Management Accounting – Australian Electronic Division (AED)

Keywords: ABC costing, Forecasting and Budgeting, Make Vs. Buy, Inventory Management, Relationship management, Master budget

Introduction

As a management accountant, in this report, the range of management accounting issues at Australian Electronic Division (AED). The report is structured into two sections. The first section presents the summary of issues as email for company chairman. In the second section, it analyses and evaluates the key management accountings issues.

Section 1: Email for Nagasai Motoko

Subject: The evaluation and recommendations for five management accounting issues

With reference to our board meeting, this email encloses the evaluation and recommendations for issues discussed during the meeting.

The five key issues include forecasting and budgeting for material, procurement of Theolite in bulk, implementation of ABC costing, in-house production vs. outsourcing of MKA 1919, ethical issue surrounding Mel and Alistair and Mel relation and transferability of maintenance cost.

For forecasting and budgeting, it is important that AED align its supply and demand using the demand forecasting techniques and prepare the master budget to overcome uncertainty enclosed in planning process. The operational and strategic level of forecast would enable to demand forecast through the company. The tactical level of forecast includes would include master budget, sales planning and inventory planning. On the operational level of forecast includes production scheduling and inventory deployment. It is recommended that Dominic must prepare sales budget because all other departments reply on its information.

In case of bulk purchase of Theolite, AED should not purchase material for discount because of inventory holding costs and its effect on working capital of company. As mentioned by Joe, AED has appropriate level of material and excess inventory would result in inventory costs such as storage, investment and insurance. It is recommended that rather purchasing in bulk, company should use MRP approach for material purchase and inventory to working capital ratio is useful to understand the operating efficiency for company.

For ABC costing, AED is currently allocating cost based on direct labour hours and implementation of ABC would involve five steps which are activity identification, activity analysis, assignment of costs, calculating activity rates, and assign the cost to cost objects. The benefits of ABC for Unlike traditional costing method in which machine hours, volume or direct labour are used for cost allocation, in ABC, system allocate cost based on levels of activity (transaction drivers and duration drivers) in relation to how many units are produced.

However, the implementation of ABC involves issues such as large volume of data collection and identification may require for additional cost which may demotivate employees. ABC system would change the product margins and some costs may be irrelevant in decision-making.

For MKA 1919, the in-house production of component is critical for AED, as it is critical to strategy and performance of company. The in-house production differentiates the product and generates synergies for business. For AED, it has spare capacity and knowledge to produce MKA 1919.

The purchase management process should be transparent and confine within legal and commercial constraints. It is important that suppliers understand the processes, timescales, procedures, expectations and selection criteria. The relationship of Alistair and Mel represent a conflict of interest and purchase of MKA should commercial and legal requirement as well as meet demand requirement for production rather buying for discount.

In the context of expense recognition principle, the transferability of maintenance costs is not possible for AED because expenses should be recognised in the period in which revenues are generated (matching principle).

Section 2: In-depth evaluation of evaluation of five management accounting issues

Introduction

Epstein and Lee (2012) described that management accounting provides valuable information to management for decision-making along with advice on information provided. The range of issues at strategic and operational level includes budgeting, forecasting, agency theory, and production management as well as performance appraisal. The management accountant is concerned with providing complex analysis and information for business management for timely decision-making in the context of planning and control.

As a management accountant, in this report, the range of management accounting issues at Australian Electronic Division (AED).

Company Overview — Australian Electronic Division (AED)

Australian Electronics division (AED) operates as a stand-alone business of HighTech in Kwinana, Australia.  The three key products (circuit boards) produced by the company are HT prime (mainstay product), HT Maximus (new and medium-range advance product) and HT Zenith (top range and latest technology). The key management of company includes Nagasai Motoko (division head), Gemma Gooding (Finance manager), Alistair Cook (purchasing manager), Dominic Chan (Sales manager) and Joe Yarran (production manager).

Purpose and scope of this report – Five key issues

This report analyses and apprises fives issues for the AED which are

First issueForecasting and budgetingThe first issue rises by ‘Alistair’ is associated with ‘forecasting of material demand’ because of consistently changing in estimates by production and sales department. Joe believes sales department (Dominic) constantly changing production schedules. The constantly changing demand has affected the budgeting process as highlighted by Gemma
Second issueProcurement of Theolite and inventory managementThe second issue is associated with procurement of ‘Theolite’, a key material used in the production of the circuit board. Alistair mentioned that ‘Jaymie electronic’, the key supplier of ‘Theolite’ is shutting down next year and company should purchase in bulk at discount. Gemma has highlighted the budgetary constraints for purchase and its effect on working capital will be discussed.
Third issueABC costingThe third issue enclosed is related to the implementation of ‘ABC costing’. Company competitors have implemented ABC and management requires an understanding of ABC implementation for AED. Therefore, this report discusses ABC, it processes, benefits and limitation for the company
Fourth issueMake vs. buy of MKA 19419The fourth factor discussed in the report is ‘making vs. buying decision’ for ‘MKA 1919 as Joe estimates that production is a cheaper option rather producing the product. The implications associated with such decisions are discussed
Fifth issue

Nagasai concerns

Alistair relationship and maintenance costsFinally, the fifth issue discussed in the report is two key concerns of Nagasai in relationship to purchase of ‘Theolite’ and relationship between ‘Alistair and Mel’ and transferability of maintenance cost for next year

 

Discussion of issues at Australian Electronic Division (AED)

Forecasting and budgeting

A forecast represents an estimate of what company intended to achieve and budget is quantified expression of what company wants to achieve. Forecast tracks business performance to make timely decision to address shortfalls against target and maximise on opportunity. On the other hand, budgeting enables the resources allocations which align targets and strategic goals for company (Hagel, 2014).

