Spa Number one - Understanding Key Cost Relationships.

SPA Number One - Understanding Key Cost Relationships.

Section One - Reading Two

The required reading provides a number of key concepts and significant points whilst also highlighting or reiterating some ideas which were presented in the first portion of the course and appear to be significant underlying themes, I will discuss both of these aspects along with my thoughts on certain statements which I in part disagree with.

The predominant theme which runs through the reading is the significance for mangers of understanding key cost relationships, and how in doing so they can further understand the true economic realities of the firm and further presumably drive the entity in a more appropriate direction. While this is undoubtedly an obvious connection the inherent problem lies in the fact that this connection is solely reliant on the accuracy of the information provided, and as the reading highlights, inaccurate or bias accounting information provided to managers may in fact cause a hindrance.

This issue of bias and incentives for manipulating information was also a theme presented in the earlier portion of the course, and I feel is certainly a contemporary issue in modern day accounting. The reading touches on Martin's personal experience at the firm Schroders, where there was an incentive for his division perhaps not so much to manipulate the information, but where they were benefiting from the way in which costing was being allocated, and therefore they had a financial incentive in the form of bonuses to retain the status quo, even though they knew it was perhaps not the most accurate method.

Another underlying theme or key concept which arose was the level of subjectivity involved in the calculation and presentation of accounting information. Having never taken an accounting course before my opinion of accounting no doubt like many other naive individuals was that it was a very objective discipline, however I have certainly realised very quickly that this is not the case and this point was again raised at certain points throughout the reading. It appears that there are a range of costing allocation methods, particularly when considering indirect costs, which can be adopted to suit the needs of the preparer or manager. Again we therefore see the potential for bias, which brought me to my first major question; why do accounting entities not adopt all external reporting standards to their internal reporting. Clearly this move would still leave room for areas of judgement, however if it became an industry accepted practice, surely this would remove some elements of flexibility, whilst also cutting potential calculation and reporting costs, and most importantly ensuring that managers were being provided with a more realistic picture of the economic realities.

Another point which came to light was the evolution of the economy, from a manufacturing, simplistic economy to a much more knowledge based one, with increased automation and therefore a transfer of costs from direct to indirect. This trend looks certain to continue and therefore I feel there is an immediate need for a more widely adopted, industry certified procedure for allocating indirect costs, which will trim the need for judgement and again provide a more accurate picture for managers.

When discussing functional based costing systems, an example was provided using the allocation of maintenance costs, based on the number of machine hours used. This brings to light an interesting point involving the accuracy of such a method. Currently I am working in a factory which has a wide range of departments and associated machines. Our department operates on a specific job involving three machines for only three months of the year, for the rest of the year, the machines are unused. During this period obviously the maintenance costs are higher than the rest of the year for our department, so this seasonal fluctuation needs to be accounted for, whether or not it is, I am unsure, however it clearly highlights the difficulties of allocating indirect costs to production departments.

The reading then went on to discuss planning and forecasting of future costs, revenues and the importance of doing so in an accurate manner. Obviously there is a level of uncertainty involved with any future predictions especially if they are over a long term period, and so I wondered if these cost predictions had buffers built into them to accommodate errors and fluctuations which had not been expected, or if in fact any variation between expectations and actual figures where simply dealt with at the end of the accounting period.

Whilst reading the material I found on a number of occasions that questions would arise in my mind, only to be covered at a later point in the reading, which I felt was certainly an attribute of