EXECUTIVE SUMMARY

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As the role of financial director of Manac plc, the answer for Company problem will include the 3 following topics These 3 topics are: + The models and concepts affecting the pricing decision taken by organizations, critically reflecting upon their usefulness + The role of standard costing and variance analysis in management accounting, as well as value and limitations of variance analysis + Advantages and disadvantages of introducing an Activity Based Costing system to replace the current Absorption Costing system

INTRODUCTION

Manac Plc is a multinational company which produces and sells a range of standard electrical goods. As a part of its approach to strategic management accounting, the firm apply two methods which are standard costing and absorption costing. However, the companys expectation for its budgeted target profits is not qualified. The companys profit is lower than the expected profit. It is found out that the real reason for this problem is more complex than the managing directors perspective. Therefore, from the financial directors perspective, this report will help the manager to identify the problem.

CONTENT
I.

Models and concepts affecting the pricing decisions taken by Manac

Economic theory

Plc, critically reflecting upon their usefulness

According to Strategic Management Accounting course book, the role of economic theory is to assist in determining pricing decisions of a firm by looking at the demand for the product and also what level of output the firm should produce. Demand of a product can be elastic or inelastic (Appendix Ia). According to Jackson, Sawyer, and Jenkins, Elastic demand means price increase (decrease) of a certain percent lower (raises) the quantity demanded by more than that percentage. To be more specific, the elastic demand mean the quantity demanded is opposite with the price. If the price increases (decreases) then the customers demand will be decreased (increased). On the other hand, inelastic demand illustrates the situation in which the price change does not have great affect to the consumers demand. The elastic demand often identified when the products are luxury or have a lot of substitutes on the market; whereas the common products are in the situation of elastic demand. To understand the concept of elasticity can assist management with pricing decision. If inelastic demand exists, the company should increase the products price since revenues will increase and total cost will reduce. However, for the elastic demand

situation, increase in price will bring decrease to revenue, and decrease in price will bring increase in revenue. For Manac plc Company, since their product ranges are standard electrical goods, it is suggested that inelastic demand concept is applied in this situation and the company should increase the price. However, to find out at what level should the company increase the price to is important. Therefore, it is necessary for Manac plc.to have a clear view of pricing method Pricing method:

Target pricing is one of the useful approaches, applied for price takers who have little influence on their products price or a company who plan to set price for marketing goals. (Jackson, Sawyer, and Jenkins, 2009, p. 472). In the price takers situation, the decision for products price aim to cover cost and generate products. On the other hand, if the company aim for some marketing goals, the pricing decision is not necessary to cover the cost, but to focus mostly on achieving the companys planned. By applying this method, the company can estimate the target cost, in order to adjust to get to the target profit. Target cost = Target price Target profit In the case of Manac plc, the companys products focus mainly in the electrical goods. Therefore, functional products are also included in their product line. For functional product, the cost for such product lines often higher than usual. In order to reconcile between cost and product function and still reach the target cost, value engineering is applied in this situation. The company will analyze the products

function that they want to add, as well as the cost for each qualified function. After researching, products are manufactured with most of the costs are determined. Cost-plus pricing, on the other hand is a useful tool for price setter Company. To be more specific, the cost-plus pricing allows managers to determine the selling price by adding desire mark up with the products base cost. According to Jackson, Sawyer, and Jenkins, 2009, mark up is sufficient to cover costs not included in the base cost plus a desired profit. (Appendix Ib) Selling price = Base cost + (Mark-up% x Base cost) To calculate the target selling price, it is important for the company to identify the base cost. Each base cost will lead to different setting for selling price. For instance, in the situation where total variable cost is considered, fixed manufacturing cost, fixed selling and administrative cost and desired profit should be covered. The cost-plus pricing method allow managers to forecast rivals price, as well as ensure the that the companys price remain stable. However, one of the biggest disadvantages of this method it its rejection of satisfying customers demand. Manac plc case

Manac plc is a multinational company, so either Manac can be either price setter or price taker (Appendix Ic). If the company can put its influence on the market price, the company is considered as price setter. However, if the markets are competitive and there are a lot of competitors exist, Manac plc will become price taker. There must be an adjustment for Manac plcs product price to help the company compete effectively in the market. If the price is set too high, the company may lose their customers to the competitors; on the other hand, if the price is too low, the company

can not cover their cost and make loss. It is suggested that the price adjustment process should be taken in consideration carefully, and the company should add up value to attract customers. For example, although in the market, Manacs electric socket is 5 while the China products is only 1,5. The customers still choose Manacs products since the company add up more value like the companys guarantee on each product line. In the case of Manac Plc, the price setter and price taker are also related to companys short run and long run policies, which work well with different strategies. (Appendix Id)

II.

