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Evaluating the costing system in place at Apple

This report will address three issues of concern to Apple plc. First is the role and nature of management accounting information in strategic and operational decision making. Management needs to understand the type of decisions to be made at both strategic and operational levels, the traditional techniques that supported such decisions and the limitations of those techniques. Also, which contemporary techniques replaced the traditional techniques and why? Understanding this role will enhance management’s ability to make sound strategic decisions that will enhance the value of the company. The second issue will involve looking at the costing system of the company. Is the existing costing system in use appropriate or not? If it is appropriate, why? If not, why not? What will be the most appropriate costing technique and why is it appropriate compared to other techniques? Finally, an evaluation of the performance measurement system of the company and recommend either a better system or source for alternative measures to quench the growing rivalry between divisional managers of the company. We will briefly stare with a profile overview of Apple Plc.
There is no single, ideal management accounting system that suits every organization (McWatters et al, 2008). A different organizational circumstance leads to a different management accounting practice.
Introduction Apple Plc is a confectionary manufacturer. Figure one represents a breakdown of Apple’s divisions and the processes they go through to realize the final product. The different colours in each product represent the final output for each division. Although the mixing is done together, the cooking and packaging differs. For the cooking, the product type will determine the temperature level. While for the packaging, if the company is a monopoly, it would really matter. In a perfect market, customer’s preference is placed as top priority. Does the customer prefer to hold the candy bar on a stick or feel it with his/her bare hands?
Nature of Management Accounting Before establishing a common ground for the consideration of the nature of management accounting, a definition of the term would be appropriate. Management accounting can be defined as a process of providing appropriate information primarily intended to assist managers in making better decisions (Drury, 1998).
In previous years, management accounting techniques like traditional budgeting, cost-volume-profit analysis, standard costing and variance analysis, were adaptable to the business environment when product varieties were few, competition was low, overhead costs were relatively low, automated processes were minimal and firms’ were mostly labour intensive (Sulaiman, Ahmad and Alwi, 2004). An example was the traditional accounting system used by Hewlett-Packard (Groot and Lukka, 2000). This system gave Hewlett Packard information on departmental costs which made each manager aware of his/her costs and detail of the costs by type. However, many businesses and environments began to evolve as a result of technological changes, globalization and changing customer mix. Authors identified inadequacies in these techniques, when used as tools in planning and control decisions (Kaplan, 1983; Bromwich and Bhimani, 1994; Lucas, 1997). Awareness amongst companies on the need to achieve excellence in manufacturing/service delivery and use such an achievement as a strategy to compete effectively grew (Drury, 1998). Companies started linking their strategies with reduction in production and inventory costs, quality improvement and innovation, reduction in lead times and increased flexibility in meeting individual customer’s requirements (Lucas, 1997). This paved the way for the introduction of contemporary accounting techniques like target costing, total quality management, Just In Time (JIT), Activity Based Costing (ABC), Balance Scorecard and Process re-engineering, which support organization in achieving their objectives. An example is the case of Hewlett Packard when they advised all their business units to adopt activity-based costing (ABC) systems. Their intention was to provide information to help conceptualize new products (target costing), lower production costs and decide about localization of factories.
Limitations of the traditional management accounting techniques In their article titled “The rise and fall of management accounting [2}”, Johnson and Kaplan (1987) identified certain limitations to the traditional management accounting practices.
-Management accounting reports are of little use to operational managers attempting to maximize productivity and minimize cost. It takes time to prepare the report and even after preparation, the information provided is too distorted for managers to understand. This distracts managers from identifying the key factors for process and production efficiencies.
-Management accounting practices failed to provide relevant set of measures in which such organizations operates. These measures were meant to reflect the organization’s competitive environment, its products, processes and technology.
-Management accounting practices excessively focused on short term financial performance.
-Management accounting systems fail to provide accurate product costs. The use of simplistic and aggregate product costing is useful for financial reporting. However, it does not represent the demands by each product on the firms’ resources. Rather, it is based on direct labour. This distortion could result in misguided decisions on product pricing, product mix, product sourcing and rival response.
