Investment Centers within them, but they must often meet the needs of a centralized investment unit. The key advantage to the investment center approach is that the focus is on long-term goals, rather than short-term actions and results.

Conclusion

There are advantages and disadvantages to each of these approaches in cost accounting. As a manager, of a large multinational corporation, it is likely that all three of these approaches will be used in combination with in the entire organization. It is likely that a central headquarters will be set up as an investment center. The various units operating within the different countries will be set up as profit centers and within each of these profit centers will be individual cost centers. The profit centers would be the unit to report directly to the investment center. Each profit center would be responsible for the generation of its own revenues. Due to the geographical distance involved, each profit center would not have the luxury of sharing resources with others. However, they would operate different cost centers within their organization that they share resources within that profit center.

In terms of choosing a certain cost accounting approach for a large multinational corporation, it is unlikely that a single type cost accounting approach would be appropriate for the entire organization. Cost accounting in complex organizations often develops as a result of slow company expansion. It is difficult to use cost centers in areas that are geographically distanced. However, each profit center is often a large company unto itself. Therefore, within it are various cost centers. Each profit center must generate enough revenue to cover the costs of non-revenue producing units. In this case, some of the units produced supplies for other units. These units would be considered cost centers of the profit centers that they supply.

Typically profit centers must meet certain goals and criteria and they must produce a certain amount of profit or revenue for the investment center. In certain cases, profit centers may be able to function as investment centers, but they still must report to the centralized investment center at a corporate headquarters. The type of costing approach is different on all levels of the organization and the combination of approaches used depends on the structure of the company (Portz & Lere, 2010).

Costing Approaches

Marginal or Variable Costing

Variable costing takes into account costs that vary from a fixed amount. Many times these variations involve very small fluctuations that occur for very limited periods of time. The marginal cost of a product refers to its variable cost. Typical variable costs include labor, material, and a portion of overhead. Marginal costing takes into account the principle that as output increases, the cost per unit normally decreases as the costs are spread out over more units. If output decreases, typically the cost per unit increases.

Variable costing is typically used in manufacturing. If the factory produces 100 toasters, at a total cost of $300, and the facility produces one more unit the cost per group goes up to $302 this means the marginal cost of each toaster will be $2.00. This is sometimes referred to as Cost-Volume-Profit Analysis (CVP) analysis. Managerial decision making in areas that involve cost per unit analysis, such as manufacturing, are suited for variable costing methods.

This situation is also used in managerial decisions that involve stock and inventory valuation. Profit measurement is valued a marginal cost per unit or stock. This has become an important costing method in companies that are warehouses associated with online store fronts. Variable costing is most suitable for situations where revenues and profit margins are dependent on a certain level or volume of activity. However, there are several assumptions that must be considered in the valuation process. For instance, this method assumes constant sales price, constant variable cost per unit, constant total fixed costs, and a constant sales mix. It is not appropriate for businesses that frequently change the types of inventory that they carry. In a company where unit costs are important, full absorption costing can result in inaccurate pricing schemes, as they are not associated with unit cost. Activity-based costing is also not an appropriate method, as it is difficult to divide variable overhead costs into unit cost. For unit-based manufacture, variable costing is the most appropriate method.

Variable costing can also be used when the company manufactures many different product lines. It is most appropriate when the production of these products occurs at a set rate. For instance, the manufacture may have several different product lines and they know how fast each of these lines produces units. They also know the exact cost of what it takes to manufacture of each of these different units. For instance, a cereal company might have lines for the production of several different brands. They know the inputs required to produce a certain amount of units on each line. This is where variable costing would give them the most accurate picture of the costs associated with each unit. Labor costs approximately the same for each unit produced. Variable costing is most appropriate when production occurs at a steady, set pace and the number of units produced in a certain time is relatively constant.

Variable costing would not be the best choice if several products were produced on the same line and there was an intermediary setup time between each run. It would also not be appropriate if these products ran at different rates and speeds, producing a different number of units for each product. In this case, absorption costing, activity-based costing, or perhaps a combination of the two would be the best choice, if this were the circumstance.

Full or Absorption Costing

Total absorption costing involves the full cost of manufacturing or providing a service. It includes not only the cost of materials and labor but also all manufacturing costs, both fixed and variable. It is used in situations where overhead needs to be absorbed into the cost of inventory for valuation purposes. Managerial decisions that involve manufacturing where the full cost of producing goods is needed are appropriate for absorption costing. Absorption costing is typically associated with manufacturing, rather than services.

Absorption costing treats all costs of production as product costs regardless of whether they are fixed or variable. This costing method allocates a portion of overhead cost of each unit a product along with variable manufacturing costs. In situations where production is equal to sales then both absorption costing and variable costing will produce the same results. This is the theoretical assumption behind just-in-time manufacturing. This is where products are produced as close to final shipment as possible. They do not sit in inventory for a long time.

In a situation where production and sales are nearly equal, either absorption costing or variable costing will work. Absorption costing is typical in manufacturing suppliers where an order is placed and the manufacturer ships it to get it to its location just before it is needed. One example of this is a manufacturer who produces auto parts for an assembler. Many of these parts are large and take up a lot of warehouse space. The final assembler knows how many parts they will need and when they will need them. They obtain a supplier who can give them the parts when they need them and in the quantities that match their own process flow. They have the parts that they need, but they do not have huge warehouses stacked with parts to be used later. Absorption costing is preferred for an intermediary parts manufacturer for a larger assembler, if they use just-in-time manufacturing.

However, when production is greater than sales net income under absorption costing would be greater than net income under variable costing because a portion of the fixed costs will be deferred to other years. The opposite would be true if production is less than sales. Under this situation net income under absorption costing would be less than net income under variable costing because the portion of costs that were deferred from the previous year would be absorbed into this year's cost of goods. Deferred cost makes inventory valuation greater under the absorption method.

Absorption costing is appropriate in situations where production is constant and sales fluctuate. One example of this is the auto manufacturing industry. The lines produce the same amount of automobiles every year. Sales of those automobiles can be influenced by several factors. Sales go up and down even though production remains the same. Absorption costing is more appropriate where production is homogeneous and only involves a single type of product.