Introduction
Cost accounting is one of the most critical functions in an organization’s financial management practices. The production process begins with the acquisition of materials, which are then transformed into finished products. This process entails incurring various costs associated with production. Cost accounting is a facet of management that focuses on the actual costs of manufacturing or service provision by examining the expenses incurred across the supply chain.
Budgeting is another critical concept in financial management. This function allows the allocation of resources to the primary organizational operations. The focus of this essay is to discuss the key concepts and features of cost accounting and its importance. Second, the paper identifies the weaknesses of Exciteco’s budgeting systems and explains how external factors have contributed to poor performance. Lastly, a discussion of the benefits to Exciteco of analyzing variances in planning and operational elements will be presented.
Cost Accounting Explained
Concepts
Cost accounting is the reporting and analysis of a company’s cost structure. The process involves allocating or assigning costs to cost objects, including products, services, and other activities undertaken by the company. Modern applications of cost accounting concepts have led to the development of new models that target specific aspects of a firm. For example, material flow cost accounting (MFCA) has emerged to promote cost reduction while considering the environmental impacts (Dierkes & Siepelmeyer, 2019, p. 483).
According to Kitada et al. (2022, p. 1), MFCA quantifies the flow and stock of materials within the company, including raw materials, chemical catalysts, auxiliary materials, energy, and water, into physical units and examines the associated costs. Another example is environmental full-cost accounting (FCA), a novel analytical methodology that focuses on the ecological and human health effects of products and processes (Diaz, Scouse, and Kelley, 2022, p. 1). Cost accounting captures the total production costs of a business.
Cost accounting encompasses several key concepts, including cost and its various typologies. Direct costs are the expenses directly involved in the production of an item. They include materials and labor, and other costs may also fall under this category depending on the method of accounting (Lewis, 2022). Fixed costs are expenses that remain constant, such as a monthly payment for a piece of property.
Fixed costs may include interest rates, loan repayment, depreciation, salaries, lease payments, property taxes, and insurance (Ward, 2022). Variable costs are expenditures that change in response to the business’s performance. For instance, increasing the production scale may lead to higher costs, such as increased packaging expenses. Operating costs are associated with daily business activities and could be fixed or variable. Examples include rent and utilities, which are essential for business operations but not directly involved in manufacturing.
Other concepts in cost accounting comprise the types of cost accounting. Standard costing involves applying a standard cost to goods sold and inventory, rather than individual expenses. Such an approach enables firms to optimize the use of labor and materials as they strive to stay within budget. Despite having a budget, specific expenditures arise, necessitating the calculation of variance analysis (Puniya, 2022).
Activity-based costing (ABC) defines and transfers overhead costs from each department to real expense items, including products and services. This type of cost accounting focuses on the operations, units of work, or activities performed for a specific purpose. Lean accounting is designed to improve the enterprise’s financial reporting process. It entails a practical implementation of the concept of lead manufacturing. Marginal costing focuses on the effects of producing additional units of output on the product’s cost. This type of cost accounting, known as cost-volume-profit analysis, is commonly used to inform short-term decisions.
Features
Considering the definition of cost accounting, its most important feature is that it is designed to help assess and record all costs associated with running a business. In other words, cost accounting involves tracking all costs while providing informed guidance for business decisions (Lazzari, 2019). Cost accounting is a subfield of accounting that involves tracking and accounting for costs.
Cost accounting provides data critical for a company’s decision-making and budgeting activities. The rationale is that firms must manage their costs to influence their profitability. Another feature of cost accounting is that it helps establish standard budgets and costs and aids in fixing prices for products and services. Lastly, cost accounting can be used as a tool for establishing the efficiency of a process or unit. This can be achieved through cost management decisions based on cost accounting data.
Importance
Cost accounting is vital in a company’s decision-making processes. According to Lutilsky, Liović, and Markovic (2018, p. 1382), firms seek new cost accounting methods due to their growing importance in decision-making. Management decisions related to production and resource allocation are informed by the data available during the cost accounting process. Besides manufacturing, cost accounting is also important for service providers. Several aspects of cost accounting can help explain its importance to management.
First, cost accounting helps control costs by collecting and recording all cost elements of a firm. When costs and cost centers are known, decision-makers can implement strategies to lower expenses. Second, cost accounting enables the classification of costs, which helps distinguish between various types of costs. Since each cost has different implications for the business and its operations, this classification helps identify which areas of the business to focus on during cost control initiatives.
Third, cost accounting facilitates decisions on product and service pricing. Costing provides cost reports that can be used to decide the best price that achieves the company’s profitability objectives. Fourth, cost accounting is critical in budgeting, a practice often involved in allocating resources. Budgeting can be described as the process of establishing planned expenses (Lutilsky, Liović, and Marković, 2018, p. 1389). The expenses are planned based on the costs associated with specific corporate activities and operations, both directly and indirectly, that produce products or services.
Another important aspect of cost accounting is determining a firm’s profitability. Profits are calculated as the sales revenues minus the costs of goods sold. Businesses can set prices that fit the expected profit margin by managing and understanding their costs. Therefore, the data on costs of running a business can influence critical management decisions.
