Using Cost Accounting Information to Enhance Firm’s Competitive Position and Performance

Cost Accounting in Theory The last two decades has seen a revolution in management accounting theory and practice due to the challenges of the competitive environment in the 1980s. Kaplan and Johnson (1987) identified the failings and obsolescence of existing cost and performance measurement systems, which led to the re-examination of traditional cost accounting and management control systems. Conventional financial and management accounting methods have developed primarily as a result of corporate legislation in the 1930s forcing companies to provide externally published financial accounts. Management accounting is primarily focused as a decision making tool for running a business, hence they require more flexibility. According to Kaplan, management accounts have become a subset of financial accounts and that they reflect more on the external rather than internal requirements of the company. Most of the managerial decision-making and control systems in use in the late 1980s were described by Johnson and Kaplan as stagnant. As a result, they went onto research in new accounting systems raising the profile of internal accounting systems by use of financial and non-financial measures. Although their work was at first seen as controversial, it is now considered of key importance for companies aiming to enhance their competitive position and performance. The purpose of cost accounting is to ascertain the costs of products and services. When properly implemented, the cost accounting function will provide necessary information for pricing decisions, identify the profitability of each product, service, or job, aid management in maximizing profits by detecting sources of wastages and excess capacity, and can influence management behaviour. In theory, cost accounting help managers make decisions to fulfill an organization’s goals. Cost Accounting in Practice However, according to a July 2003 study done by the Institute of Management Accountants and Ernst and Young, 98% of managers believe their cost data is distorted while almost 40% believe their cost data is significantly distorted. In practice, most companies still use the same cost accounting and management control systems that were developed decades ago in a competitive environment drastically different from today. In the many cases worked on throughout the semester in Accounting Planning & Control, for example Putz, Seligram Inc. and Zytec, there was an underlying problem of inaccurate costing information that failed management when making decisions. This was due to the traditional cost systems that these companies utilized despite the changing nature of their business environment. One of the main triggers that a company will need a new cost system is when changes occur in the organization and its environment. The article â€Å"You need a new cost system when†¦ † highlights the many signals in which a company needs to redesign or create a new cost system. This article proposes that a cost system must be up to date and functioning properly in order for the theory of cost accounting to be applied in practice. The problem with the state of the accounting profession is the skewed emphasis towards Financial Accounting, as identified by Kaplan. Financial Accounting is used to prepare financial statements for external users. These Financial Accounting reports are for outsiders to assess the business, but the reports focus on compliance with GAAP in broad totals and are not designed to support decision making. Despite this fact, 80% of organizations rely on the GAAP required Normal Costing method to provide management with reports (Sharman and Mackie 12). When management reports echo standard financial reports, management loses. These reports have no activity data and often require managers to prepare their own ad hoc reports when they require decision analysis. These financial reports are difficult to understand by non-accountants and do little to give managers the information they should have at their fingertips to run a company. The Management Accounting problem in this country does not seem to be as problematic in other countries. According to the Sharman and Vikas article in the December 2004 Strategic Finance German companies employ just as many Managerial Accountants as Financial Accountants; The U. S. employs one-tenth the number of practicing Management Accountants than the U. K. , Canada, and Germany. The weak emphasis on Management Accounting and providing information to managers to run a company is partly caused by the overwhelming requirements external parties place on corporations. Companies lose sight that the most important viewers of company feedback are people inside the company. State- of the Art Cost Accounting Information to Enhance Competitive Position Companies realizing the importance of internal reporting adopt state-of-the-art, or up to date cost accounting techniques, straying away from financial reporting and normal costing, in an attempt to accurately measure the costs of acquiring or using resources. This state-of-the- art cost accounting information enables management to add-value for the consumer, and to enhance their firm’s competitive position and performance. In order for a company to enhance their competitive position, they must have an effective competitive strategy. The competitive strategy describes how an organization will compete and the opportunities its managers should seek and pursue. There are two competitive strategies that companies can decide to implement: cost- leadership or product differentiation. When companies adopt the cost-leadership strategy, they decide to uphold a competitive advantage in the marketplace by providing the best value at the lowest price. When companies adopt the product differentiation strategy, they choose to uphold their competitive advantage by offering unique products or services at higher prices than their competitors. According to the confrontation strategy, competitive advantage is not sustainable. This is a realistic view of competition by recognizing that competitors will quickly bring out similar products and match price changes. The underlying argument of the confrontation strategy is that firms must compete in terms of the survival triplet. The survival triplet consists of three strategic dimensions that characterize a product: price/cost, quality, and functionality. These three dimensions are bounded by a minimum and maximum acceptable level which defines the survival zone. In order for firms to survive and remain competitive, firms must operate in their survival zone. With that being said, companies face continuous pressure to reduce the cost of the products or services they sell, or continuously improving the consumer’s perception of quality as related to their competitors. To successfully implement such strategies, managers must have state-of-the-art cost accounting information that will allow firms to adopt target costing to enhance their competitive position. Being that managers have little influence over pricing, (the central theme of economics states that prices are determined by supply and demand), management must monitor costs to receive desired profits. â€Å"Target costing is the allowable amount of cost that can be incurred on a product and still earn the required profit from that product† (Ansari, Bell, Klammer, Lawrence). The article â€Å"Target Costing† proposes that target costing is particularly important at the design stage, where â€Å"70-80 percent of the costs of a product are committed†. Hence, target costing is more than just a cost accounting technique; it is an integral part of the comprehensive management process that aids management in reducing the overall product’s life-cycle costs, helping an organization to survive in an increasingly competitive environment. Nonetheless, target costing is useful in pre-production as well as post production and has many advantages to allowing firms to uphold their competitive position. Target costing requires analysis on competitors’ products and the customer’s perception of their products, and uses this information to assess which particular customer segment of the market to target. This analysis done in target costing allows for companies to create products that adds value, in the eyes of the customer, while staying ahead of the competition by identifying areas of improvement based on the customers’ perceptions. Furthermore, target costing enhances a firm’s ability to uphold their competitive advantage. Target costing reinforces top-to-bottom commitment to process and product innovation and is aimed at identifying issues to be resolved, in order to sustain competitive advantage. Target costing helps to create a company’s competitive future with market-driven management for designing and manufacturing products to meet customer expectations and market price. Also, target costing identifies market opportunities that can be converted into real savings to achieve the best value rather than just simply the lowest cost. Target costing enhances competitive position in the ways aforementioned; however, without state-of-the-art cost accounting information, target costing is impossible to achieve. State-of-the-art Cost Accounting Information Enhancing Performance State-of-the-art cost accounting information can also enhance a firm’s performance in the marketplace. In measuring a firm’s performance, a state-of-the-art accounting technique was developed by Kaplan and Norton called the balanced scorecard. â€Å"The balanced scorecard translates an organization’s mission and strategy into a set of performance measures that provides the framework for implementing its strategy† (Hongren). The balanced scorecard uses financial and non-financial measures to evaluate short-run and long-run performance. Key strategic nonfinancial and operational indicators measure adjustments that a company is making for the long-run. For example, an improvement in quality, as measured by improvement in yields, signals a strong likelihood of higher sales and income in the future. By balancing the mix of financial and nonfinancial measures, the balanced scorecard brings management’s attention to short-run and long-run performance. In for profit companies, the main goal of the balanced scorecard is to improve a company’s financial performance. Non-financial measures simply serve as leading indicators for hard-to-measure long run financial goals. Kaplan and Norton developed four perspectives that firm’s should analyze to achieve performance levels that are necessary to meet customer needs, compete effectively, and achieve financial goal; the financial perspective, the customer perspective, the internal-business-process perspective, and the learning and growth perspective. The financial perspective focuses on increasing shareholder value. Measures of the financial perspective include ROI, ROCE, residual income, and EVA. By managing financial performance, managers are able to manage costs and unused capacity. This will enhance performance by increasing profitability of the firm. The customer perspective measures customer satisfaction and focuses on the importance of the customer on the business. This enhances performance by increasing the firm’s market share and overall customer satisfaction. This will enable firms to meet the future needs of customers and increase customer focus of sales on the organization. The internal-business process perspective focuses on the internal business processes that will meet the needs of customers. This area focuses on product design and innovation, improving efficiency and quality, and post-sales service. This perspective enhances performance by improving the customer-service process, identifying operational problems to improve quality, reducing delivery time, and improving manufacturing capabilities. The learning and growth perspective includes employee training, system capabilities, and employee motivation. Measures of learning and growth perspective include employee satisfaction, and employee training programs. This enhances performance by empowering the workforce, developing employee’s process skills, and enhancing system capabilities. By implementing an effective balanced scorecard, for-profit companies are able to motivate managers to take actions that result in improvements in financial performance. When financial and nonfinancial performance measures are properly linked, nonfinancial measures serve as indicators of lagging future financial performance. These indicators can aid management in improvements in future performance. Conclusion State-of-the-art cost accounting information allows for the implementation of modern cost accounting techniques. Such techniques include target costing and the balanced scorecard. Target costing enhances competitive position and uses state-of-the-art cost information to identify activities that do not add value to the customer. Without modern cost accounting information, there will not be a breakdown of activities and their respective costs to assist managers in analyzing non-value added activities. Target costing relies on state-of-the-art cost accounting information to identify these non-value added activities that managers will eliminate to reduce costs, and uphold their competitive position. The balanced scorecard uses state-of-the-art cost accounting information to motivate managerial behaviours and enhance performance. Managers’ rewards are based on the financial perspective, which metrics rely on cost accounting information. Analysis of operating income, a metric of the financial perspective, depends on modern cost account information that accurately separates material costs and conversion costs to identify spending variances and efficiency variances, which aid management in future financial performance. State-of-the-art cost accounting information enhances a firm’s competitive position as well as their performance in the future by allowing the implementation of modern techniques. Focusing on internal reporting, and not just financial reporting will allow companies to adopt continuous improvement in dynamic, highly competitive environments, through techniques such as target costing and the balanced scorecard. Works cited Sharman, Paul A. and Kurt Vikas. â€Å"Lessons from German Cost Accounting† Strategic Finance. 2004, December. 28-35. Cooper, Robin. You Need a New Cost System When†¦ † Harvard Business Review. 1989, January. 6 pages. Sharman, Paul and Brian Mackie â€Å"Grenzplankostenrechnung (GPK)† Notes from Institute of Management Accountants Annual Conference. www. imanet. org. 1-58. Ansari, Bell, Klammer, and Carol Lawrence. â€Å"Target Costing† Management Accounting, A Strategic Focus. McGraw-Hill Companies Inc. , 1997. Hongren, Datar, Foster, Rajan, and Christopher Ittner. Cost Accounting: A Managerial Emphasis. Thirteenth edition. Pearson Education, Inc. New Jersey 2009. 462-485. Print