The role of Management Accounting Information in Strategy Strategy is the process of establishing a profitable or sustainable position against the forces that determine industry competition (Porter, 1985). The objective is to position the firm so as to gain competitive advantage. This involves producing long term plans while possible plans and actions of competitors. Tricker (1989) compared “the relationship between strategy and management accounting to the relationship between military strategy and military intelligence” (Hopper et al, 2007). For management accounting to play a role in strategic management, managers must provide both internal financial and non-financial information about the internal environment, and external financial and non-financial information, about the external environment in which the company operates.
In the 1970s, Bowman’s (1990) study showed that firms had developed an economic orientation in which external actors were considered as competitors that drive down profit levels. However, Hopper et al (2007) argued that benefits can also come from partnering with competitors, customers and suppliers. The perception that competitors can be cooperative as well as confrontational has broadened the concept of strategic management accounting as a process of information sharing between competitors. Accounting information will be required at each phase of the strategic decision making process.
Strategy Problem identification: This requires non-financial, qualitative information about issues of an internal and external nature. This will involve conducting a PESTEL analysis and analyzing Porter’s five forces industry structure.
Strategic alternatives: To generate these alternatives, management requires both financial and non financial quantitative data produced from internal and external issues.
Strategic actions: To select appropriate actions, management requires primarily quantitative, financial, internal information about costs, benefits and probabilities of courses of action.
The necessity of financial and non financial data as well as quantitative and qualitative data is what makes the prior management accounting information insufficient.
Strategic Decisions using management accounting information
The fundamental purpose of management accounting is to assist managers in achieving the organization’s strategic objectives. For this, managers have to consider the strategic decisions involved. These include
-Make or Buy Decisions Managers have to decide whether to produce the goods and provide the same services within the organization (insourcing) or outsource some of their activities to outside vendors. This decision is based on the firm’s strategy to achieve and maintain a competitive advantage within the market. One of the ways to achieve this advantage would be to reduce the cost of production activities by exploiting within the value chain of the company.
This is either by keeping cost low or differentiating the product. One of the ways it can achieve this is to utilize Porters’ generic strategies to define the position it wants to take. Sometimes, companies prefer to make the product in order to retain control of the product, market and technology. However, companies can also decide to outsource some of the company’s activities to reduce costs of production and enhance quality by outsourcing to specialists in that field.
Traditional technique The traditional management accounting technique previously adopted by companies was more of a ‘value added’ perspective which was largely internal to the firm (Shank and Govindarajan, 1993). This starts with payment to suppliers and ends with charges to customers with the aim of maximizing the difference. `For managers from a strategic point of view, this technique was deemed inadequate for three reasons
-It starts too late and ends too soon: Opportunities to exploit linkages with the firm’s suppliers is missed since the cost analysis will at the point of purchase. Also, opportunities to exploit the firm’s customers are missed since the cost analysis will end at the point of sale.
-It arbitrarily distinguishes between raw materials such as maintenance and other purchased inputs.
-Competitive advantage cannot be fully explored without considering all purchased raw materials and cost elements involved.
Contemporary technique These inadequacies are made up for by value chain analysis which is a contemporary development tool. Unlike the value added perspective, this tool considers both the suppliers and the customers as linkages in the value chain. This provides the company with an opportunity to exploit any of the linkages that will add value to the firm.
Product-Mix Decision Managers must also decide which product to make and in what quantity (Bhimani et al, 2008). This involves management identifying the direct and indirect cost associated with producing that product. The most important factor to consider when making a choice is to weigh the benefits of the product with the cost of providing the product.
Traditional technique The traditional management accounting technique adopted is Cost Volume Profit Analysis. It helped managers understand the interrelationship between quantity sold, cost, selling price, profit. Although this technique is simple to use, there are certain limitations that make it inadequate.
-Fixed and variable costs only approximate costs in an intermediate range of output. If levels of output should vary beyond this range, a valid estimation using CVP analysis will not be possible.
-It assumes a constant sales price which is unrealistic if one wishes to increase sales.
-CVP analysis suggests that price is maximized if an infinite number of units are produced. This is unrealistic given capacity constraints and the need to make price concessions to sell more units.