Demand forecasting

The three steps are industrial trends, demand planning, demand forecasting and demand management. The alignment of demand and supply plans helps the company to maximise profitability as shown in the diagram below (Kilger and Wagner 2015).

Demand Forecasting

The demand forecasting in a company supports company-wide planning activities at both strategic and operational forecast. As Alistair has complained that the changing in production plans and changes the forecast based on sale demand by Dominic. In order to overcome forecasting issues, the strategic demand forecast business and capacity planning should be managed. The tactical level of forecast includes would include master budget, sales planning and inventory planning. On the operational level of forecast includes production scheduling and inventory deployment. The operational and strategic level of forecast would enable to demand forecast through the company (Hansen and Mowen, 2017).

Master budget for planning and control

As integrative financial planning document, master budget encloses number of other budgets and provide company guideline on what it wants to achieve and what must be accomplished. The key components of master budget are enclosed in the diagram below. These components are interlinked and i.e. must be prepared in particular order because each budget reply on information generated from other budget (Maher, Stickney and Weil 2012).

Dominic must prepare sales budget because all other reply on its information. The range of sources to estimate sources are mathematical models, economic forecast, trend analysis and industry data. Once sales budget is prepared, the next stage is preparing production budget to produce units to achieve desire level of sales. The production budget information helps the purchasing department to plan for ordering material (Warren, Reeve and Duchac 2016).

It is important to understand the differences of raw material and finish goods level. The material purchase budget depends on number of units needed for production and level of inventories. The formaula for production budget is

Master budget for planning and control

Procurement of Theolite from Jaymie electronic – inventory management

Material requirement planning (MRP)

Alistair has recommended that company should purchase ‘Theolite’ in bulk for discount. Company holds inventory to satisfy present or future demand. The inventory holding smooth-out variations in operation performance, safeguard against price changes, avoid stock shortage and take advantage of quantity. Theolite is used by AED for production and available at discount but production manager states that company has appropriate level of material. The inventory cost includes storage, investment and insurance (Muller, 2011).

Inventory Annual holding cost

The high level of inventory for AED would incur additional cost for storage and mismanagement of inventory could create the financial problem for business. The successful level of inventory management is based on neither too much nor the too low level of stock.

One of the useful approaches for inventory management is ‘material requirement planning’ (MRP) which involves purchasing material based on sales forecast.  Economic order quantity (EOQ) is useful model for AED to hold level of inventory which minimises the cost (Meyr, Wagner and Rohde, 2015)

Economic order quantity (EOQ)

Whereas; D= Annual demand (units), S = cost per order, C = Cost per unit, I = holding cost (I x C)

Inventory to working capital ratio

As mentioned by Gemma, the company is financial constraint to purchase inventory in bulk discount. The inventory directly influences the working capital of company and affects profitability. Inventory to working capital ratio is important indicator of operating efficiency. The value of 1 or lower means company has high liquidity of current assets and high value represents company holding high investment in stock.  The excessive inventory put burden on cash resources of company and thus, not favourable. The optimum level of inventory is linked to operational efficiency and minimisation of cost. The inventory to working capital ratio is (Bragg, 2012)

ABC costing for AED

According to Mahal and Hossain (2015), Activity-based Costing (ABC) is accounting method to allocate cost through identification of activities performed by company and use activities to assign an indirect cost to the product. ABC recognises the relationship between activities, costs and product and consequently, it assigns the indirect cost to the product in the less arbitrary manner to compare to traditional costing methods.

Under ABC system, cost driver or activity driver is used to allocating cost. For example, the range of cost drivers includes purchase orders, maintenance, machine setup, production orders and quality inspections (Needles and Crosson, 2013).

Implementation of ABC

AED is currently allocating cost based on direct labour hours and implementation of ABC would involve five steps which are activity identification, activity analysis, assignment of costs, calculating activity rates, and assign the cost to cost objects. In the activity, the range of activities performed by various departments and need to identified and gather in activity pool. The activity pool represents supporting activities tied to the product.

For activity analysis, AED management needs to clearly identify the processes which support the activities which resulting allows the identification of indirect cost relationships. On the basis of activity pool, costs are assigned to product and activity rates will be calculated. Finally, the activity costs, rates and pools helps to assign the cost to the object (Adler, 2013).