Weaknesses in Exciteco’s Budgeting
Exciteco employs a well-established incremental budgeting process, which enables divisional managers to forecast sales volumes and costs several months prior to the budget year (Stefanka, 2022). Incremental budgeting can be described as making incremental changes to the current budget. Therefore, no new budgets are created for a new financial year. Instead, predicted changes are incorporated into the existing budget to improve it for the new period.
As a result, forecasted cost increases and such aspects as prices and inflation are used to adjust the budget. Exciteco has been using the same approach, and it can be observed that it has several weaknesses. The first drawback noted in the case is that it took too long to budget, and that the budget constrained the performance. Divisional managers at Exciteco are expected to work within the budgets, and they are appraised on the financial performance of their divisions. Therefore, any shortcoming in the budget critically affects their performance levels and remuneration.
Incremental budgeting has several disadvantages that can be considered weaknesses for any business using the method. First, it promotes unnecessary spending since departments tend to spend all the money allocated to them in the budget. The rationale is that these departments seek to obtain even bigger allocations during the next budget period (CFI Team, 2022).
As a result, unnecessary spending may occur to deplete the funds. Additionally, departments may overestimate their need to solicit more funding (Ouassini, 2018, p. 6). The company suffers in the process since the more money the divisions spend, the more the firm’s profitability is affected. It is difficult to establish that Exciteco faces this weakness, but it can be argued that the firm faces a situation where divisions strive for more funds since failure is not tolerated.
Another weakness of Exciteco’s budgeting process is that it discourages innovation. The rationale is that new budgets are built on the old ones, meaning the same ideas and processes are reused (CFI Team, 2022). At Exciteco, the incremental budgeting process meant that the company continued to produce the same products using the same processes.
As a result, the company could not innovate its products, especially in the P Division. New products in the market were becoming increasingly popular, and the P Division could not adapt since it had already committed to producing large quantities of the current products. Therefore, the incremental budgeting process effectively hindered the company’s ability to innovate.
Lastly, incremental budgeting fails to account for external factors and changes. This is because incremental budgeting is designed for the operational stability of a company (CFI Team, 2022). Exciteco’s failure to adapt to the new phones is one example of how it failed to accommodate external factors. The changes in consumer demand should force a business to adjust its product design and production.
Another example is the changing prices of silver, which were not considered in Exciteco’s incremental budgeting. As a result, these external factors have become critical in undermining the company’s performance. Considering the weaknesses of incremental budgeting, it is likely unsuitable for the environment in which Exciteco operates.
External Factors in Poor Performance
External factors play a critical role in determining a firm’s performance. Exciteco’s performance last year was heavily influenced by external factors, especially the changes in customer preferences and fluctuating prices in critical materials. From a theoretical perspective, current literature establishes that focusing on consumers’ needs is key to a business’s performance.
The concept of customer orientation describes a scenario where organizational employees are oriented toward promoting and supporting the collection, dissemination, and responsiveness to market research or intelligence. This is done to improve the ability to serve consumer needs (Feng et al., 2019, p. 111). Consumer needs and preferences are dynamic, which means that what works well for the market today may not be well-received tomorrow. Therefore, Exciteco’s poor performance in areas such as the P Division resulted from external factors, specifically changes in consumer tastes and preferences.
However, customer needs and preferences may change due to other external factors, including technological advancements. In this case, the new smartphone model was becoming increasingly popular with consumers since it offered improved technologies compared to those offered by Exciteco’s products. Consumers are always attracted to new products that offer them a better experience. Therefore, the fact that the new smartphone offered a larger screen designed for games meant that previous models, including those produced by Exciteco, could quickly become obsolete.
The customer orientation concept described by Feng et al. (2019, p. 111) remains relevant in explaining the effect of external factors on firm performance. The rationale is that being customer-oriented should allow a company to anticipate these changes and improve its technologies to meet emerging needs. Lastly, the fluctuating prices of silver may have affected the sales volumes. However, the most significant factor was a fire at the company’s main customer. Losing the primary customer means losing a significant portion of the annual demand and declining sales volume.
Benefits of Analyzing Variances: Planning and Operation
Analyzing variances in planning and operational elements can benefit Exciteco in several ways. As mentioned earlier, cost accounting and budgeting may not always remain standard since new expenses may necessitate the calculation of variance analysis (Puniya, 2022). This means that Exciteco should incorporate variance analysis in planning and operational elements to account for new items not included in the initial calculation. Calculating the actual and expected figures helps understand the sources of variance to support corrective measures. Variance analysis highlights controllable and non-controllable variances, which should help the company decide what to do with them.
Exciteco can make the necessary modifications for controllable variances. At the same time, the firm can only aim to manage the effects of the uncontrollable variances. Operational variances also offer a fairer reflection of the actual performance of a business. Planning involves setting standards and expectations for a set period regarding performance and other metrics. However, uncertainty means that these standards are not always met. Variance analysis helps identify uncertainties and use them in the next planning phase. However, rectifying the plans and operations is the most important use of variances.
Conclusion
Exciteco is a company that faces several budgeting and cost accounting issues that affect its performance. The shortcomings of the company’s incremental budgeting process have been linked to its poor performance. For instance, the budgeting process prevented the company from adjusting to the new product designs. However, external factors also played a critical role in influencing company performance. The examples given include the loss of the main customer, technological changes, and shifts in consumer preferences. Cost accounting has also been discussed in detail, including the concepts, features, and importance of cost accounting.
Reference List
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