. Contemporary technique The use of Activity-Based Costing or throughput accounting will be useful in the long run that considers the entire life-cycle of a product. This is unlike CVP that is only appropriate for short run marginal analysis.
Other decisions include pricing decisions, customer profitability decisions, and one-off special order decisions.
The Existing Costing System Dilemma Situation Apple PLC is currently allocating common costs to products using absorption costing system. This is a process of allocating fixed and variable overhead costs to products. This system has become a problem because of the incentive compensation scheme in place. Every division is presently evaluated based on their ability to meet the minimum profit margin of 25%, which will earn the manger a flat bonus of £100,000 if achieved. Also, every 1% excess of the 25% the managers makes, he/she earns £2,500 extra. This has resulted in a growing rivalry between managers
Limitations and consequences of Absorption costing system adoption in Apple PLC -Divisional managers cannot distinguish between their fixed costs and variable costs. This poses a problem because adequate information for making relevant decisions cannot be obtained. Thus, product costs are distorted.
-The existing cost system distorts profit estimation due to Apple’s exposure to stock fluctuations as a result of its costing profit being a function of both sales and production.
-Apple’s divisional managers have to deal with fixed overheads being capitalized in unsaleable stock. Assuming there is a decrease in sales demand, Apple will be left with surplus stock. If such surplus is not disposed of, the profit calculation for the current period will be misleading.
The consequences of these limitations are that costs are unfairly divided amongst the managers despite the fact that not all of them are involved in all the processes. This will result in the distortion of profit margins achieved by managers.
The profit margins are highly inaccurate because the costs have been equally split amongst the divisions. This in turn, faults the appraisal system which is dependent on the profit margin to assess performance of managers.
F(x) = y, where X represents the profit margin and why is the performance
Adoption of Activity-Based Costing System at Apple Plc Activity-Based Costing is a system that calculates the costs of individual activities and assigns costs to cost objects on the basis of the activities undertaken to produce each product or service. It is claimed that ABC is particularly useful in companies when:
-Varying demands on resources.
-Volume does not drive costs;
-Overheads are a large percentage of total cost;
-Diverse product range;
Implementation of ABC at Apple plc will involve certain stages:
-Identifying the major activities that take place in an organization- For Apple Plc, packaging is the only activity that involves the three divisions
-Assigning costs to cost pools/cost centres for each activity- For Apple plc, each activity is assigned cost centres
-Determining the cost driver for each major activity-
-Assigning the cost of activities to products according to each product’s demand for activities.
These factors will apply to Apple Plc. A wide variety of products are produced with highly automated processes. The products are likely to consume/cause different costs in their manufacture and it highly unlikely that volume drives many of the costs. From figure 1, not all the products pass through the three processes. For example, the question states that the products pass through a combination of common processes: one such process could be cooking. The factory pot used can be used as long as the current flavour that is being cooked is needed but when a new flavour is needed the pot has to be cleaned out. This causes costs. Therefore, it can be seen that the driver of this cost is “flavour change”, not volume. Apple plc currently allocates most of its costs based on volume, the products that have very few flavours will be bearing too much cost.
Table 3: Hypothetical calculation (assuming ABC) Limitations of ABC Apple plc will need to think very carefully about the nature of the costs. The scenario says that “some but not all the processes are common”. How can these be costed? Although ABC will help with the activities that surround the processes for example set-ups, sluicing and so on rather than the process itself, it is very doubtful that ABC can offer much help here. Other limitations to ABC include
-It is based on historical analysis and thus become invalidated when there is a change in the method or system of doing business.
-It is not a regular reporting routine
-It does not identify the true cost of a product or service.
Performance Measurement Benefits of using profit margin to measure managerial performance include-
-Managers can assess whether the profit being generated covers the capital invested in the unit.
-Management use it to promote discipline in the organization’s capital budgeting process.
However the use of Return On Investment by Apple Plc was based on a faulty profit margin that did not take into account the accurate costs incurred by each division. With the introduction of ABC, the accuracy of the profit margin for each division will be higher.
