A costing system method means the procedure adopted to ascertain costs. There are several ways of ascertain costs. Companies choose among the alternatives depending on circumstances in which accounting is required to be made based on the product being manufacture and the nature of the industry making the product.
Depending on the nature of Dynamic Models PLC, the appropriate costing method will be specific order costing where the activity being accomplished consists of tasks which are specifically identified at each stage.
Specific order costing is applicable where the work consists of separate jobs or batches. The main sub-division of specific order costing is:
Job costing: this is a traditional method for cost accounting where costs incurred are allocated, apportioned and absorbed by the cost unit. The company production is divided into different jobs but the same nature in order to determine the profit made on each job for future planning.
Batch costing: this is a different type of specific order costing where a quantity of identical items is manufactured as a batch. It is like job costing method but the main difference is the unit cost represents the ration of the total cost of the batch to the number of units in the batch.
1.3 Improvements to the costing and pricing system used by an organization
In order to improve the costing and pricing system used by Dynamic Models PLC, important information is needed.
Data need to be relevant, timely and accurate. The main characteristics of information needed are explained below:
Relevance: managers only need relevant information for decision making;
Timeliness: useful information for decision making needs to be available when needed.
Accuracy: cost should be identified accurately for each product, each activity, and each customer. In order to target the make appropriately and make decisions about the volume mix and pricing.
2. Apply forecasting techniques to obtain information for decision making
2.1 Apply forecasting techniques to make cost and revenue decision in an organization
Accountant use many techniques for forecasting purposes. Firstly, they use correlation coefficient method to measure the degree of relationship between two variables.
There is a perfect correlation when R= +1.0 or R=-1.0 and all the point of the diagram do not lie on a straight line. There are some cases where all the point of the diagram do not lie on a straight line and R would not be 1.0/
Therefore, a perfect correlation can still exist where all the points lie on the line but not a straight line.
Month
Output
Cost
X
Y
1
2
9
2
3
11
3
1
7
4
4
13
5
3
11
6
5
15
X
Y
X2
Y2
XY
2
9
4
81
18
3
11
9
121
33
1
7
1
49
7
4
13
16
169
52
3
11
9
121
33
5
15
25
225
75
18
66
64
766
218
R = 1 it is strong correlation.
Secondly, regression line method is used to find the values of the constant a and b in the equation y= a+ bx. This method is also called the least squared method. The line we obtain is the one which minimizes the sum of squares of the vertical deviation of the points from the line.
a = y average – b*x average = 66/6 – 5*(18/6) = 5
Among the other different method of forecasting, there are:
Quality forecasting methods which is based on judgments about future revenue collection. However this technique is not really reliable because of the lack of rigorous assumptions.
Judgmental forecasting is a technique where people make assessment of futures conditions. Based on previous conditions (economical, historical and other relevant factors). This technique can provide good estimates especially when it is done by experienced forecasters.
Quantitative method is based on numerical data relevant to the source revenue. This method is also practical and makes considerable assumption about forecasting. The way this method provides the level of uncertainty makes it one of the common forecasting methods used by companies.
The following techniques is Times series approach which is the technique that private sector often uses because of the characteristics of data used by these companies.
2.2 Assess the sources of funds available to an organization for a specific project
There are several sources of funds available in organization for a specific project:
Issue additional equity: there are often used on the second tier market by a quoted Dynamic Model PLC issuing shares or an unquoted Dynamic Model PLC to obtain a quotation.
When the company needs to expand and grow, the organization could rely on difference in order to provide necessary resources (lenders). The amount of money needs to payback with interests and capital repayments at a particular period of time as fixed by the contract.
Shares represent the amount of funds supplied permanently to the company for their acquisition. These are provided by an investor and are non-returnable unless in an event of liquidation. Investor expects rewards from the company profitability and do have ownership of the remaining funds of the business.
