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The management of costs has become one of the core determinants of the success of a company. Companies that are capable of effectively managing their costs have higher chances of success. The companies that do not manage their costs as effectively eventually fail. In order for the organizations to attain growth, the selection of the costing method and the management of the costs is a vital and the irreplaceable activity. Companies have to focus on the cost centers and relate the costs that they incur in the cost center with the output or contribution of the said centers on the general profitability. Costs efficiency is important in the production process since it determines the effectiveness of the organization as a whole.
Poor cost management will translate into either noncompetitive pricing or loss. Noncompetitive pricing is prohibitive to the customers, and it pushes them away from the company’s products. The company has to price its products according to the prevailing market conditions. However, if the costs of production are too high, they will eat into the margin hence the poor performance of the product in the market. The paper will focus on the Spirit Aerosystems, Inc. and recommend the right approach to costing. It will use a desk research to collect the data. Finally, the paper will culminate in a recommendation of the handling of relevant costs and the best costing method to use given its operations.
History of the company
Spirit systems are leader in the production of aircraft additions. The company producer compels assemblies for the commercial and military clients. Some of the product that it produces include the metallic aircraft fuselages, wings and propulsion systems. The assemblies are highly contoured to meet the strict specialization of the jet manufacturers. The company also offers the turnkey design and alternative manufacture of the assemblies, support of the companies that use the spirit systems, automated fastening technology, rapid response to the emergency situations involving previous and new clients, supply chain management of the products that it has offered in the global market, manufacturing processes for some of the aircraft components and design of some of the parts that are used in the modern planes.
The company maintains the need for research and development hence the development of excellent production systems. Focal point of the company is the maintenance of the position of the innovation in the product development. The company is composed of qualified technical force that is involved in the numerous activities in the production of the assemblies. The company's focus on the research and development is evident in the patent that it holds since it was created. Currently, the company has over 85 patents (both pending and approved). The global footprint of the company is spread to the United States, United Kingdom, and Asia.
Determination of the true costs incurred by the company and the subsequent profitability is also always a daunting task. However, the development of advancements such as activity-based costing methods has helped in the effective determination of the costs incurred by any organization. The processes sued in accounting have to be able to leverage on the existing technology. Inclusion of the time aspect in the activity based costing is an important improvement that can be used in the development of a more accurate and favorable accounting convention that can be used by the management in the development of the right decision making process in business environment (Doyle, 2002). Activity-based costing was advanced in the 1980s. However, it fell out of favor among the managers due to an array of reasons.
One of the most cited reason for the loss of favor of the system as the requirement of the approach that the company conducts lengthy interviews with the employees. The interviews were seen as hindrances of the costing method such that organizations with the large staff could not be effectively managed suing this approach of costing. However, with the development of ERP systems, the collection of information is easy. The enterprise resource planning systems have all the data that the organization needs in order for it to conduct its costing using the activity-based costing approach (Doyle, 2002).
The information developed can be pumped into a time-driven activity-based costing system, and the information will be effectively employed in the development of the reports. However, the managers have to answer two aspects when coming up with the time-based activity-based costing systems. On one hand, the managers ought to consider the time took to deliver the resource capacity for every business process in the organization. The second question is the time taken to deliver each of the transactions that are conducted by the customers. Use of the system ensures that there will be profit improvements for the firms (Doyle, 2002).
Improvement of any business requires the understanding of the managers on the costs that it needs to produce the products. The analysis of the costs is a simple process. However, the collection of the data and securing it is the main issues that affect the cost computation process. The qualitative data collection is often taxing for both the origination's time and complex such that it will take more time to complete (Doyle, 2002).
The introduction of the system of costing in the 1980s was influenced by the common approach of the day assumed by the consultants in terms of the strategy. The consultants used interviews and surveys as the main basis for the assignment of costs to the activities of the employees (Gosselin, 2005). The interviews turned out to be the main reason for the rejection of the ABC mode of costing. This means that the system of costing was not rejected since it was inferior or ineffective. The cost of performing the interviews and surveys of the employees was too high such that they were not justifiable (Feridun, Korhan & Ozakca, 2005).
