Explain in details the modern view of cost accounting Weaknesses of Standard Cost Accounting for Management Decision Making
As time went on, standard cost accounting lost its usefulness for management decision making due to a variety of reasons:
* The practice of paying workers on a 'set-piece' basis changed in favour of paying on an hourly rate.
* Modern companies tend to have relatively low truly variable costs (primarily raw material, commissions or casual workers) and very high fixed costs (worker salaries, engineering costs, quality control, etc.).
* Equipment has become more complex and specialized and may be a very significant proportion of total costs.
* Changes in the level of full cost inventory create swings in profitability that are difficult to explain or understand. An increase in inventory can "absorb" costs of production and increase profits, while a decrease in inventory level will decrease profits.
* Organizations with a wide range of products or services have processes which are common to several finished items, making cost allocation irrelevant or misleading.
As a result of the above, using standard cost accounting to analyze management decisions can distort the unit cost figures in ways that can lead managers to make decisions that do not reduce costs or maximize profits. For this reason, managers often use the terms "direct costs" and "indirect costs" to replace the standard costing, to better reflect the way allocation of overhead is actually calculated. Indirect costs (often large) are usually allocated in proportion to either labor cost, other direct costs, or some physical resource utilization.
For example: If the railway coach company now paid its workforce a fixed monthly rate of $8,000 (total) and its other fixed costs had risen to $2,600/month, the total fixed costs would then be $10,600/month. The unit cost to make 40 coaches per month would still be $325 per coach ($60 material + ($10,600/40)), but producing 100 coaches would result in a unit cost of $166 per coach ($60 + ($10, 600/100)), provided the company had the capacity to increase production to that level.
Managers using the standard cost for 40 coaches per month would likely reject an order for 100 coaches (to be produced in one month) if the selling price was only $300 per unit, seeing that it would result in a loss of $25 per unit. If they analyzed the fixed vs. variable cost distinction, they would see clearly that filling this order would result in a contribution to fixed costs of $240 per coach ($300 selling price less $60 materials) and would result in a net profit for the month of $13,400 (($240 x 100) - 10,600).
[edit] The Development of Throughput Accounting
As companies have become more complex and begun producing a variety of products, the use of cost accounting to make decisions to maximize profitability has come under question. Managers learned in the 1980's about the theory of constraints and began to understand that every production process has a limiting factor somewhere in the chain of production. As managers learned to identify the constraints, they learned to use throughput accounting to manage them and maximize the throughput dollars from each unit of constrained resource. |
