Design of Management Accounting Systems

Performance Management accounting

CUAC 411 Modules

Design of Management Accounting systems

Planning, Controlling and Decision Making

Hierarchy

-Planning, controlling and decision making can be classified into tree levels namely:

1. Strategic Planning

·  The process of developing long term plans for the organisation that is 5-10years or more

·  This mainly concerns new products to be launched, new markets to be developed etc.

·  It is planning and decision making done at board level and this tends to be an outline rather than detailed planning.

2. Management Planning/Tactical planning

·  A more detailed short-term planning for example one year budget in order to ensure resources are obtained and used efficiently to achieve the long term plans of the company.

·  This focuses on future staff needs of the company

·  Control is then exercised against the budget using the aspect of variance analysis.

3. Operational Control

·  The day to day management of the business in order to ensure that specific tasks are carried out effectively and efficiently for example ensuring that budgeted production has been achieved effectively.

·  The information used will be very detailed and will be quantitative but will often be expressed in terms of time taken that is hours or output for example units instead of in monetary terms.

Strategic Planning

·  The strategic plan covers the following

VISION

·  This is a much broader way of predicting the future of an organisation

Mission Statement

·  An expression of the overall purpose and scope of the organisation which is in line with the values and expectation of the stakeholders

·  It answers the question; what sort of business are we/do we want to be?

·  A mission statement will generally cover or contain 4 the elements :

1. Purpose

·  -what and for whom the company exist for?

2. Strategy

·  The range of business in which the firm seems to compete and some indications of how it intends to compete.

3. Polices and Behavior Standards

·  These are the guidelines which help staff decide what to do on a day –to –day basis to carry out the strategy.

4. Values

·  These are the beliefs and moral principles which lie behind the firm’s culture.

·  The purpose of the mission statement is to communicate to stakeholders, the nature of the organisation and to focus strategy.

·  However, in practice, there are generally full meaningless phrases.

·  Taking an organisation of your choice, briefly outline its mission statement.

Goals and Objectives

·  -Goal is broader than objectives, these are also known as aims of the entity.

·  Goals and objectives are often put together without any distinction made between them.

e.g. of goals could be to improve profit or to reduce costs.

·  However, goals are statements of general intention where as objectives are more specific or targeted.

·  An objective could be to achieve a 10% return on asset or a 10% mark-up /margin within 6 months 1 year, 2 years etc.

·  - Objectives must be smart (specific,measurable,attainable,realistic and time –bound)

·  Example of financial objectives are :for the next 12months :

ü  To increase operating profit by 20%.

ü  To increase return on capital employed by at least 15%.

ü  To cut net losses to below 0, 5%.

·  Examples of goals:

ü  To be a clear leader in the market.

ü  Achieving biggest growth in volumes/meeting higher customer satisfaction.

Corporate Appraisal

·  It is a critical assessment of the strengths, weaknesses, opportunities and threats in relation with the external and internal factors affecting an organisation.

·  The purpose is to establish the condition of an organisation prior to preparing a long-term strategic plan.

Position Audit

·  This assesses the strength and weaknesses of the company by asking questions such as: what are we good/bad at?

·  In particular, existing products will be reviewed and consideration given as to which products should be continued /promoted and which ones to be phased out /abandoned.

·  0ne thing to be considered in relation to each pr0duct is as to where it is positioned currently on its product life cycle.

Diagram

·  If the product is currently in the maturity /decline phase, the company needs to develop strategies for replacement of the product in the long term rather than relying on its continuing profitability.

NB. The pricing methods used depend on whether they are appropriate to the circumstance in which they are used.

·  It may be appropriate to charge the same price as competitors, e.g if customers perceive different producers` products as largely generic since no significant are achieved.

·  In situations where competition is limited ,competitors ‘s prices provide no real yardstick and hence full cost +mark up provides the way of arriving at a fair price which is reasonable relative to cost of production.

·  The general problem with adhoc approaches to pricing is the danger that the pricing approach used in particular circumstances will not be appropriate in other circumstances, will not serve the company’s strategic objectives and ultimately will be sub-optimum.

·  The proposal to adopt a strategic approach to pricing (is a very good one especially where it is started that there is no intention to lock the company into one particular approach to pricing.

Possible Strategies to pricing

1.  Pricing permanently a product at a level in excess of competitors’ comparable product.

·  This is only feasible as part of product differentiation strategy. Here, the supplier needs to convince customers that its products are superior to those of competitors and hence the need for customers to pay extra for superiority.

·  However shrinking consumer incomes may cause few customers to accept to a price premium and hence this lowers profitability of the entity.

2. Setting a high price in early months of a product’s life cycle and reducing the price for the remainder of the cycle.

·  The technique is used for ensuring that enthusiastic ‘early adopters (those who are not price sensitive) pay a higher price for the product.

·  The approach is not suitable for regular items like food where profitability is achieved through customer frequency and repeat purchases.

·  It is also not proper where competitors offer similar products.

3. Charging a low price in the early months of a product’s life cycle and then increasing the price for the remainder of the product’s life cycle. (Addictive products).

·  It is a good way to penetrate a market where the key to profitability is to ensure that customers make repeat purchases.

·  The low initial price will encourage customers to try new products and this becomes an effective way of gaining market share.

·  Subsequent increases in selling price provide profitability although price sensitive customers may be lost at this stage.

·  The strategy is effective in building customer loyalty to a differentiated product.

4. Selling a product at loss throughout its life cycle

·  This is desirable if it facilitates the profitability of some other product ranges.

·  Example, in order to obtain shelf space from a bread retailer there may be need to a comprehensive range of bread products for various allergy sufferers.

·  The major goal is to achieve overall profitability of many products rather than an individual product from the distribution channel.

5. Bundling Products

·  This is a way of concealing individual product prices from the customer.

·  The profitability of a bundle can be assessed by comparing its sale price with the combined production and distribution costs of the products in the bundle.

·  While bundles may be profitable, the customer is forced to buy some products which may be unwanted.

·  Difficult strategy to sustain since their opportunities for competitors to offer customers the chance to buy similar products individually rather than purchase the entire bundle.

·  A potentially useful approach to considering each existing product is to position them on a Boston Matrix Grid.

Market share

High low

GROWTH

Low high

QUESTION MARK

·  This generates income but consumes more so we have aggressive marketing to turn product into cash cow.

Cash Cow

·  This is a well invested product and this generates income, all you have to do is to maintain the low growth.

Dog

·  Is a product that no longer generates cash

STAR

·  Generates cash but consumes all what it generates and investment is needed to turn products to cash cow.

·  N.B. Having positioned the products on the grid, it can then be used to consider future strategy for each of them.

·  An environmental analysis can be carried out which identifies the opportunities and threats presented by the external environment.

·  These are summarized as PEST analysis.

Additionally (esp. when launching a new product) consideration may be given to Porter’s 5 forces model i.e.:

v  Threat new entrance

v  Threat of substitute

v  Bargaining power of buyers

v  Bargaining power of suppliers

v  Rivalry between competitors

·  The Ansoff’s product market matrix can also be used.

·  This is commonly used by businesses that have growth as their main objective and is used to focus management attention on the four main alternative (strategic) available for growth.

Existing products new products

Existing market Market penetration

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·  Having carried out the position audit and environmental analysis the task is to develop the strategies in order to:

1. Convert weaknesses into strength

ii) Convert threats into opportunities.

iii) Match strengths and opportunities

·  The exercise is commonly

·  A SWOT analysis helps in identifying suitable strategy

·  To assist in identifying sufficient strategies, a gap analysis is also required.

·  Diagram

·  The types of strategy that can be adopted in order to fill the gap are:

ü  Cost saving measures

ü  Becoming more efficient

ü  Making changes to the product /the market matrix, this could be by organic or by acquisition

ü  Withdrawal.

Strategic Choice

·  Having carried out a corporate appraisal and having identified potential strategies, it is then necessary to appraise them and formulate a strategic plan.

·  The types of techniques that may be employed in appraising the strategies are :

i) Strategy Implementation

·  The strategic plan will generate the formulated on the board level and once it has been prepared, managers of the company are then expected to implement it.

·  The management will then carry out tactical planning0r management control.

II) Free Wheel Opportunitism

·  This occurs where the company deals without a strategic plan but operate a system where the opportunities are exploited as they arise.

·  The major advantage is that opportunities can be sized as they arise.

·  The major drawback is that it cannot guarantee that all opportunities are identified and appraised.

TARGET COSTING

Historical Background

·  It originated in Japan in the 1970s, it came to being as a result of recognition that customers were demanding more diversity in products that they bought and the life cycle of the products were getting shorter.

·  As such, it meant that new products had to be designed more frequently.

·  Companies realised that the larger proportion of costs were committed in the design stage of the product and hence the design stage become critical for the company to make profit.

Purpose

·  Target costing is a method that is employed to manage costs and profits.

·  It involves setting a target or objective for the maximum of a product /service and working out now to achieve this target.

·  It is used for business strategy and marketing strategy in particular by companies who operate in a competitive environment and where new products are continuously being introduced.

·  For companies to achieve these, they need to:

ü  Continually improve their existing products or design new ones.

ü  Sell their products at a competitive price just like competitors or slightly below competitors.

ü  Make a profit.

NB in order to make a profit, companies need to make the product at a cost below the expected sale price.

Target costing and New product Development

·  It is mainly used for new product development; this is due to the fact that whenever a new product is designed and developed for a competitive market, a company needs to know what maximum cost to be placed on a new product so that it will sell at a profit.

·  Keeping the cost of the product within the target level is the major factor in controlling its design and development.

New product design and development

Setting target cost

$

Target selling price xxxx

Less target margin xxx

Target cost xx

·  The reason that target costing is used for new products is the opportunities for cutting costs to meet target costs since it is from the design stage and development that all production processes are set up.

Target costing method

·  The principles of target costing can be summarized as:

·  Target costing is based on the idea that when a new product is developed ,a company will have a reasonable idea about:

i) The price at which it will sell the product.

ii) The sales volume that will be able to achieve for the products over its product life.

iii) Their may be need to estimate capital investments, incremental fixed costs such

as marketing costs and additional salaries.

·  Taking estimates of sales volumes, capital investments, incremental costs over the life of the product, it then becomes easier to ascertain the target cost.

·  The target cost for the product might be the maximum cost for the product that will provide at a least a required return on the investment.

Elements in Estimates Cost and Target Cost

·  It is difficult to measure the cost of a product that has not yet been created and the cost must include such items as raw material wastage, direct labour idle time which is expected to occur in normal circumstances.

Raw material

·  The target cost should allow for expected wastage rates/wastage in the process.