The employees that had to fill in the forms for the data also found the form filling process irritating since they did not have to do it as part of their responsibility to the organization. The use of the employee estimates led to the high recurrence rate for the errors evidenced. The second reason that led to the failure of the ABC in the 1980s was the failure of the designer of the system to recognize the role of the capacity and the importance that the organizations placed on it (Epstein & Lee, 2011). Capacity is crucial in the determination of the cost driver rates. The insight on the role of the capacity was not realized until 1990 long after the costing system had failed.
The limitations mentioned above led to the abandonment of the system by the companies that had already adopted the system. The obvious advantages of the ABC costing method were overlooked to opt for the standard costing system that relied on the arbitrary allocation of the overheads according to the traditional standard costing systems (Badem, Ergin & Drury, 2013). The companies that stuck to the ABC were using infrequently updated systems since the cost of constant updates was prohibitive. The factors mentioned above were also pertinent in the development of the irregular application of the ABC. In the years, the application of ABC was contingent on the low technology and the lack or low adoption of the ERP systems.
In the 1990s, many companies adopted the use of the ERP systems. The ERP systems capture the data at each transaction, and the data can be stored and accessed after the transaction had been completed. The introduction of the systems led to the development of a different attitude towards the ABC costing approach (Feridun, Korhan & Ozakca, 2005). It was not feasible for organizations to use the costing approach at the data collection stage that was the main deterrent in the 1980s was no longer an issue. The gridlock of the employee frustration, constant errors and time consumption were no longer pertinent in the adoption and implementation of the ABC. The introduction of the enterprise resource planning systems led to the development of the stage for major shifts in the conceptual foundations that consisted of the strategic costing systems (Jelić, Aničić, Đurović & Radojičić, 2014).
Benefits of activity based costing
Enables effective planning
Compared to the standard costing method, the organization has the power to plan effectively. The main reason for this assertion is that the activity-based costing method assigns the costs to the activities directly (Fleischman, Boyns & Tyson, 2008). Accurate assignment of costs leads to the development of two desirable aspects. On one hand, there is the capability of the management to trace the costs directly to the cost center. Secondly, the assignment of the costs leads to the development of insight into the under performing parts of the organization the costs cannot be physically traced to the under performing cost center. The people involved with the cost lowering are now capable of following the under performing cost center and carry out surveys of the ways of reducing the costs.
All the activities that make up a given process can be accounted for. The ability of the management to follow the costs to the main source makes it effective for the manufacturing companies that are built on the premise of waste reduction (Liu & Gong, 2013). The organization can use this aspect to account for the parts of a process that increase the cost of the overall process and come up with the require adjustment to reduce the costs to the acceptable levels. Father investigations can be conducted to apportion the costs in the said section to a certain behavior of the individual employees or process defect with the aim or removing the source of the cost (Epstein & Lee, 2011).
Risks ought to be tolerated if they are bound to increase the returns enjoyed by the organization. If a risk does not have any traceable benefit associated with it, there is a need for its immediate and expeditious elimination. The ABC systems are used to ensure that the activities are increasing the cost add value to the product (Feridun, Korhan & Ozakca, 2005). In the event there is an activity that does not add value to the product, it has to be eliminated since it increases the business risk of the organization while providing no return. The system can be used to streamline the production of the commodity in the organization such that all the costs that are irrelevant to the production are eliminated.
Elimination of the costs will also translate in the increment of the profits garnered by the company (Liu & Gong, 2013). Cost elimination could culminate in the reduction of the price hence development of continued customer relations owing to the fair pricing. The process enables the organization to attain the cost reduction since it focuses on the processes as opposed to the structure (Suthummanon, Ratanamanee, Boonyanuwat & Saritprit, 2011). Most of the costs hide in the organizational structure (Gazely & Lambert, 2006). Positive identification and further action on these costs lead to the uncovering of the hidden cost centers and eventual streamlining of the organizational structure with the core performance indices (Epstein & Lee, 2011). The focus on the process helps in the identification of all the costs incurred in the production of a certain output.
Organizations are focused on the development of business processes that will help in meeting the needs of the individual customers. Meeting the unique and individual needs of all customers is the future competitive frontier. However, customization is an organization that uses standard costing is difficult and almost impossible. In order for the company to deal with this issue, there is a need for the development of a system that can be used to trace the costs of producing an individual unit of output (Epstein & Lee, 2011). Activity based costing is the ideal system that ought to be used in the identification and production of production of products that are meant for a customer.