Table 4: A Hypothetical manipulation of the ROI
The table may present a clear increase in ROI. However, decomposition will show how a manger might attempt to manipulate his performance evaluation by giving an illusion of a nice increase in profitability when actually managers increased their ROI but decreased the long run value of each division. These and other limitations have led to the introduction of the balance scorecard. For Apple a suitable balance scorecard will consist of a linked series of objectives and measures that are both consistent and mutually reinforcing.
Conclusion The introduction of ABC could lead to greater awareness of some drivers of costs and therefore this will lead to a robust and defendable base for those costs. This will, in turn, make the managers responsible for their actions and turn their focus towards efficiency. However, it will not solve the issues discussed. There is possibly a sign of weak management here. ABC will enable a better view of cost drivers to be formed and should therefore lead to better activity management but it will not cure the problems of an inappropriate performance appraisal system. Thus the introduction of the balanced scorecard will assist management in aligning the performance of managers with the vision of Apple Plc. The balanced scorecard might not be sufficient and should be considered as a template for measuring performance. Economic Value added or Process re-engineering could be used to complement the balanced scorecard.

Suppy Chain Management At H C Starck Accounting Essay

I. Background: Richard Morse, a MIT graduate started National Research Corporation (NRC) as a process development company focused on developing vacuum technology. NRC initially used the technology to produce frozen orange juice concentrates and instant coffee. In 1950 NRC applied this technology for producing of high purity metals and started with tantalum (Ta) production in 1959. NRC went through a series of ownership, with HC Starck AG (Germany) acquiring fifty percent stake and a venture capitalist acquiring the rest in 1976. In 1986 Bayer AG (Germany) and Bayer Corporation US purchased majority of HC Starck. In 1989 HC Starck (HCST) acquired Ta mill and wire production facilities from Fransteel, thus adding to its existing Ta reduction and powder manufacturing facility. This largely increased its share of tantalum metallurgic products market.
II. Situational Analysis: Industry HC Starck International was manufacturing Ta, an expensive metal used in various industries like aerospace, nuclear reactor, surgical equipments. The largest buyers were the manufacturers of electrolytic capacitors and vacuum furnace parts. The total worldwide consumption of Ta was about 550 tons annually.
HCST used tantalum double salt, Ta Scrap and Ta ingot as a raw material for manufacturing Ta powder, wire, and mill and fabricated products. It sourced the raw materials from mined ore, scrap generated from open market, scrap from its consumers, scrap generated from its own production and Ingot from government reserves.
The raw materials are melted into an ingot and cold forged into a 4inch thick sheet bar, which was the starting material for the metallurgic product division. These sheet bars were rolled into sheets of varying thickness. The entire procedure resulted in production of scarp ranging between 20-30%. Figure 2 and illustrates the generic product hierarchy.
Figure 1: Generic product hierarchy
Though no substitutes were available in the market to replace Ta, delays in supply of the Ta products had often created a fear that customers might switch to Zirconium as a substitute and if it worked well, consumer would never switch back to Ta which was priced four times more than Zirconium. HC Stack Inc also recently faced challenges for other suppliers, in particular the Chinese companies selling Ta wire. HC Starck also experienced difficulties in sourcing Ta scrap, the availability were uncertain and this forced them to maintain huge inventory. Also the market demand for finished goods was very erratic.
Organization Scheduling of Production: Though new ERP (SAP’s R/3) system was installed at Starck Inc, ordering for raw material, planning and scheduling for production was done manually. Jim Mc Mohan, Supervisor of production control collected sales order and converted them in to production forecast, often for a whole year on month bases and revised it a few times. I addition to raw material ordering Jim also did manually performed shop floor scheduling. SAP system were not used as there were problems with the product recipe pricing (cost) and efforts to fix the problem were taking longer than expected, making the system unreliable.
Orders from consumer were very erratic, to account for this uncertainty HS Starck acquired “blanket orders” and scheduled production of these orders randomly spread, throughout the year. For example if it received a total order for 5000 feet of tubing it produced a standard 20 feet tubing in batches and later sectioned them in to varying sizes based on requirement. But very often sectioning based on order sizes resulted in odd sized pieces generating a huge amount of scrap.