Bank borrowings, retained earnings and limited shares are used by small businesses and Private Sector Company. (The Association of Business Executives, 2011)
3. Participate in the budgetary process of an organization
3.1 Select appropriate budgetary targets for an organization
In order to evaluate financially the various targets of Dynamic Models PLC’s management, the company needs to set up an appropriate budget.
Budget is a financial tool which includes a forecasting profit and loss account, balance sheet, cash flow statement analyzed per month of the accounting period in order to facilitate control.
Budget aims at forecasting a long term objectives of Dynamic Models PLC management. It also aims at comparing actual performance to the budget by using variance analysis. An adverse variance is a negative outcome for the company and, inversely, favorable variance is positive.
Accountants are supposed to review their manufacturing strategy and costing method when the company is not performing well in order to take corrective action and pursue the company objectives in a long run which is profitability.
Most of the time, budget are used for a period of 12 months only small companies set up their budget for a period of 6months.
3.2 Create a master budget for an organization
In order to create a master budget for Dynamic Model PLC, accountants and all the people involved in the accounting process need to go through two different sections: the operation budget and the financial budget.
Current economic conditions helps accountant to overcome difficulties met during the budgeting process plan, In fact, relevant information need to be considered to set up accurate targets.
During the operation budget, the income statement, sales budget, operating expenses and cost of goods sold are analyzed. In such case, Dynamic Model PLC has no got sales revenue yet and the operation budget will be made based on budgeted expenses and supporting schedules.
During the financial budget, the impact of the budget is analyzed based on the cash of the organization (cash budget, capital budget, budgeted balance sheet).
Budgeting is a financial tool which helps managers to use qualitative and quantitative information in order to communicate their financial strategy and expectations to the top management and others people involved in the budgeting process.
Opportunities and capabilities can be analyzed by people involved in the budgeting process when communication is clear.
This financial tool is a key for providing relevant information about corporate financial strategies, opportunities and potential challenges to be avoided.
Budgeting process is aim at:
Planning: in order to improve performance. Dynamic Models PLC need o establish a plan. It helps managers to forecast the organization expectations based on opportunities and challenges of the current economic climate and the effectiveness of strategies implemented. A plan could be modified during the course of the company operations in order to respond quickly to any unexpected environmental threats.
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Coordination: Dynamic Models PLC needs to work as a team in order to achieve the best possible results. That will enable the company to work effectively and efficiently in a perfect harmony. The budget will be an agreed planned which is supposed to meet the company objectives. Performances need to be monitored in order to ensure that the relevant work is implemented successfully.
Control: As it said above, performances need to be monitored and controlled in order to ensure that the relevant work is implemented successfully. When the budget period ends, there is a need to compare actual expenditures and actual income to the budgeted ones and understand if the company has being doing well or in what ways the company has been unsuccessful.
Variances analysis will help managers to be able to monitor performances. In cases expectations are not met, corrective actions need to be taken.
Motivation: all the people involved in the accounting process need to work towards achieving the company objectives. That will reinforce motivation and people will work hardly in order to achieve company’s objectives.
Improved communications: Dynamic Models of PLC need to establish a good communication strategy with all the people involved in the budgeting process. Responsibility, authority needs to be given to appropriate people in order to set the required directives to employees, their job specifications and duties and make sure they all understand what the company expects them to do.
In that way, people will work together to achieve organizational and feel more committed.
Financial decisions are really important. That is the reason why senior management needs to understand and set achievable objectives.
3.3 Compare actual expenditure and income to the master budget for an organization
Budget is a financial tool that managers use in order to forecast quantitative expression of plans. The master budget is set for an overall period according to the organizations objectives.
As the master budget includes two main parts: operation budget for the company planned sales and operating expenses and; financial budget for all the different financial actions like cash management, loans…
An appropriate budget aims at planning and control. The budget is planned before the financial period and actual performances are compared to the expected ones in order to be monitored and take corrective actions if necessary.
Organizational Budget, January – December 2011
Plan
Fact
Variance
EXPENSES
Total
Total
Total
I. SALARIES
1. Staff salaries
18,000
18,500
-0,500
2. Consultants
6,000
6,000
0,000
II. ADMINISTRATION
1. Rent
7,000
7,000
0,000
2. maintenance/equipment
500,000
510,000
-10,000
3. Furniture
5,000
5,200
-0,200
4. Fuel
1,500
2,000
-0,500
5. Telephone bill
1,500
2,000
-0,500
6. Internet
1,000
1,200
-0,200
III. PROGRAMS COSTS
1. Research and development
10,000
9,000
1000
2. Press and publicity
2,000
2,000
0,000
3. Training staff in house
2,000
2,000
0,000
4. Economic Justice Training for Rural Communities
14,000
13,500
0,500
5. Printing and publication of materials
10,000
11,000
-1,000
6. Community awareness workshops and discussions
10,000
10,000
0,000
7. Legislative advocacy
2,000
2,000
0,000
8. Media training/workshop
10,000
10,500
-0,500
TOTAL – Favorable variance
600,000
611.900
-11.9
Business management aims at planning, organizing, staffing, directing and controlling. An effective budgeting process helps to understand financial issues based on the company objectives. Once the plan is executed, there is a clear understanding of the budget. Then, there is a need to monitor and control performanc4es to take corrective actions if required.
Based on the budget above, the company strategy is not well implemented as the total variance is adverse (-11, 9). This means that the company operations are not profitable and there is a need to take corrective actions.
3.4 Evaluate budgetary monitoring processes in an organization
Budgeting monitoring is aimed at comparing actual performances of an organization against budgeted ones. The differences between actual and budgeted performances are called variances. When the company realizes profit, variances are favorable. However, an adverse variance reduces profit and actions need to be taken immediately.
This process helps managers to review variances. By doing so, they can easily identify in what areas of the business the company is not performing well.
According to the figures above, the company is not performing well. The cost of actual performances is higher that the budgeted. The company spends more than expected for media training, printing, telephone bill, internet, fuel, furniture, and maintenance and staff salaries.
Therefore, there is a need to corrective action in order to implement effective budgeting monitoring needs to take place for better results.
4. Recommend cost reduction and management processes for an organization
4.1 Recommend processes that could manage cost reduction in an organization
Based on the budget above, the company is not doing well. Therefore, managers need to be focused on areas of the business that are not successful.
In order to do so, financial technique such as cost control and cost reduction are the most appropriate techniques will help managers to take corrective action and drive the cost down as expected.
The company needs to control their operating expenses and avoid crucial increase of cost like the cost of maintenance and equipment which has increased significantly.
Cost control is a proactive action to avoid surprises for future results. However cost reduction is a reactive action and seems to be the most appropriate one to undertake in order to drive the cost down and react to crucial adverse variances.
Managers need to control the cost and encourage higher profitability to provide better return to the company shareholders.
Cost control and cost reduction will help the business to:
Operate more effectively;
Drive the cost of materials at the lowest possible level while maintaining quality and good customer service;
Helps to computerized processes to get the labor cost at the lowest possible level and avoid waste
4.2 Evaluate the potential for the use of activity-based costing
Activity based costing method has risen and become the technique that companies used the most compared to the traditional ones. ABC theory identifies all the relevant activities which take place in an organization and costs are incurred based on each activity cost driver identified.
These are the main stage in activity based costing:
Identify all the activities that cause overheads to be incurred;
Cost are allocated per activity;
Identify all the relevant cost driver which may impact to each activity cost;
Determine the volume of each cost driver;
Calculate the cost driver rate;
Determine the volume of each cost driver required by each product;
Calculate overheads attributable to each product.
Traditional methods tend to be overestimated because cost are often allocated based on the number of machine hours for activity with high volume in nature. And, this cause accountant to under-estimate cost of certain activities because traditional processes do not often take into account additional cost which occurred with short run production cost.
There the use of activity based costing method is a better technique in order to forecast the business activities and expectations. The importance of ABC is:
Cost associated with activities are identified accurately;
Manager can use cost drivers as a cost measure and cost performance;
Budget can easily be made using the cost of each relevant cost driver;
It helps manager to identify unprofitable product and review the manufacturing
Process and decide whether to manufacture the product or supply it.
5. Use financial appraisal techniques to make strategic investment decisions
5.1 Apply financial appraisal methods to analyze competing investment project in the public and private sector
In order to make competing investment project, the company needs to use investment appraisal technique which will help them to look at the potential capital of investment by a firm and measure its potential value to the firm.
There are 3 methods of investment appraisal which evaluate the potential return on investment:
Payback method;
Annual or average rate of return;
Net present value method.
Payback method is simple and clear. It helps managers to determine what project among the chosen ones return the initial cost of investment quicker. For instance, the organization has chosen 2 different projects, A and B. By using the payback method, we can identify what is the project with a quicker return on investment capital: if project A takes 4years for the company to get their investment capital and project B takes 3 years, the project that will be chosen will be the project B as the company recover from the capital investment quicker.
Annual or average rate of return is also simple and clear. However, managerial decisions are made based on annual or average rate of every project compared to the previous. Therefore the project with a highest rate of return will be the one the company has to choose.
Then, the last method of appraisal technique is Net Present Value. This method seems to be more complex than the previous ones. Managerial decisions are made based on the net cash flow adjusted for the effects of changing value of money over time. The quicker business have to wait to get the money generated from investment, the higher the value is and the most appropriate it is to choose that project,
Project A
Project B
Discount rate
Investment
52 000
100 000
8%
Year 1
25 000
10 000
0,926
Year 2
20 000
36 000
0,857
Year 3
14 000
40 000
0,794
Year 4
4 000
42 000
0,735
ARR
30%
32%
PBP
2,50
3,35
NPV (8%)
2 346
2 742
5.2 Make a justified strategic investment decision using relevant financial information
Here comes the most important challenge of managers in the decision making process. In fact, strategic investment decision involves identifying the most profitable product among the different capital investment projects. Information provided by the investment method used will give a better understanding to managers on project profitability.
Senior management needs to have a closer look to relevant information in order to make strategic investment decision and determine if it is either right or wrong to invest on the project.
Project A
Project B
Discount rate
Discount rate
Investment
52 000
100 000
8%
20%
Year 1
25 000
10 000
0,926
0,833
Year 2
20 000
36 000
0,857
0,694
Year 3
14 000
40 000
0,794
0,579
Year 4
4 000
42 000
0,735
0,482
ARR
30%
32%
PBP
2,50
3,35
NPV (8%)
2 346
2 742
NPV (20%)
– 7 261
– 23 282
Based on 8% discount rate, manager should decide to go for project A as the NPV and ARR are more important.
5.3 Report on the appropriateness of a strategic investment decision using information from a post-audit appraisal
Post audit appraisal is a financial tool aimed at analyzing the actual cost and benefit of the project after been implemented. Then comparison with initial expectations is made in order to identify anything that might have gone wrong during the implementation of the project.
In case expectations are not what the company has planned corrective action need to be taken.
Based on the table above, the payback period of project A is (2,5years) is more suitable than the payback period of project B (3.35years).
However, the annual or average return of return of the project B (32%) is more suitable than project A (30%).
Both methods are not really accurate because they do not consider the factor of time value of money.
The net present value is the most accurate and most used financial appraisal method as it does consider the factor of time value for money.
Therefore, if the discount rate remains the same (8%), both projects are suitable for the company but the project B is more profitable. However, if the discount rate goes up to 20% both project are not suitable for the company objectives because of their negative impact.
6. Interpret financial statements for planning and decision making
6.1 Analyze financial statements to assess the financial viability of an organization
For the company to pay its obligations one time as required, Dynamic Model PLC needs to be liquid. Therefore the use of financial ration will help manages to meet their current liabilities.
