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Posted on March 28th, 2013, by

2. Also based on the above article and other readings, what types of situations may be more appropriate for application of the some of the “tried and true”¯ costing methods of the 20th Century? Are these industry or firm specific?

As it was mentioned above, for certain industries or companies previous costing methods might be more appropriate than value-based costing since they will yield the same results taking less effort and less expense. For example, techniques of average cost are appropriate for companies dealing with a single product and stable technology of production (Gupta & Gunasekaran, 2005). However, in current globalized environment it is difficult to think about an industry or company with such operating environment. Absorption costing involves the distribution of overhead costs basing on a selected cost driver, and might work good for stable environments, stable demand and low diversity (Shank & Govindarajan, 1999). Again, in the current world it might be difficult to face such an environment, but the possibility of it is still above zero. In general, the factors determining the appropriateness of a certain costing system depend on the characteristics of the industry, region and other economic factors determining competitive position of the firm.

Direct costing might have a higher scope of application, but this approach is good for short-term decisions, and can thus be applied for products with relatively short life cycle. This method gives good results for strategic, managerial and accounting decisions, but it has several deficiencies. First of all, this method suggests that in future costs classified as fixed will remain fixed; in addition to this, it assumes that factors affecting production in future and in the past are going to be the same (Shank & Govindarajan, 1999). Thus, this method is good for environments where the set of factors affecting the industry does not significantly change, and the same statement is true regarding costs affecting the product (Spenser, 1998).

Transfer pricing is a set of costing methods developed for decentralized companies (Gupta & Gunasekaran, 2005), and a certain set of these methods is likely to be incorporated into value-based pricing. Such approaches as profit split method, transactional profit and transactional net margin methods are used to evaluate division performance and to perform divisional profit sharing (Innes & Mitchell, 2003). Overall information presented by transfer pricing can be used for goal setting. Thus, transfer pricing is rather an actual model and certain elements of it are likely to be used for decentralized companies currently and in future.

One more recent system is throughput costing, which is also likely to provide accurate costing for systems using lean manufacturing approach. In general, the choice of costing systems depends both on the industry and on the company, but the industry performs a stronger effect on the selection of approach to pricing.

3. Is Cost-Volume-Profit Analysis still relevant in the 21st Century business organization? Support your answer with reasoned arguments and references as appropriate.
Cost-volume-profit analysis is a technique aimed to determine the impact of changes in volume and cost on the company’s revenues and such figures as operating income and net income. This type of analysis requires to identify all costs as variable or fixed, and associates variable costs to fixed costs, allowing to find the break-even margin for each product or service. Cost-volume-profit analysis is the basis for direct costing method, which is widely used for operational planning, for management decisions and control procedures (Williams & Carcello, 2008). This method allows to make effective pricing decisions, especially for short term survival periods, and works good for environments where the competition is rather tight, and the companies are using cost effective manufacturing methods. In addition to this, marginal approach to costing focuses on the controllable business factors (fixed and variable costs), and clearly shows the short-term effect of policies and managerial decisions on the profit (Williams & Carcello, 2008).

However, cost-volume-profit analysis has a lot of limitations. First of all, it is based on historical data and cannot be used for costing in rapidly changing environments, in environments closely dealing with most recent technologies or involving virtual/outsourcing teams or components.

The industries where knowledge management is prevailing are also inappropriate for cost-volume-profit approach. In the long run, costs assumed as fixed under this approach might become variable, and have a greater impact on profit. Also, there are certain costs which are difficult to classify, let alone the “intangible”¯ costs, which are not incorporated into this model. Thus, cost-volume-profit analysis has a broad range of advantages and disadvantages. This method can be selected for determining product or service costs in such industries where the companies are operating closely to break-even margin, where production technology is similar, and competition is fairly strong (Spenser, 1998). However, it is still not recommended to use this approach as the sole costing method.

Cost-volume-profit analysis is an effective technique which is applied in the 21st century for certain purposes: short-term forecasting, quick approximation for consequences of changing cost and volume, selecting short-term strategies in a highly competitive environment and for urgent decision-making (Innes & Mitchell, 2003). Thus, this technique is still relevant and it should be used as a part of a generalized value-based approach to costing.

Gupta, K.M. & Gunasekaran, A. (2005). Costing in new enterprise environment: A challenge for managerial accounting researchers and practitioners. Managerial Auditing Journal, 20 (4), 337-353.
Williams, J.R. & Carcello, J.V. & Neal, T.L. (2008). GAAP Guide Level A. CCH.
Shank, J.K. & Govindarajan, V. (1999). Strategic cost analysis: the evolution from managerial to strategic accounting. Irwin.
Spenser, N. (1998). A Textbook of Costing Principles. Heinemann.
Innes, J. & Mitchell, F. (2003). Activity-based costing research. Management Accounting (CIMA), 68(5), 28-29.
Jones, L.R. & Thompson, F. (2000). Responsibility budgeting and accounting. International Public Management Journal, 3, 205-227.

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