Sales and Marketing: Sales and marketing team at H C Starck, Inc had consistently achieved sales target, return on assets. The team uploaded its sales figures and forecast through the SAP system, however the production planning continued the use of manual methods, this resulted in ‘information black hole” as the data forecasted was not utilized at the melt shop for planning, physical piece of paper still travelled from sales to production, resulting in longer lead times.
As a way around to this the production planning, sales and operations team instituted a “drumbeat” meet every day to review the shipment that was due in a week time. The meeting managed to keep everyone up dated and expedite delayed orders, but this resulted in most of the jobs being by passes unless they made it to the ‘drumbeat list’.
Lead time and Inventory level: Inventory was very expensive and H C Starck maintained huge stocks, this was largely due to scarcity of Ta scrap. They also purchased excess to keep it out of the hands of competitors even though the need was not immediate. At any time they had more than adequate to ensure high level of availability.
The average lead time was estimated at 7 weeks. Average manufacturing time was 2 weeks. Analysis showed that longer more than longer time, up to 2 week, was utilized from the point the sales orders were released to the point when stock rooms issued material for processing. This process was still largely manual and SAP R/3 system was not used.
The typical production routing used a made-to-order policy with either 4 inch bar of quater inch sheets as the starting material. Depending on the final product the material passed through multiple process orders before ending up as final product (Figure
Figure 2: Production cycle: Multiple process orders
To expedite on lead time sales team often entered hard orders on probable sales, hoping that the operations team would begin fabrication even before the order is placed and the order would be read by the time customer placed their orders. Sometimes these worked well but often the SAP system required orders have delivery dates and so the sales team made up dates.
III. Problems areas highlighted as in the Case*: The Metallurgical Products department at HCST was scheduled as a make-to-order job-shop, with customer lead-time performance averaging seven weeks. Can we go in for made to stock kind of arrangement?
Order expediting is the rule rather than the exception, and in fact a daily meeting occurs to enable the expediting.
The plant carries an average of six months inventory, yet few items are sold from stock, or even made in a single production step from stock.
Nearly all work passes through some of the standard gauges of 4″, ¼”, 1/8″, and 0.030″, yet no standard stock is held at these sizes other than a small amount at ¼”, and small left-over pieces at the other gauges.
The Sales group was pressing hard to reduce customer lead-times to fewer than three weeks. The goal seemed attainable since production orders averaged just over two weeks, but something needed to be done to speed the time between when an order was received, and operations began working on producing the final product.
It seemed as though maintaining stocks of some of the standard intermediate sizes would help customer lead times, since end-items could be produced in a single production operation, but which items should be stocked, and at what levels?
Also, not everyone in the organization was convinced that reduction of customer lead-time was a priority – some were more focused on inventory reduction, while others felt that inventory levels were not that important.
Based on the problem statement given in the case, we now work on the strategic alternatives and implementation.
IV. Strategic Alternatives and Implementation What to stock and how much? Our product demand analysis shows that for all products being made out of Alloy-A, The top 8 (a class inventory)(20%)products contribute 80% of the sales volume the respective standard deviations and the relative standard deviations percentages are shown as below
*Ref:-Designing and Managing the Supply Chain-Concepts, Strategies and Case Studies (3rd Edition). Page 119-120, Case Wrap Up.
1999 Invoiced Sales – Pounds per month
Cum %
Disk – 10″
Since the standard deviation for these products is fairly high, a higher level of inventory level is advisable for these series of products, also most of the products are in the form of sheets, which can be modified or value added to arrive at an alternative product, these can form a part of the raw material inventory being kept in the system. Further on Alloy-A, the balance products from 20% (B class inventory) of the customer requirement and are characterised by low standard deviations, hence they can be manufactured as and when an orders come in.