The role of standard costing and variance analysis in management

accounting, value and limitations of variance analysis

The Role of Standard Costing and Variance Analysis

Standard costing is a type of control system, often found in conjunction with budgetary control. (APC309, Strategic Management Accounting, Unit 7, page 168). To be more specific, standard cost is a pre-determined cost of manufacturing a single unit or a number of products units. (Administrator of Accounting for management, 2009). Standard costing is a useful and reliable method that will help the manager to compare the standard cost with the actual cost, in order to identify the reason for any variances. If any of the significant variances are found, the companys manager will run the management by exception process. Through the process, the managers will devote his time to investigate and analyze the situation in which the gaps between

actual results differ significantly from planned result. There are 2 methods that can help the manager to identify significant variances easily which are: Variances based and Statistical Control Chart. It is suggested that Manac plc should apply the

Statistical Control Chart method so that the company can identify and evaluate the problem efficiency (Appendix II.a) After identifying the variances, it is the company mission to analyze the variance. Through the variance analysis process, the manager will know whether sales, production, and manufacturing costs are higher or lower than planned (Jackson, Sawyers, and Jenkins, p. 370). The basic approach to identify and solve any problem of significant variances is exploited in the variance analysis cycle (Appendix II.b). At the beginning of this cycle, the accounting department will prepare the standard cost performance report, in which they will highlight the variances and what should have occurred according to the standard. The variances raise a lot of question: Why did this variance happen? Why is this variance larger than it was for the last period? Etc. After that, the significant variance will be investigated in order to find the root cause, as well as the corrective action to fix the problem. The next periods operation is carried out and the cycle is then beginning again from the first step. Value and limitation of variance analysis

Variance analysis is a valuable method since it can help the manager to measure the companys performance. It helps the company to analyze any differences between budgeted and actual performance easily so that the firm can solve any occurred problem, as well as manage to generate profit. Besides, the variances analysis is also

considered as the companys compass to know whether the business is going on the right direction to the planned budgeted or not. However, there are some limitations when the board of director decides to apply this method to Manac Plc. Since Manac Plc is a big and multinational company, it is time consuming to analyze the variance, especially to identify the significant variance. For instance, the information needed to analyze variance such as standard and actual price of materials will be hard and take time to collect. Besides the time consuming problem, the accuracy of collected information is another issue that the company need to consider. The information is collected through many channels before gathering and being checked by the manager. Therefore, there should be some policies to check and ensure the accuracy of the information. Any of the wrong information will bring trouble to companys decision, as well as businesss performance of the company. The last limitation of this method is that to apply only the variance analysis is not enough to measure the whole performance. Hence, the company should take in consideration other information such as employers performance, machinerys issue when evaluating the companys performance as a whole. (Appendix II.c)

III.

Advantages and disadvantages of introducing an Activity Based

The current costing system

Costing system to replace the current system

Until now, Manac plc is still working with the absorption costing system. The absorption costing system is the practice of charging all costs, both variable and fixed, to operations, processes or products (The Chartered Institute of Management Accountants CIMA, United Kingdom).

Although when apply this system, Manac plc can have a clear picture of all the cost included in the unit price, it is not helpful for managerial decision making process (Management Accounting, Debarshi Bhattacharyya, 2011, Unit 9). The decision making process will base on the fact that whether the business is generating profit or not. However, since absorption costing system will include both variable and fixed cost, it may affect the decision making process in some situation and lead to the wrong decision. For example, the company has unused office in the building. The cost of the building is fixed cost, so whether the office is used or not, when Manac plc apply absorption costing system, the cost is still taken into account. Later on, when the boards of directors take in consideration whether the company gain profit or not, they find out that their business is not profitable, and their cost is higher than their extra revenue. In this situation, the fixed cost is irrelevant and creates inaccuracy information that may confuse the managers decision making. Apart from the reason of its inutility in some cases, the absorption costing system is not also accommodating well with the companys current strategies. Manac plc plan to differentiation and customize its products to compete against other competitors in the electrical market. If the company keeps using the old system, it may cause the cost-subsidization problem: Over cost and Under cost for some products. Over cost a product will lead to higher selling price lead to less competitive with other rivals; whereas under cost a product will lead to lower selling price, which mean the company can not cover their actual cost and make loss in their business.

Based on all of the reason above, it is necessary for Manac plc to find a replacement system that may work well with the company goal and help the firm to gain the market share.

The replacement system (Activity Based Costing)

It is suggested that the suitable system in Manac plc case is Activity Based Costing system (ABC system). ABC system involves the identification of the factors which cause the costs of an organizations major activities. Support overheads are charged to products on the basis of their usage of the factor causing the overheads (APC309, Strategic Management Accounting, Unit 3, page 56). In order to design an ABC system, the manager will have to follow 3 steps. At the very first step, the company needs to allocate indirect costs to departments. After that, all of the cost will be allocated from departments to activities. For the final step, the costs which are allocated to activities is being allocated to the cost objects products. (Appendix IIIa). To be more specific in the case of Manac plc, the 3 steps will be identified clearly through example below. First of all, there are different departments in the company. Therefore, the indirect costs will be allocated to each department based on its consumption level. For example, when the manager takes into consideration of building rental, the cost will be allocated base on the space that each department consumed (in percentage). The product and development department will consume the larger space, approximately 40% of the whole building; while other departments such as sales and promotion

department, administrative department are apportioned 35%, 15% of the area respectively. There are different activities that will happen in each department. The product and development department will have to design and test the products; whereas in the Sale and Promotion departments, they will have to work with promotion campaign in order to bring the companys image to customers, etc. The indirect costs are assigned to each activity of each department and depend on the time consuming for each activity. For instance, the product and development department will spend 60% of the time to research and upgrade the products, 30% on testing the products and 10% of the time to finish the products before transferring the products to Sale department. For the last step, cost of each activity is allocated to products. For example, the costs of all the activities that happen in the Product and Development department will be apportioned to each products based on time spent on each of the products line. Therefore, the cost will be 15%, 25%, 55% and 5% for fan, televisions, air-conditioned and electrical sockets respectively. When comparing the ABC system to absorption costing system, the ABC system bring out some good advantages that can work well with Manac plc strategies, as well as some problem that the manager should take care of. Advantages

ABC helps to improve accuracy and utility value of management information, thus enabling managers to make better informed decisions at both tactical and strategic levels.

Besides, the ABC will help Manac to completely get rid of cross subsidization, the problem which happen when the company apply traditional system since ABC are allocated cost to products level order. ABC also allows all managers to understand and control costs in their area since the costs are all allocated in each department before apportioned to products. Therefore, the manager can find a better way to improve performance within the company. By involvement with ABC, accountants can now contribute to the organizations future, rather than merely reporting on its past. Besides, they can improve the cost estimation since the ABC helps them to identify and understand of cost behavior. Disadvantages

The first obvious problem when apply ABC system to Manac is that it will take time to identify the cost drivers since the company has to work out with each department managers. Besides, the cost for data gathering can be very expensive. Not only is it very labour intensive, it can also take many hours to extract all the relevant information from the various managers and staffs. The cost may also rise if any external consultant are involved in this process. Another problem that may cause problem to the company when apply ABC system is the reluctance to change from the company and its staff. The problem may even get worse when the department refuse to provide needed information for the firm to measure the cost. These disadvantages are the problem that Manac plc s manager need to carefully look for.

CONCLUSION
It is expected that through this report, the board of directors will have a clear view of the reason for not meeting with the targeted profit of the company, which is variance and companys pricing model. Besides, it is suggested that the company should change from the old absorption costing system to activity based costing system in order to help the company improve its performance in the future.

REFERENCES
Steven R. Jackson, Roby B. Sawyers, and J. Gregory Jenkins. 2009. Managerial Accounting: A focus on Ethical Decision Making. 5th Ed. Unknown, APC309, Strategic Management Accounting, Ver 1.0, University of Sunderland Debarshi Bhattacharyya, 2011, Management Accounting, 1st Ed Administrator of the accounting for management, 2009 [accessed on April 08 2012] http://www.accountingformanagement.com/standard_costing.htm The Chartered Institute of Management Accountants CIMA, United Kingdom

APPENDICES
Ia. Elastic and inelastic demand

Source: http://ww2.nscc.edu/gerth_d/MKT2220000/Lecture_Notes/unit09.htm Ib. Cost-plus pricing Assume that the direct material, direct labor and manufacturing overhead are 3500, 4000 and 1800 respectively. The selling and administrative expense is 300 and the desired profit is 3000. Therefore, the cost of good sold (COGS) base cost in this situation will be: COGS = 3500 + 4000 + 1800 = 9300 Mark-up con COGS = = 35.5% Selling price = Base cost + (Mark-up% x Base cost) = 9300 + (35.5% x 9300) = 12601

Ic. Price setter and price taker Price setter, according to APC309, Strategic Management Accounting, Ver 1.0, University of Sunderland are the the one who strong enough to put their influence on the price of the products. Price setter is likely to be the market leader or company with differentiate products line. On the other hand, price taker is the one who gain small market share and has little, or no impact on their products price and setting price based on the market price. Unlike the price setter, the aim of price taker is to sell as much as possible to cover all of their cost. Over all, it is important to identify whether Manac plc is price setter or price taker to give out right strategy for the company. Id. Price setter and price taker in Manac plc case, long run and short run decision If the company has great influence at the market, then Manac plc is playing the role as the price setter. The products price is then set by this formula Price = Cost + Mark-up For short run, it is suggested that Manac plc should set price following this formula Price = Variable cost + Mark-up The reason for setting price by the variable cost in this situation is that when the company can control its fixed cost well, then it is easier and simple to set price through this method for short run period. The only weakness when apply variable cost is that the calculation do not include overhead.

To be more detail, for the variable cost, it is suggested that the manager should choose standard cost since it can be specified at reliable level, especially needed for company that product focus on electrical goods like Manac plc. For example, when the company start manufacturing an electric socket, the price is set at 4 and all the other electric socket that use the same material will be allocated to that standard. The price setting process is much faster and giving remarkable help to the company in short run. However, if there is any inflation happen, it may affect the standard cost of the products and the company may make loss if it do not update the cost permanently. If Manac plc want to ensure the price setting period, the firm can also apply actual cost instead of standard cost. However, the whole setting price process will be slow down and it is not suggested for Manac to apply that. For long run, the price setting process is suggested to follow the formula Price = full cost + mark-up Or = Marginal cost + mark-up It is said that for long run purpose, it is better for the firm to apply full cost instead of marginal cost. When calculating base only on marginal cost, it can not fully reflect the cost. On the other hand, full cost can sum up all of the cost and allocate separately to each products line. It is more accurate, as well as efficiency than the marginal cost. The only problem with full cost is that it take time to collect information. If the company play the part as price taker, the price setting process should follow this formula Price = Market price + Adjustment

The adjustment here will base mostly on the companys policies. If the company have its own competitive advantage, the manager can raise the price. If not then the price should be decreased in order to compete again other rival on the market + Suggested pricing policies for Manac plc There are 2 suggested policies that Manac plc can apply. Skimming pricing strategy: for Monopoly policies, where the company will charge higher price to high income group. The company can increase the mark-up without worrying of any competitors coming in. To apply this strategy, it is necessary for the company to put more effort in research & development products. Penetration pricing policy: Penetrate the market, gain more market share by providing lower price and mass products to the customers. The company can apply this strategy to the products line which is easier to products and essential to the customers. IIa. Statiscal control chart

http://www.scribd.com/doc/15577259/Chap6Variance-Analysis

The managers analyse and investigate variances whether they are within or outside the normal fluctuation range. On the chart above, it can be easily noticed that week 4 5 and 9 need to be investigated since its too far from the limit. IIb. Variance analysis cycle

Source: Introduction to Managerial Accounting, 5th edt. IIc. Direct Material Variance Assuming that the item purchase is tubes and the quantity that the purchasing department has consumed is 5000 pounds. The standard price for each pound is 3 while the actual price that reported is 4.5. Therefore, the material price variance is Material price variance = AQ x (AP SP) = 5000 x (4.5 - 3) = 7500 Material price variance = AQ x (AP SP) = 6,700 pounds x (4.7 per pound 5 per pound) = 1,340 IIIa. Designing ABC system

Source: http://www.mrdashboard.com/Activity-Based-Costing.html