Benefits and limitation for AED

In ABC, the indirect costs are allocated based on cost drivers and eliminate the additional costs charged to the product. For example, AED absorbs overhead based on direct labour hours and ‘HT Zenith’ has only $13 as labour cost (compare to $26 for other two older products).

Therefore, ABC costing would allow absorbing the exact cost associated with new products based on machine hours which are missing under older costing method. In similar approach, ABC would allow the identification of non-value added activities and fix prices that are excessive through better understanding of overhead associated with each product (Weygandt, Kimmel and Kieso, 2015).

For AED, the implementation of ABC could be expensive and time-consuming. It is important that activities are broken down and each component must be analysed. The large volume of data collection and identification may result in additional cost and demotivate employees. The implementation of ABC system would change the information on product margins and some costs may be irrelevant in decision-making. As mentioned by Dominic, the performance is based on sales targets and implementations could result in misinterpretation of data and demotivate the sales team (Broadbent and Cullen, 2012).

Make vs. buy decision — MKA 1919

A make or buy decision involves choosing between manufacturing product in-house or purchasing product from external supplier. For AED, the external supplier has quoted the price of $3.85 per unit and in-house production cost for company to producing each MKA 1919 is $5.16. The important consideration is company currently produce 50,000 whereas it has full capacity of 70,000 units.

The range of factors influence company decisions are capacity and expertise to produce in-house, volume required and importance of item for firm strategy. For AED, it has spare capacity and knowledge to produce MKA 1919 (Arya, Mittendorf and Yoon, 2014).

The MKA is critical in production of circuit board and outsourcing could raise the problem of quality control and proprietor technology as HT Maximus is based on latest technology. The reliability of supplier and relationship management with external supplier could affect the operations of AED. In addition, company has to deal with spare capacity as outsourcing affect the existing production resources of company.

For Joe concern, why AED should not outsource the production of MKA 1919, there are numbers of factors involved. First, the product is critical to strategy and performance of company, involves design changes and time-sensitive. The tight control over logistics and production is critical and product should quality requirement. The in-house production differentiates the product and generates synergies for business (Puranam, Gulati and Bhattacharya, 2013).

Nagasai concerns – Purchasing Theolite and maintenance costs

The two concerns for Nagasai is Alistair relationship with Mel and its influence on purchase of bulk Theolite and transferability of maintenance costs. The purchase management process of company should be transparent and confine within legal and commercial constraints. It is important that suppliers understand the processes, timescales, procedures, expectations and selection criteria. Purchasing and supply chain managers should declare material personal interest which could affect the judgement in respect of their duties (conflict of interest).

The relationship with Mel represents a conflict of interest for Alistair. The purchase decision should follow the commercial and legal requirement as well as meet demand requirement for production rather buying for bulk discount (Ferrell and Fraedrich, 2015).

The transferability of maintenance costs is not possible for AED. In the context of expense recognition principle, expenses should be recognised in the period in which revenues are generated (matching principle). It would affect the income tax (underpaid), as the expenses for the period would higher and overpaid in the subsequent year. The expense recognition is at the core of accrual basis of accounting and recoding expenses when incurred (advance accrual is prohibited) (Warren, Reeve and Duchac, 2016).

Conclusion and Recommendations

Conclusion

This report evaluates the five management accounting issues at Australian Electronic Division (AED). The issues include forecasting and budgeting for material purchase, procure of Theolite in bulk, implementation of ABC costing, in-house production vs. outsourcing of MKA 1919, ethical issue surrounding Mel and Alistair and Mel relation and transferability of maintenance cost.

The results highlight that AED alignment of demand and supply plans to help the company to maximise profitability through deploying techniques such as demand forecasting and developing master budget. Rather purchasing in bulk, company should use MRP approach for material purchase and inventory to working capital ratio is useful to understand the operating efficiency for company.

For AED, Unlike traditional costing method in which machine hours, volume or direct labour are used for cost allocation, in ABC, system allocate cost based on levels of activity (transaction drivers and duration drivers) in relation to how many units are produce. The production of MKA 1919 is critical to strategy and performance of company, in-house production differentiates the product and generates synergies for business.

The bulk purchase of MKA should commercial and legal requirement as well as meet demand requirement for production rather buying for discount. In the context of expense recognition principle, the transferability of maintenance costs is not possible for AED because expenses should be recognised in the period in which revenues are generated (matching principle)

Recommendations

  • The alignment of demand and supply plans to help the company to maximise profitability and operational and strategic level of forecast would enable to demand forecast through the company.
  • Master budget approach would allow to overcome budgeting issues and Dominic must prepare sales budget because all other departments reply on its information.
  • AED should purchase material using material requirement planning’ (MRP) which involves purchasing material based on sales forecast.
  • Company should implement ABC costing as it would allow the identification of non-value added activities and fix prices that are excessive through better understanding of overhead associated with each product.
  • AED should produce MKA 1919 in-house production as it differentiates the product and generates synergies for business.

 

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Appendix 1 : Master budget

Master budget

 


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