We see a similar pattern for Alloy-B
Here the requirement is much more focussed with the almost 80% of the customer requirement being focussed around top 6 of the products (11%). A similar strategy can be used as above. These products can be made to stock; most of it is in the form of welded tubes hence it would be advisable to place semi-finished stock of plates of alloy-B of the desired thickness so that complete products can be made on short notice. A similar strategy for B class inventory can be adopted for Alloy-B as well
Raw Material Inventory Planning and Wastage Reduction The corresponding Raw material inventory can be arrived at by calculating the inefficiencies in the system, now it is given that there is wastage of 20% in following stages of manufacturing
There is wastage of 20% in the first stage and wastage of 10% overall in the second stage, hence the total wastage is 28% since the first process serves as a feeder for the second process. We believe that the wastages can be avoided by introducing a minor process change during the tension rolling process, that accounts for 20% of the wastage and it is given that the same is due to the two ends of the Ta sheet touching the cylindrical springs that are essentially there to hold the sheet/bar in place while it is undergoing rolling operation. We suggest that the profile of the Tungsten head be made so that it matches the profile of the “rolling drums” thus allowing additional area of the Ta sheet to be exposed to the rolling operation thus reducing wastages. Depending on the precision with which the Tungsten profile is made the wastage of 20% can at least be bought down to 5%, a saving of 15%.
However, for our current estimates we assume that the wastage is 28% and we plan our raw material inventory accordingly. Currently there is a practice of storing 6 months of raw material which is very high. Various reasons have been given in the case to justify the same, however at the end of the day; inventory does block the company’s working capital. In the model suggested below, based on past sales data and the current lead time of 2.3 weeks for manufacturing which in turn is calculated from the time the raw material is received and goods are packaged ready for dispatch, we suggest that the following inventory be maintained for the two alloys.
Inventory of Raw Material for Alloy A Inventory of Raw Material for Alloy B Drum beat meetings and implementation of SAP R/3 The company should continue with the practice of drum beat (DB) meetings as they are a good means to reduce distortions in communications, identifying urgencies and expediting resolution of pressing issues. However, the current purpose of DB meetings is to communicate production and sales urgencies which should not be the case. SAP R/3 should be immediately implemented for the production planning stage and the process of issuing multiple production orders should be done away with by homologation of input parts.
D. Multiple Product Orders: The problem of issuance of multiple production orders will also be minimized once we focus on key SKUs as suggested in the inventory rationalization model. One more purpose of the DB meetings could be to iron out continuous issues with the implementation of SAP for PPC (Production, planning and control). However the discussion on planning should be kept out of preview consciously by those attending the meeting.
E. Cost Savings from raw material inventory Reduction: H C Starck maintains large quantities of raw material inventory. The total cost saving from reducing inventory levels and making the production a just in time (JIT) process would reduce the cost as shown below. The company can begin by hiving off the raw material procurement division, and develop the same as a centre of excellence, supplying quality raw material.
Labour rate: Process Avg. piece weight Process time Operatives Labour Rate Large rolling 570.00 lbs
55 mins
$ 25.00/ hrs
Finish rolling 450.00 lbs
120 mins
Change over time 480 mins
Total Time 655 mins Man Hours 5.46 hrs
Labour cost ($/pound) $ 0.67 (1) Cost ($) $272.92
Inclusive of 10% on Overtime $ 300.00
Raw material and finished goods price: Form Price/pound
Average price (in $)
»¿Tantalite ore (contained pentoxide basis) $ 35 – 45
Capacitor-Grade Powder $ 135 – 240
Capacitor Wire $ 180 – 250
Sheet $ 100 – 150
Average Material Cost ($) (2) 141.875 Total Cost of raw material and work in process Inventory Break Down and Finished 1998 1999 Average 43,878 lbs
38551 lbs
Net Average/month 41,215 lbs
– 6 months Inventory 247,288 lbs
– Cost of Material (2) $ 141.875
– Total Cost (3) $ 35,083,985.00 – Average cost of work in progress inventory (WIP) For Alloy-A 6,756 lbs
For Alloy-B 6,074 lbs
Total (80%) 12,830 lbs
100% (4) 15,396 lbs Raw material cost component for WIP $ 2,184,326
Labour cost (1*4) $ 10,271.00
Total (WIP) (5) $ 2,194,598.00 Total savings (3-5)_ $ 32,889,387.00 Hence the total saving form reduction in raw material inventory would be $32.89 million.
F. Cost saving from Safety Stock Assuming that the fixed cost per service order (SO) is $2000 and a service level of 97%, cost of holding the safety stock for 7 and 3 weeks lead time for the top 10% of product line for alloy A are shown below: