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Paper Abstract: This accounting paper discusses the strengths and weaknesses of published financial statements and of accounting ratios as a means of interpreting the position and performance of a business. Discusses the strengths and weaknesses of an absorption costing approach compared with a marginal costing approach in decision making and explains how the use of activity based costing might improve a firm's decision making. Paper Introduction: Accounting for Managers Published financial statements including audited financialsstatements have a number of weaknesses Some of the limitations offinancial statements and financial statement analysis include Past financial performance good or bad is not an indicator of future performance Unaudited published financial statements may contain either or both of these two types of errors unintentional mistakes or intentional misrepresentations Unless a customer provides prior period financial statements for comparison there is no starting point for comparison Explanatory notes to the financial statements contain Text of the Paper: The entire text of the paper is shown below. However, the text is somewhat scrambled. We want to give you as much information as we possibly can about our papers and essays, but we cannot give them away for free. In the text below you will find that while disordered, many of the phrases are essentially intact. From this text you will be able to get a solid sense of the writing style, the concepts addressed, and the sources used in the research paper. This process is sometimes called tracing. Reality: It is true that many privately held companies will not share financial information with creditors, but it is not true that routine requests for financial statements creates problems. . The principles of activity based costing are: . . There are limitations associated with traditionalcosting methods. . Myth: Financial statements audited by an independent auditor that include an unqualified auditor's opinion are reliable. This is the result of theabsorption of fixed manufacturing overheads into the value of work-in-progress and finished goods inventory. They are: . All activities are consumers ofresources in production of materials, services, events, or information.Activities are the common denominator between business process improvementand information improvement. . The fact that a company's stock is publicly traded and its financial statements are readily available does not guarantee that the company is financially stable Auditors may be required to add cautionary notes to a client company'spublished financial statement. Freimark explains that accountants may issue anadverse opinion on one type of financial statement, such as the balancesheet, while giving another kind of opinion on the other statements(Freimark 1 ). However, absorption costing doesnot provide relationship between profit and sales. Product costs, which are included ininventory, consist of: . An "adverse opinion" is the most serious of all the letters that canaccompany a customer's financial statements. Auditors may be required to add acautionary note when an outside auditing company questions the going-concern assumption. As a result, the book value of an asset may not be close to the market value of that asset. If the auditor has questions about the viability of the company, that information will be in the auditor's opinion letter. Reality: Customer financial statement analysis is one tool in evaluating the short and long-term viability of a company. Herbert A. . In this context, traceability refers to tracing costs to cost objects to determine why costs were incurred. An unqualified opinion requires that allnecessary disclosures in the form of explanatory notes to the financialstatements have been added. Ameen explains in Review of Financial Economics that a qualifiedaudit opinion contains information if it alters investors' beliefs aboutthe value of the firm (Ameen 41). It is also essential to know whether a customer's financial performance is [a] weak but improving or [b] weak and deteriorating, or [c] weak with no significant improvement or deterioration detected. variable factory overhead, . It is anoversimplification, which can result in company management receivingincorrect information. The mechanics of activity based costing are as follows: . Marginal costing systems treatfixed manufacturing overheads as period costs (i.e. ABC uses unit cost as a way of measuring outputs.More specifically, ABC traces rather than allocates each particular expensecategory to a particular cost object; in effect, making indirect expensesdirect expenses. In order to accurately assign or allocate costs to specific productsand services, ABC assigns cost to activities based on their use ofresources. Due to scope limitations imposed by a client, a CPA may be unwillingto express any opinion about the accuracy of a customer's financialstatements. The unqualified opinion . These include: . A "qualified" auditor's opinion letter is one in which the auditor hasincluded one or more specific qualifications to its assurance that thepublished financial statements follow established accounting practices.This means that one or more irregularities were found and that the customercould not or would not correct them before the completion of the audit.Elsie C. . Myth: The choice of method of depreciation is a minor detail of little concern to someone analyzing published financial statements. Determine the cost for each activity . . This process allows a higher proportion of total company cost to beallocated to products more strictly. Activities consume resources . G&A costs would remain the same no matter what level of output the activity produced. a charge against profitin the period incurred). The Objective Evidence Requirement requires that financial statements be based on documentation that reasonable people would interpret in similar ways. Historical Cost Basis - Fixed assets, with the exception of land, are recorded at their historical cost less accumulated depreciation. Some of the limitations offinancial statements and financial statement analysis include: . Under variablecosting, fixed factory overhead costs are considered period expenses.Consequently, under absorption costing some fixed factory overhead costswill appear on the balance sheet as a part of the cost of ending inventoryrather than on the income statement as an expense. Activity based costing involves: . . Explanatory notes to the financial statements contain new information but many recipients do not take the time to read and understand these notes. Traditional costing involves allocating a wholeitem of cost or revenue to a single cost unit, center, or account. A violation of one or more loan covenants . Published audited financial statements are not a guarantee of accuracy. . In this all important step, activity costs are assigned to outputs using activity drivers. 3. Thus, marginalcosting information can be useful for short-term planning, control anddecision-making, especially in a multi-product business. The adverse opinion . Norm Raffish writes inManagement Accounting that traditional cost accounting techniques havebecome less effective because direct labor accounts for 5% to 15% of costs,material accounts for 45% to 55% of costs, and overhead, which is becominga fixed cost, accounts for 3 % to 5 % of total costs (Raffish 36). In a marginalcosting system, sales less variable costs measures the contribution thatindividual products or services make toward the total fixed costs incurredby the business. A marginal costing systememphasizes the behavioral, rather than the functional, characteristics ofcosts. The debtor's default on one or more loan payments . Lawsuits filed against the debtor. This, in turn, may help management to decide whether or not toaccept a low offer price for an order assuming that order would utilizeotherwise idle productive capacity. Since marginal costingassigns only the marginal costs [the costs that vary with the level ofproduction] to products, manufacturing overheads are written off each yearas period costs. . ABC defines categories of activity in overheaddepartments, which on the one hand are recognizable to overhead departmentmanagers but, on the other hand, are driven by factors, called cost driversthat are characteristic of products and other cost objects. The focus of the marginal costing approach is on separating costs intovariable cost elements, and fixed cost elements - where total cost remainsthe same in each period regardless of the level of activity. Myth: Analysis of published financial statements is the only tool needed to evaluate a company's problems and potential. Myth: Requesting financial statements from privately held companies that do not normally publish them is an insult. Without somemethod of correctly allocating these costs to a particular product, itwould be impossible to answer a question about product profitability in acompany that manufactures only two products. Absorption costing involves attaching all costs, whether direct orindirect, to the product itself. Identify outputs. This is where the need for independentauditors becomes necessary. The most obvious problem involves proper allocation offixed costs, and of indirect costs. "How much does that product really cost?" Management Accounting 72.9 (1991): 36.Rouse, Robert. Robert Rouse writes in CPA Journal that in an unqualifiedopinion the auditor must be able to support the client's assertions as tothe existence, completeness, rights and obligations, valuation anddisclosure of the audited accounts (Rouse 74). Addressing this type of error isbecoming more critical as a tool senior management needs to understand thetrue picture of product profitability. Examples of situations that could cause anauditor to issue a going concern warning would include: . For example, ifcustomers present fraudulent or inaccurate financial statements investorsmay make the wrong decision and purchase the company's stock. Reality: All of the accounting conventions adopted by a company are important. The fair market value of these assets is always different from the book value. In fact, thisapproach still plays an important role in deciding how to allocate scarceresources among products and in pricing decisions. 4. The net profit reported by absorption costing as well as marginalcosting systems would not be different based primarily on the differingtreatment of fixed manufacturing overhead. Traditionally, manufacturing companies have tended to allocatemanufacturing overheads on the basis of one or more direct costs, such asdirect labor, or machine time, for the purpose of profit calculation. The Full Disclosure Requirement states that a company must disclose all facts relevant to readers of its published financial statements. Reality: Unaudited financial statements may be accurate or they may contain false and misleading information. It should be emphasized that marginal/direct costing can be useful forshort term pricing decisions in establishing a minimum price for marginalproduction below which additional losses will certainly result, even in theshort-term. The fixed costs are treated as period costs and, as such,are simply deducted from contribution in the period incurred to arrive atnet profit. Thistraditional method is simple, but it is limited because it relies on onecost driver, volume, and focuses on one cost object, products. Activity based costing is a more accurate cost management system thantraditional cost accounting. The qualified opinion . Published, audited financial statements can be changed legally by adjusting certain reserves. The absorptioncosting method allocates or apportions a share of all costs incurred toeach of a company's products or services. Activity based costing [ABC] identifiesopportunities to improve business process effectiveness and efficiency bydetermining the true cost of a product or service. Originally, this led initiallyto the growth of marginal or direct costing approach in which only variableor direct product costs were traced to individual products. Improper accounting and inaccurate reportingtend to conceal waste and inefficiency, and thereby prevent economicresources from being allocated in a rational manner. Given the fact that some costswill tend to remain fixed, apportionment of costs will depend on the levelof activity. Costs are allocated to costobjects without being categorized as fixed or variable. Accountants must allocatemanufacturing and other indirect cost to specific products and processes.Traditional financial accounting methods of product costing that focus onprofit calculation for the company as a whole often do not provide thedetailed information needed to whole company usually do not usually providethe information to accurately determine the profitability of a specificproduct. The unit cost is simply the average total cost of producing one unit.It is calculated by dividing the total cost of production by the totalnumber of units produced. Marginal costingclarifies the relationship between costs, volume, and profit. The Business Entity - A corporation is a business entity separate and distinct from its owners. Assign resource costs to activities. Understanding costs is essential to the wise allocationof resources. 2. Anunqualified opinion means that the independent auditors found no grossexceptions to generally accepted accounting principles when reviewing theclient's books and records. Since most companies sell more than one product, management accountingoften shows the effects of one product on the profit of the whole company.This might result in a decision to drop a product, to raise its price, toreduce promotional expenditures, to manufacture it less expensively usinginferior products, or to outsource manufacturing. Essentially, activity based costing forces managers to identify whatactivities are value-added...meaning the activities that will best delivera service, or meet a customer demand. Indirect. The Going Concern Concept - Financial statements are prepared based on an assumption that the company is a going concern. . Independentaudits add credibility to a company's published financial statements. There are four different typesof auditor's opinion letters. Each process may consist of one or more activities required by outputs. . Past financial performance, good or bad, is not an indicator of future performance. In manyinstances, this is a convenient shortcut for accountants. Myth: Unaudited financial statements are better than nothing. Resources consumption drives costs . This important step identifies all of the outputs for which activities are performed and resources consumed by an activity segment. The accounting concept of Materiality states that only items that are of sufficient size to be relevant to the reader of a company's financial statements need to be included in the published financial statements and explanatory notes. Identify activities . tabulating activity data . However, these differences can bereconciled by an analysis of changes in inventory levels and the fixedmanufacturing overhead absorption rate. The Monetary Unit Assumption requires that published financial statements translate foreign currency transactions into the business's home currency. "Adverse opinions - a reporting wrinkle." The CPA Journal 56 (1986): 1 .Raffish, Norm. An auditor sends an adverseopinion letter when the auditor discovers information during the audit thatdemonstrates material noncompliance. Accurately analyzing each product cost provides an importantmanagement tool to assess the individual profitability of the products.This process helps companies to determine the company's optimal productportfolio by concentrating on manufacturing promoting and distributing itsmost profitable products. Apportioning involves spreading costs over two ormore cost centers. Activities, in the context of ABC, can be defined as a named process,function, or task that occurs over time and has recognized results.Activities consume assigned resources to produce products and services.Inputs are transformed into outputs under the parameters set by controlsperformed by the organization's employees. Ineffect, traditional cost accounting