Managerial Accounting - Traditional Costing Systems

1. Abc system

Pros e cons of the two methods

Traditional costing systems use unsophisticated methods to allocate indirect costs to cost objects, while ABC systems use sophisticated methods to allocate indirect costs to cost objects.

Both systems use the two-stage allocation process.

In the first stage traditional systems tend to allocate costs to departments whereas ABC systems allocate costs to activities (ABC systems tend to have more cost centres/cost pools)

In the second stage traditional systems rely on a small number of volume-based cost drivers (typically direct labour or machine hours) whereas ABC systems use many second stage cost drivers. ABC systems seek to use only cause-and-effect cost drivers whereas traditional systems often rely on arbitrary allocation bases.

The design of the a cost system should be based on cost versus benefit considerations. A sophisticated abc system should generate the most accurate product costs. The cost of implementing and operating an abc system is significantly more expensive than operating a traditional costing system. In particular, the requirements may prohibit its adoption by small organizations. however, the the distorted costs reported by traditional systems, may result in significant mistakes in decisions arising from the use of this information. If the cost of errors arising from using partial or distorted information generated from using these systems exceeds the additional costs of implementing and operating an abc system then an abc system ought to be implemented.

When do I use traditional and when abc system?

Traditional costing systems use volume-based (e.g.direct labour and machine hours) second stage drivers but if volume bases are not the cause of indirect costs reported costs will be misleading.

The optimal costing system is different for different organizations. A simplistic traditional costing system may report reasonably accurate product costs in organization that have the following characteristic:

• Low level of competition
• Direct costs are the dominant costs
• Indirect costs are relatively small
• There is a standardized limited product range which are all consuming organizational resources in similar proportions
• Information costs were high

In contrast a sophisticated abc system may be optimal for organizations having the following characteristics:

• Intensive competition
• Non-volume-related indirect costs that are a high proportion of total indirect costs
• A diverse range of products, all consuming organizational resources in significantly different proportions.

2. Società concertistica case

3. Management control system

“purposes of MACS” e

“advantages or disadvantages of results controls”

Management control systems have two core elements. The firs is the formal planning processes such as budgeting and long-term planning. These processes are used for establishing performance expectations for evaluating performance. The second is responsibility accounting, which involves the creation of responsibility centres. Responsibility centres enable accountability for financial results and outcomes to be allocated to individuals throughout the organization.

Control is the process of ensuring that a firm’s activities conform to its plan and that its objectives are achieved. There can be no control without objectives and plans, since these predetermine and specify the desirable behavior and set out the procedures that should be followed by members of the organization to ensure that a firm is operated in a desired manner. The term management control system is used to refer to the entire array of controls used by an organization.

Companies use many different control mechanism to solve the problem of organizational control. There are 3 different categories of controls: action controls, personnel cultural and social control, and results controls. Results or outputs controls involve collecting and reporting information about the outcomes of work effort. The major advantage of results control is that senior managers do not have to be knowledgeable about the means required to achieve the desired results or be involved in directly observing the actions of subordinates. They merely rely on output reports  to control if whether or not the desired outcomes have been achieved. These systems are mostly defined in monetary terms such as revenues, costs, profits and ratios. Results control involve the following stages: establishing results measures that minimize undesirable behavior, establishing performance targets, measuring performance, providing rewards or punishment. Harmful side-effects occur when the controls motivate employees to engage in behavior that is not organizationally desirable (i.e. system leads to a lack of goal congruence).

Results controls can encourage individuals to focus only on what is measured,  regardless of whether it is organizationally desirable, focusing mainly on quantifiable and easily measurable items. Another risk is that result control is subject to data manipulation and it can lead to negative attitudes towards the control system.  Regarding to action control, it may discourage creativity, while referring to cultural controls there is a lack of goal congruence where group goals do not coincide with firm goals.

Advantages and disadvantages

• Personnel/cultural controls • Few harmful side-effects • Inexpensive to operate • Appropriate only in certain circumstances

• Action controls • Direct link between control mechanism and the action. • Measurement problems do not apply. • Not feasible where cause-and-effect relationships are not well understood or easily observable.

• Best suited to stable situations.

• Results controls • Can be applied where knowledge of what actions are desirable is lacking. • Focus is on outcomes (individual autonomy is not restricted). •

• Subject to limitations described on sheet 3.

“responsibility centres”

macs tend to be the predominant controls in most organizations because: 1. Monetary measure provides a means of aggregating results from dissimilar

activities. 2. Profitability and liquidity are essential for company survival. 3. Financial measures enable a common decision rule to be applied. 4. Measuring results in financial terms enables managers to be given more

autonomy.

the complex business environment makes it impossible for most firms to be controlled centrally. It is simply not possible for central management to have all the relevant information and time to determine the detailed plans for the entire organization. Some degree of decentralization is essential for all but the smallest firms. organizations decentralize by creating responsibility centres. A responsibility centre may be defined as a unit of a firm where an individual manager is held responsible for the unit’s performance. There are four types of responsibility centres: