Management Accounting System
Allocation of Costs
Scrap and Faulty Goods
Electronic Boards plc require to construct a management accounting system which is accurate, updated regularly and integrates the whole team and processes. Currently there is a distinct lack of attention given to anything related to management accounts, show by the clear absence of a finance director. There are 4 keys areas identified which this report will highlight and discuss in order for Electronic Board plc to be able to design a system appropriate to themselves: costing system, budgeting, capital budgeting and performance.
2 Management Accounting System
Electronic Boards Plc has neglected to implement a management accounting system and has no qualified accountant on the board. There is an overall element of managements' reluctance to change the company's processes as the company due to its previous success' over the past 25 years and has not encountered any issues of note that have thus far affected performance, to their best knowledge.
The firm's management has a dismissive attitude toward accountants, believing they lack knowledge about the electronics industry and problems they face. Accountants within Electronic Board Plc need to get the whole team on board with helping them to best understand the workings of the company to ensure both their integration into the team and for them to be best formulate management accounts. The company need to stop looking in the past and consider the future- there is constant evolution and the only way to stay competitive in the current is to be open to adapting, changing and innovating.
The creation of a management accounting system would, no doubt, be extremely beneficial to the company and help to maximize performance and profits. Some of the benefits of an accounting system include: assisting in problem solving and long-term decision making, increasing profit by controlling the cost of production and reducing expenses and wastage, and allowing for complete communication between all levels of the business.
3 Costing System
Electronic Boards plc need to produce a framework for which they can estimate the costs of the boards precisely, in order to perform more in-depth analysis. Presently, the information on cost structure is basic and based on previous year margins, if management accounts were produced more regularly then the costing of products would be more accurate, as the direct materials to sales margin can change regularly. Increasing the frequency of costing process means profit statements will be more accurate, the business can ensure there quotes to customers maximise profit and can help identify areas where these costs can be reduced. Especially if the company is dealing with international customer and suppliers, exchange rate will change on a daily basis so a monthly estimation of this would allow for more precise quotes.
Electronic Boards Plc does not have a costing system in place, as a result there is a chance that their cost of sales figure could be misrepresented. Work in progress is calculated at an estimate of the direct material that is used and as we have talked about previously there is an extremely high amount of waste. Therefore, this will not be an accurate representation as waste as the defective boards are included within cost of sales, even though these have to be scrapped. Having a costing system in place will help with the pricing of jobs to measure the profitability and also toward preparing accurate and credible financial statements.
Finished goods are being valued at a discounted selling price and this is not the correct method, finished goods should be valued at the lower of either selling price or cost of production. This is an example of yet another factor affecting the accuracy and credibility of the financial statements which could lead to issues regarding misrepresentation.
Some managers have complained about the lack of knowledge that they have when it comes to the profitability of the contracts that they handle. Having a costing system will give an accurate representation of the cost of a job also, helping the managers to understand how much a contract is worth, profitability and margins to decide on a final price for the job.
4 Allocation of Costs
As discussed Electronic Board plc currently have a simplistic pricing system which is being based upon the previous year's direct material cost to sales margin. As the company is evolving and expanding they should implement a more sophisticated costing system, they should consider either absorption or activity based costing methods.
Absorptions costing means overheads can be allocated fairly and absorbed using an overhead absorption rate; non production overheads are absorbed by adding a proportion of the costs of production. It also is consistent with external reporting purposes and requires less recording effort compared with Activity Based Costing. However, absorption costing is a very old system and determining basis of apportionments is very arbitrary often providing inaccurate information. As Patel, D states ‘Therefore, basing its selling prices on this inaccurate information could have a dramatic impact on financial performance' (2014).
Activity-based costing increases accuracy of product costing, therefore setting of selling prices. Traditional costing may result in cost subsidisation. It better supports other management techniques such as the balanced scorecard, activity based budgeting, continuous improvement and performance management. It will also help to focus more on cost consumption and what causes costs to be incurred. This should result in better cost management. However as Electronic Board plc has high levels of direct materials and low overheads it may be less useful. It is costlier to implement and run ABC compared with the simpler traditional methods. Record keeping and separate calculations can be complex if there are many products.
Electronic Boards Plc should implement an activity based costing system as it provides more accurate information, especially as they quote each customer separately they should have a better understanding of both cost drivers and overheads. Furthermore, activity based costing helps to identify and reduce waste.
Currently there no budgets are being prepared for Electronic Boards plc as a result of the previous success the company has had. Furthermore, there is a disgruntled attitude towards participation as the engineers feel accountants don't have an understating of the decisions being made and would therefore deem the accountants aims as unrealistic. It would be a good idea to include all relevant members of staff when preparing a budget as this allows a more accurate representation of costing to be given. This would also encourage staff to stay within the targeted budget as they have had an input in preparing them. Electronic Boards Plc should run in house training events in order to be able to integrate the full team into the accounts and teach each other on the relevant roles each other perform so they can best work together.
Moving forward, that it would be beneficial to the company if a finance director was appointed to the board of directors as this would give the accounting department more authority throughout the firm. The director would also oversee that the company is complying to all relevant standards and be involved in board meetings. It would then become easier for the accountants to put their systems in place as they have authority and understanding from the board.
6 Capital Budgeting
The budgeting of capital is focussed solely on maintaining the best equipment, although this in itself is would considering, it should not be the only area of focus. From the research, it would be beneficial to invest in other areas of the business such as HR due to the high level of staff turnover. High levels of staff turnover are costly for the company as there is additional money spent on recruitment, advertising and training.
Electronic Boards plc has to ‘find' the capital for the investment in machinery, suggesting that obtaining finance cannot be done at ease and takes a lot of time to consider presently. Difficulty to find capital could be due to the preparation of financial statements and the lack of accounting knowledge throughout the company. If the financial statements are ill prepared then it isn't likely for people to invest in the company making it difficult to obtain the finances required.
Currently the companies financing options are limited, the best form of finance may not the chosen causing there to be a high level of finance costs e.g. using a bank overdraft or having a bank loan with a high interest rate. Due to the lack of updated accounting information, it is unlikely that the company will have any forecasts for the next accounting period, without these it will be virtually impossible to secure the finances required. In addition, the company cannot keep track on the different financing options and opportunities of investment.
Electronics Boards Plc prepares accounting statements every 6 months, the norm throughout the industry is to prepare and analyse on a monthly basis. The lack of information available about the company's performance is no doubt detrimental as the quotes they are providing customers based on materials is outdated and they have no way of monitoring progress.
Consequently, as the company does not work with current financial information business decisions are likely to be unreliable as they do not reflect the economic reality. Electronic Board Plc need to consider the wider economic world when conducting their business as political and social factors can easily affect all business running's. For example, Brexit caused an instant plummet in the pound to dollar rate, even though since then this price has recovered the company would need to allow for this impact. Also, if an underlying problem emerges in the business, it may take a significant amount of time to identify the issue and take action which would magnify the effect of such issue. It is imperative to find problems early in order to effectively control risks and minimize the amount of damage to the company. Effective planning and preparation not only help to limit the damage of unexpected events but ensure that there is smooth running's of the business and allows time for managers to communicate the business plan throughout the team members.
8 Market Circumstances
Electronic Board plc has observed a recent fall in the market price due to many possible reasons. The market in which Electronic Board plc operates in is highly competitive, as other competitors sell products with similar quality and price. Quality is an important factor in the eyes of a consumer. According to Sahay (2016: pg. 17), “the quality of a product or service can be determined by the extent to which the product of service satisfies the needs and requirements of the customers.” Therefore, Electronic Board Plc should take some action in order to keep its major existing customers and attract new potential customers. The ways that the company can achieve that are explained below.
First of all, Electronic Board Plc should differentiate its product to make it unique and more attractive to its customers. This could be done through an increase in spending on research and development, however to achieve this, we would need increased management accounting information in order to forecast available budgets for this, in particular the cash flow position and the retained earnings available for reinvestment. It is an effective method that will result in a competitive advantage over its competitors as no other brand will offer a similar product. However, once further information becomes more available to the market on how to develop the product, competitors will follow. Electronic Board plc should use this time lag to build up a positive reputation and customer loyalty.
On the other hand, the company can employ a cost leadership strategy. “Cost leadership is an organisation's ability to achieve lower costs relative to competitors through productivity and efficiency improvements, elimination of waste and tight cost control.” (Bhimani, Horngeren, Datar, Rajan, 2015: pg. 697). This should reduce operation costs below that of others in the same industry, which would result in the company being more price competitive. An example of a company that achieved this cost leadership method and has been benefited a lot is McDonald's through hiring lower skilled workers and keeping their costs and fast food prices low they have managed to be one of the most successful restaurant industries worldwide (Scilly, 2017).
Many of Electronic Boards plc's largest customers have in-house facilities in order to produce their own circuit boards; making the company very vulnerable in case of a recession because the large customers will naturally switch to in house production in order to minimise the loss of their own skilled labour force. A possible solution to this would be the introduction of fixed term contracts for customers, so they would no longer have the option to cease or reduce their existing subcontracts. A means of incentivising customers to take up fixed term contracts would be to offer cheaper prices, as long as it was still profitable for Electronic Boards plc. Many companies offer these options of loyalty discounts dependent on the longevity of the relationship, as the company has been established for a number of years then more than likely they have a number of long term customers.
If the fixed term contracts with lower prices were taken up by customers, it should reduce the amount by which market share fell, as well as significantly reducing the amount by which sales fell. Furthermore, if fixed term contracts were in place, this should solve any liquidity issues too, as money from customers should be received on a regular basis. However, in order to be able to achieve lower prices, more management accounting information is required, in particular a costing system. This should allow the company to identify points where costs can be reduced, and as a result, directors can re-assess price quotes for customers, with the aim to encourage customers to take out new fixed-term contracts or continue to use Electronics Board plc in case of a recession.
Being a successful and well-established company for 25 years, many wonder what is the need to change the structure of management, however the layout of Electronic Board plc is unusual as they don't have a finance sector. This is now causing them slight difficulty and meaning they aren't as profitable or efficient. One continuous problem is the production process, due to the circuit boards being “complex, multi stage(d) and highly automated.” As, generally, every order is different; many steps are involved in the set-up process which consequently takes a long time. Any hold-ups greatly affect the flow of work and so mistakes are not recognized across the full production process.
According to Dolinsky and Vollmann (1991) an over emphasis on product costing may overshadow the importance of using non-financial performance measures, such as time to market, quality and customer service measures. This is also emphasised by Kaplan & Norton who say that “A balanced scorecard is a system of linked objectives measures and targets and initiatives which collectively describe the strategy of an organisation and how the strategy can be achieved.” These measures should be across a range of dimensions not just financial. In this way, the company will get a balanced assessment of their performance. One perspective on the balanced score card is the ‘business process perspective.' This involves thinking about what satisfies their shareholders, whether it be quality, delivery times, innovativeness and cost.
11 Scrap and Faulty Goods
Resulting from the continuous, multi stage production process, scrap levels are far exceeding the industry standard. Scrap levels are also being increased due to inexperienced staff and lack of training, although they are improving on repeat orders; suggesting that once staff are comfortable with a certain production they improve and get into ‘a routine'. One way to resolve this problem is to upgrade the circuit boards, however this would require specialist knowledge and would also come with research and development costs.
In order to reduce scrap costs, Electronic Boards Plc could recruit people who have the right experience - this will prevent long training hours so staff can start immediately increasing productivity. Continuous assessment should be performed in order to evaluate employees' skills and readiness to perform tasks and individual training plans put in place. This type of planning includes shifting employees around to different task roles until the best arrangement for maximum production is found.
At present, faulty products are identified only on completion, and so errors are not spotted until they are too late to fix. They could introduce a new quality control service which checks products more frequently, giving them some time to alter the product or reuse the material. By giving them the chance to recycle the materials, this will reduce labour costs.
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