ABC costing enables the organization to accurately the expenses of the services and products that it offers (Gazely & Lambert, 2006). The system is capable of this assessment since the focus is on the individual processes that are used in the production of a certain unit of output as opposed to the entire organization structure. This means that the unique processes used in the production of a certain output can be assessed and analyzed using the cost-benefit analysis. The processes that have the highest return on investment are the most profitable and they ought to be customized for the organizational effectiveness. The company can customize its production to focus on the production of the output that will offer the highest returns.
It can also be used as a basis for the customization of the products such that they meet the individual customer needs. For instance, when the production cost of a standard product is known, their additional costs of the customized product can be effective calculated using the information from the standard production processes (Fleischman, Boyns & Tyson, 2008). Any modifications of the product can be assessed in terms of the costs incurred in their addition. These costs are added back to the final price of the customized product and content.
Factors that influenced the decision
Activity based costing method is the best approach for a company that is focused on the cost reduction. The effectiveness of the system in the attainment of the organizational goals is another aspect that informed the decision to select ABC system. Additionally, the modifications implemented by the founders of the costing system to include the technological development in the enterprise resource-planning sector also influenced the recommendation of the system for the company. The data collected from ERP can be used to calculate the costs of the organization. Unique aspects of the organization will also be accommodated by the costing method. The regained trust in the system also informed the recommendation of the system. However, the adoption of the costing system will have far-reaching effects on the entire organization given the global nature of its operations.
Ramifications of the ABC on a global organization
Companies with global operations can still apply the ABC costing. The rolling out of the Global activity based accounting systems is dependent on three aspects; country-specific factors, cultural norms (in the company and country) and the capabilities of the staff in the satellite operations.
1. Specific practices
Accounting applications depend on the host country. The variations apply mainly to the board applications. Costing in the global market is dependent on the country factors. The variations could be because of the government regulations. Therefore, a company has to ensure that it modifies its ABC to suit the country-specific factors. However, the variations are minimal and can be managed effectively by the staff in the countries. Current accounting practices are developed according to the country’s unique business practices and the prevailing environment. In most instances, the architecture of the hardware as well as the software varies according to the sites. Different sites may be running different versions of the software. The lack of uniformity in the sites emanates from the lengthy process of global conversion of the technology. There are also different levels of the software support.
2. Cultural norms
The norms of the country and the company may indicate numerous variations. The business etiquette depends on the setting of the company. The deployment of the system in one location may not be as successful in the other due to the varying culture and the flux culture that comes from mergers and acquisitions by the multinationals.
3. Capacity of the local staff
The local staff may be underequipped to handle the activity based business management effort. The capacity of the staff and competence is important in all contexts. However, in the international businesses the situation ranges from acute to dire. The level and quality of education may not be the same in some of the locations. All the workers in the subsidiary companies are employed as a progression of the cultural norm. Their education level and the tendency towards technology may be lacking due to the cultural norm of the location. Therefore, the effectiveness of the employees in the deployment of the activity based accounting systems could be impossible. The global company has to bring in the professionals from other parts of the world to train them on the systems. Their training is an additional cost that the company has to absorb. The three ramifications are the main aspects that the company could be facing in the event that it adopts the ABC.
How to structure the system
A very important aspect in structuring the system is to apportion the costs to the cost objects and not the products. The apportionment of the costs to the cost objects ought to be based on the usage of the objects. The reasoning behind the apportionment is that the activities are not necessarily used in the production so a product. The different cost objects in the organization will depend on the production and the usage. In some cases, the activities that are or a service nature will be accounted for separately.
Standard costing entails the substitution of an expected cost with the actual cost incurred in the accounting record. It periodically records the variances between the actual and expected costs. The standard costing is a simplified alternative to the cost layering systems since they (cost layering systems) increase the bulk of information that has to be handled at any instant. Standard costing creates estimates of the costs of the activities in the company. The standard costing is used if the collection of actual information is too time-consuming that the management has to rely on more labor (Badem, Ergin & Drury, 2013). Standard costs are close approximations of the actual costs incurred by the organization.