Current ratio = Current assets/ Current liabilities
Quick ratio = Current assets less stock/ Current liabilities
Trade Receivable turnover = Trade receivables/ Sales revenue
Stock/ Inventory turnover = Inventory/ Cost of sales
Profit Margin = Net income/ Sales
Asset turnover ratio = Sales revenue/ Total assets
Return on Capital Employed = Operating Profit/ Sales revenue
Gearing = Preference Share Capital + Long-term liabilities/ Total assets – Current liabilities
2010
2011
Current ratio
650/350 = 1,9
490/300 = 1,6
Quick ratio
(650-330)/350 = 0,9
(490-230)/300 = 0,9
Trade Receivable turnover
220*365/3500 = 22
170*365/2990 = 20
Stock/ Inventory turnover
330*365/2135 = 56
230*365/1823 = 46
Profit Margin
114*100%/3500 = 3,26%
76*100%/2990 = 2,64%
Asset turnover ratio
3500/2300 = 1,5
2990/ 2065 = 1,4
Return on Capital Employed
258*100%/3500 = 7,37%
193*100%/2990 = 6,45%
Gearing
(150+625)/(2300-350) = 39%
(150+540)/(2065-300) = 39%
6.2 Apply financial ratios to improve the quality of financial information
Careful interpretation is required when interpreting ratio analysis. They give a full understanding on the company profitability, liquidity, efficiency and structure of gearing, sources and uses of cash and their net effect.
However, ratio analysis has some limitations:
Changes in financial results are explained but they do not show the reason why;
Deterioration shown not always indicate the poor management issues
Good decision cannot be made on too much significance to individual ratio.
2010
2011
Variance
%
Current ratio
1,9
1,6
-0,3
-16
Quick ratio
0,9
0,9
0
0
Trade Receivable turnover
22
20
-2
-9
Stock/ Inventory turnover
56
46
-10
-18
Profit Margin
3,26%
2,64%
-0,62%
-19
Asset turnover ratio
1,5
1,4
-0,1
-7
Return on Capital Employed
7,37%
6,45%
-0,92%
-12
Gearing
39%
39%
0
0
According to the table above, we can see that current ratio decrease by 16%. However quick ratio shows that liquidity is available to pay their short term liabilities. Trade receivable turnover and stock/inventory decreased by 2 and 10 days respectively. Profit Margin decrease by 19% in 2011 and asset turnover is less than 0.1 times. Return on capital employed decrease by 12% but gearing remain constant.
2011
Average
Variance
%
Current ratio
1,6
2,2
0,6
38
Quick ratio
0,9
1,1
0,2
22
Trade Receivable turnover
20
10
-10
-100
Stock/ Inventory turnover
46
7
-39
-85
Profit Margin
2,64%
25,00%
22,36%
847
Asset turnover ratio
1,4
2
0,6
43
Return on Capital Employed
6,45%
50,00%
43,55%
675
Gearing
39%
20%
-0,19
-49
Figures in 2011 compare to industry average ration shown that average current ration and quick ration are better value and increase by 38% and 43, 55% respectively. Gearing was decreased by $(% and asset turnover 0.6times more than 2011.
6.3 Recommendations on the strategic portfolio of an organization
In order to address new capabilities and new potential markets, managers use a strategy portfolio. It is a financial tool which enables organization to look at the market opportunity in the long run.
A strategic portfolio needs to be developed in a way where strategies undertaken are aimed at pursuing Dynamic Model PLC’s mission and objectives.
It aims at setting positions, identifying targets and monitoring performances. It also takes into account all the potential changes that may occurred to take corrective action.
Therefore, Dynamic Models PLC can only improve their current situation and financial statement by:
Increasing total current assets such as inventory;
Increasing income for better profit margin and return on capital employed;
Increasing sales for better profit margin and trade receivable turnover.
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