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Managerial Accounting and Decision Making

Businesses need information for evaluating performance, for establishing goals, and for developing plans to meet goals (financial and managerial accounting). Managers need timely and detailed information for evaluating performance and implementing plans (primarily managerial accounting).

They need very timely and detailed information for day-to-day decisions to achieve company goals. The value of information and who exactly uses it will be discussed so as to try and realize that the effectiveness of strategic decision-making is all based on suitable information. In this paper, we will determine whether the result of the completion of a financial report is harmful to a business’ planning and direction, through making strategic decisions.

Obviously an accountant requires valuable information to construct the report. Valuable information is that which “may cause a change in any planned course of action”. The valuable information which can be represented on a balance sheet, such as profitability levels, will affect strategic decision-making. So of course, financial reports can help formulate decisions also. The purpose of the balance sheet is simply to set out the financial position of a business at a particular moment in time. So, from this, strategic decisions regarding future performance can be formulated. A financial report will always centre on accounting. This can be defined as “the process of identifying, measuring and communicating economic information to permit informed judgments and decisions, by users of the information”. If we just put aside the fact that there are these contingent factors that cannot necessarily be represented on a financial report, we can still see that information is vital. Mangers determine whether the decision-making is ideally short or long-term. In the short-term, a manager is looking for a profit and a healthy balance sheet. His/her strategic vision of stability and growth would come in the longer-term. All companies have these objectives, which prove that management does think long-term when formulating plans for future economic developments. However, there is often a separation of departments within a company into the finance, marketing and production. These three departments all have differing corporate objectives, some of which are focused on in the short-term and others in the long-term. For example, the finance department will aim to just survive initially which could be seen as a short-term objective. They would then perhaps target a debt-free balance sheet, which is more long-term. The marketing department in the short-term may well focus on increasing market share! , but in the long-term may wish to overtake a competitor. These examples prove that management needs to achieve the short-term before they can even consider the long-term goals. They then have a firm structure on which to base their strategic decisions upon. If a firm just relies upon assessing financial reports to make decisions, what would the management be leaving out?

Well, according to Emmanuel and Otley “a firms’ ultimate survival is determined by the degree in which it adapts and accommodates itself to environmental contingencies”. When referring to the environment, this does not necessarily mean the surrounding trees and woodlands per se, but more a focus on the competitive environment within the market being produced. The degree of competition a company faces will severely affect the firms’ strategic decision-making. If a rival company is selling goods at a lower price because they are producing more efficiently, the chances are the rival company will experience higher demand (this is assumed through use of the demand curve theory that as prices fall, demand rises.) This will affect the other company’s sales, therefore cash and very likely, profitability will fall. It could be seen as a disadvantage to be a public limited company in one way, as they are required to publish a financial statement to the public, yearly. Sales, revenue and profitability have to be stated, as well as wage costs and any other business activity. A rival company can then assess their competitor’s performance and learn from that. In this way, publication of financial reports can adversely affect other firm’s strategic decision-making. A company that can learn how a rival is performing will be likely to altar their approach in response to what they’ve seen. For example, if they can see the rival is producing more efficiently and are spending less on raw materials but producing the same amount of goods, they could alter their production methods and increase their efficiency. This may affect the company who has produced the statement by way of falling demand – unless they, in turn, alter their objectives and strategically change their plans. Competition levels cannot be stated on a financial report, but they can have a large impact on a company’s future success or failure. The question of whether accounting fails to represent different ‘resources’ such as the environment can be answered with a firm “yes.” There is a suggestion that financial reports are too focused on just the large numbers and not enough on other external influences. There are other contingent factors mentioned in the introduction which are difficult to represent on a financial report, yet are perhaps vital in determining the success of business performance.

The ABC (Activity Based Costing) method can help or influence management decisions. The method of Activity-Based Costing (ABC) was developed primarily for solving problems which emerged from traditional cost management systems. Troubleshooting in the management of companies throughout the late 70’s and especially the early 80’s held a constant presence. The problems generated were mainly from the traditional cost accounting systems’ way of functioning which provided the management with inaccurate data. Where the old cost accounting systems failed badly was in supplying the company’s management with inappropriate information in order for crucial decisions to be taken in the correct and true perspective of a given company’s true position in its market territory. Since this currently accessible “itemized” information could not be provided to a company’s decision making sector, the information provided had an impact which of course distorted the decision which would have otherwise been taken in the light of different and more accurate information. This misinformation had an adverse impact on a multitude of managerial decisions especially in the multi-product firm sector in respect of long-term, mid-term and short-term consequences such as investments in technology, quantity and specification of product production. The accuracy of data on which management decisions are based in order to maximize efficiency and establish one’s company identity in a competing market through, besides quality, a selection of sound marketable prices applied in the proper time scale to all of a company’s product range, is of paramount importance. In other words activity based costing pin-points problems by focusing on the activities associated with operating the business. If a manager were told that the cutting of cost was first on the list of priorities, he or she would cut headcount, understandably believing that it might possibly be the only largest cost contributor in the entire company. But today people are not the major cost contributors, it is, in fact, the cost of the activities that people are engaged in which contribute more to the firm’s costs. Activity based costing allows managers to attribute costs to activities and products much more accurately than conventional accounting methods. This method is more than an accounting tool. These tools give you a view of what you have done financially and are fundamental to shareholding disclosure and the statutory reporting. But it is just as equally important to have the ability to be able to translate this cost information into the language of operational units and the business in which it is to be applied. With activity based costing management is in a position get a strong and comprehensive, internal view of the company products or services to customers. Armed with this information, the management of a company is automatically put in a position where financial, operational, and strategic decisions can be made, such as outsourcing and pricing of the company products or services and customers. Armed with this information, the management of a company is automatically put in a position where financial, operational, and strategic decisions can be made, such as outsourcing and pricing. Activity based costing identifies the activities that are responsible for costs. It is sometimes call Transaction costing and its major advantage over other methods is that it can greatly enhance the tractability of overhead costs. This can result in more accurate unit cost data for managers, if placed into the correct hands. The optimum accuracy in costing can be attained by recognizing four general levels of activities within a company, each of which can be further subdivided into specific cost activity centres. These four are as follows; Unit level activities. These arise as a result of the total volume of production going through a facility. An example could be the consumption of power as a result of the number if hours required by a machine to complete all units on a production line which could be thought of as a unit-level activity. Some companies recognize one unit-level activity centre but most companies recognize two; one related to machine activity and the second related to labor activity. Batch- level activities are things such as placement of purchase orders, shipments to customers. Costs at batch level are dependent on the number of the batches produced rather than on the number of units made, or sold. The actual cost of, say, placing an order would be the same for one item or 10,000 items, so the total cost generated by a batch-level activity would be the function of the times an order would be placed rather than on the total quantity of items ordered. Product level activity, are specific and are related to the support of the production of a particular product like for instance special test routines, machine maintenance inventories. Facility-level activities are these activities relate to the production as a whole and therefore are usually combined into a single activity centre. The purpose of activity based costing is to help operations do their job by making cost information available at a level that everyone can use for day to day decision making. The biggest obstacle to incorporating activity based costing as a way of life is employee resistance. Unit managers may be afraid that activity based costing is just a way for senior management to discover detailed information about a department or to reveal inefficient practices that had previously been hidden by the traditional accounting system. The corporate culture must be such that new information is not used against a business unit. Instead, all company employees should be encouraged to dig up problems and inefficiencies so that all of those practices can be changed and decisions can be made that will benefit the company as a whole.

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