Standard costing has the following advantages
Budgeting entails the use of the standard costs since it is almost impossible for the management to collect the actual costs of the item during the finalization of the budget. The budgets are mainly prepared with a futuristic focus. The main application of the budget is the comparison of the budgeted amount and the attained amount. The budget is also used for the comparison with the upcoming seasons. The standard costs used in it still appear in the financial statements of the organization until the end of the budgeted period. Therefore, standard costing will help the company come up budgets (Badem, Ergin & Drury, 2013). Therefore, the company can come up with the standards that will be compared with the actual data reported from the activity.
Standard costing also accords the company the advantage of the inventory costing. The system makes it extremely easy for the generation of the ending inventory valuation. The results obtained from the standard costing may not match up with the actual inventory balances but they are close. The printout indicating the period-end inventory balance can be multiplied with the standard costs if the company uses the perpetual inventory system. However, in order to make the difference between the actual and the approximated inventory, there is the need for regular review of the standard costs (Epstein & Lee, 2011). The update focuses on the high dollar components that indicate highest levels of variation. The high dollar components ought to be reviewed frequently compared to the low-dollar items whose updates have to be conducted occasionally.
It usually takes too long for the aggregation of the actual costs then allocation to the inventory. In order to save on time, it is imperative that the standard overhead application rate ought to be used. Adjustments to the rates can only be conducted in a few time to reduce the cost and time expended while maintaining the application rate at the closest range to the actual overhead application rate (Badem, Ergin & Drury, 2013).
The other benefit of the approach is that it helps in the price formulation. The costing can be used in the customized product offerings that the company uses. The company can use the standard costs to compile the costs needed to meet the basic customer requirements. After the computation of this amount, the company can now add in the margin charged for the customization of the product (Badem, Ergin & Drury, 2013).
Ramifications of the company using standard costing in international business
Standard costing is more appealing to some industries than others are. In the manufacturing industry is more appealing since the specific values of the production process are assigned to each of the product that has been developed. The standard costs are the costs of goods sold when compiled. The costing method appeals to the manufacturing costs that aim at reducing the costs of production. In the most optimistic settings, the standard costs are placed at the lowest level possible to ensure that the work centers produce the final output while adhering to the set standard costs (Epstein & Lee, 2011). The allocation of the standard costs does not have to be developed according to any other needs.
In retrospect, it has to be developed according to the unique needs of the organization or subsidiary. Therefore, the organization that has a global operation does not have to deal with the issue of the single process. The guide acts as the map for the direction of the activities of the costing department in the allocation of costs. However, the standard costing can be used according to the needs of the individual market. There is no need for special training in the standard costing method since the standard costing is an approach that has global operations. Therefore, the adoption of the standard costing method will not need new training. The organization will only have to issue a guideline on the standards that have to be placed. There is will also be a need for the reliance on the international ethical stipulations (Epstein & Lee, 2011). Due to these aspects, the business will not have to be involved in the standard costing approaches used in the satellite locations.
The standard costing method means that there will be no need for the development of a new approach to costing. On the contrary, the organization will have to work with the conventions developed by the satellite locations. Use of standard costing allows the company to accommodate the international conventions on standard costing (Epstein & Lee, 2011).
The company will also have to accord the subsidiaries the power to determine the standards that they are to use. Therefore, the system will allow the satellite companies to develop the costing method that suits the environment in which they operate. This focus enables the company to operate with flexibility and accommodate the diversity in terms of the operating environment.
Standard costing method roll out depends on the products that are being produced by the company (Epstein & Lee, 2011). Standard costs include the direct and indirect costs and overheads. The direct costs are the material or direct input that is used in the production of a certain output. The direct cost includes the material and direct labor involved in the production of a certain output. The direct overheads are the other costs that are involved in the production process, and they can be factored into the final cost of the product.
Indirect overheads are all costs that cannot be traced to the product. Some of the indirect overheads could be fixed while other is not fixed. This classification will be ideal for the company since it will enable the managers to measure the cost of goods sold in an accurate manner. The accuracy at this stage is important since it determines the execution of the upcoming jobs. The data from the previous projects that have been using standard costing methods can be used in the future budgeting. Therefore, getting the standard costing right in the first instance is the main determinant of the future budgeting.
Relevant costs are all the costs that are pertinent to the decision making of any organization. The relevant costs are only relevant in a certain context.
The decision costs are often used to determine the effectiveness of a certain course of action over another approach. The company ought to use the relevant costs only in the development of an opinion over the future projects. Since the relevant costs are specific to a certain situation, they should be arrived at and analyzed differently. The process of using the relevant costs ensures that all the projects to be undertaken by the company are reflective of the situation. Relevant costs are the main points on which the organization can deny or accept a certain project. The analysis of the success or failure of a project also relies on the relevant decisions. Relevant means connected to an event. If a decision is not linked to an event, it is not relevant. Therefore, the relevant costs are all the costs that pertain to a certain process. Relevance of costs is analyzed according to the proportion of the cost in the total cost of the project and the role of the cost item in the project. For instance, the relevant cost of the production of the software is the intellectual property right guarantee, registration or wages paid to the developers of the software solutions. Relevant costs include the opportunity cost and differential costs. The differential costs are the difference between the cost of one alternative and the other. This costs helps in the assessment of the most expensive project.
The company has been in the business of producing assemblies for OEM users for over 80 years. Due to the success it has attained over the years, it has been able to attain international presence. This aspect makes it a global company, even though, all its production systems are based in the United States. The nature of the operations also determines the costing approaches that it has to use. The following are the recommendations
The company ought to use the relevant costs in the analysis of the future projects. The use of sunk costs in decision-making is a source of erroneous decisions. The constant issues that it could be facing in all the projects could be emanating from the focus on the costs that are not pertinent. The decision making of the company has to be based on the information that will help the management decide between two options.
The company ought to use the ABC costing approach. The mode of approach has been developed over the years and refined to include the aspects that made it unfavorable in the early years after it was introduced. The ABC costing enables the company to use the data from the ERP systems to conduct costing this advancement led to the solution of the main issue that led to the failure of the costing approach in the formative years.
The company can roll out ABC costing system in the international market. The only consideration that it has to make is the prevailing market condition in the destination where it will be rolling out the program.
Consideration of the ability of the host country to support a costing system is the main determinant of the selection of the costing in the host country. Therefore, it should roll out the costing system with the education and skills of the staff in the host country in mind.
In conclusion, the assessment of the costing method that a firm uses is a vital step. The section of the costing method by Spirit Aerosystems, Inc. determines the development and execution of the business model. The expansionary plans of Spirit Aerosystems, Inc. will depend on the effective assessment and management of the cost. Costing approach that is relevant to the time-based activity based costing. The company will need to track the cost of each activity individually and identify the ones that have the main sources of wastes. Activity based costing systems are better suited for the development of the insight on the profitability or otherwise of each of the activities conducted by the company. The effective management of the activities will determine the overall sustainability of the organization and the chances that it has in the achievement of its strategic goals of expansion.
Badem, A., Ergin, E., & Drury, C. (2013). Is Standard Costing Still Used? Evidence from Turkish Automotive Industry. International Business Research, 6(7).
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Epstein, M., & Lee, J. (2011). Advances in management accounting. Bingley, UK: Emerald.
Feridun, M., Korhan, O., & Ozakca, A. (2005). Impact Of Total Quality Management (TQM), Activity Based Costing (ABC), and Just-In-Time (JIT) on corporate financial performance: an empirical analysis of the Turkish textile industry. IFE Psychologia,
Fleischman, R., Boyns, T., & Tyson, T. (2008). The Search for Standard Costing in the United States and Britain. Abacus, 44(4), 341-376.
Gazely, A., & Lambert, M. (2006). Management accounting. London: SAGE Publications.
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Jelić, M., Aničić, J., Đurović, J., & Radojičić, S. (2014). ABC COSTING METHOD. FBIM, 2(1), 91-100.
Liu, S., & Gong, B. (2013). Research on Manufacture Enterprises’ Logistics Costing Account and Control Based on ABC. AMM, 278-280, 2218-2225.
Suthummanon, S., Ratanamanee, W., Boonyanuwat, N., & Saritprit, P. (2011). Applying Activity-Based Costing (ABC) to a Parawood Furniture Factory. The Engineering Economist, 56(1), 80-93.
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