allocates overhead to the cost objects. In the short term, a company's financial results can be improved by reducing or eliminating discretionary expenditures - even if the decision affect the company's long term success . . A major advantage of using ABCover the other two methods described above is that ABC avoids or at leastminimizes distortions in product costing that result from arbitraryallocations of indirect costs. The Four Steps to ABC Implementation 1. Unless a customer provides prior period financial statements for comparison, there is no starting point for comparison. The problem of allocation of costs involves both the manufacturingoverhead cost as well as cost allocation involving other expenses such asResearch and Development and other Administrative costs. determining activity costs . Basic Accounting Concepts Understanding certain key accounting concepts is key to acomprehensive understanding of published financial statements. Under the absorption costing method, all fixed and variable overheadcosts are treated as production costs. Myths about financial statement analysis abound. Byreconciling sales revenue to marginal costs, marginal costing provides alink between s profit and the level of sales generated. This costing approach does notdifferentiate between fixed and variable costs. The disclaimer of opinion An "unqualified opinion" letter involves a certification made by theindependent auditing firm attesting to the fact that the company'sfinancial statements were prepared in conformity with Generally AcceptedAccounting Principles, and fairly represented the firm's financialcondition. direct materials, . Identify activities. The Conservatism Principle states that given a choice of options, an auditor must select the accounting method that has the least favorable impact on the net income or asset value of the company under audit. Making accurate connections between costs and outputs creates a truerfinancial picture. "Completeness - the perplexing assertion." The CPA Journal 56 (1986): 74. There are weaknesses associated with the absorption costing approach,and businesses understand these weaknesses. The emphasis on the impact of fixed and variable costs helps predictcash flows in relation to volume changes. Direct-costs that can be traced directly to one output. An understanding of this relationship is critical to management's efforts to control overhead costs. When a substantial doubt exists about the company under audit'sability to remain in business, auditors must add the going concern cautionto published audited financial statements. Fixed assets are shown on the balance sheet at their acquisition cost minus accumulated depreciation. The absorption costing approach absorbs overheadinto the cost of goods produced and is charged against profit in the periodin which those goods are sold. Works CitedAmeen, Elsie. Collect activity data, and . Accounting for Managers Published financial statements, including audited financialsstatements, have a number of weaknesses. Specifically, methods used to apportionthese costs are often arbitrary and subjective. This form of analysis assists marketing and senior management inmaking critical decisions about pricing, outsourcing, capital expendituresand operational efficiency. determining driver costs . Unaudited published financial statements may contain either or both of these two types of errors: (1) unintentional mistakes, or (2) intentional misrepresentations. Activity drivers assign activity costs to outputs based on the outputs' consumption or demand for activities. . This step requires an in-depth analysis of the operating processes. Often, total company overhead is allocated to the products manufacturedbased on volume based measures such as the labor or machine hours requiredto produce a product. The ABC system uses cost drivers to assign the costs ofresources to activities. identifying activities . These are costs that cannot be allocated to an individual output because they benefit two or more outputs, but not all outputs. Published financial offer no insight about anticipated changes in demand, competitive challenges, or management changes at the company under financial review . Assign activity costs to outputs. . A disclaimer of opinion means the auditor does not assumeresponsibility for the accuracy of the company's financial statements. Therefore, under absorption costing, fixed factory overhead costs areconsidered part of product costs and allocated accordingly. In some cases, the goals of the providers of financial information arenot identical to those of the users. Marginal costingcauses fluctuations in profit measurement based on the exclusion of fixedcosts from the calculation of profitability. Thus, using an absorption costing system, the profit reportedfor a manufacturing business for a period will be influenced by the levelof production as well as by the level of sales. . . . Outputs can be products, services or both. An adverse opinion letter states thatthe customer's financial position is not fairly presented by the statementssubmitted. General and Administrative costs. The Consistency Principle states that companies should normally use the same accounting method from period to period so the company's financial condition can compare from year to year. Fixed factory overhead. This means that products andservices that are considered highly profitable may in fact be unprofitablebased on inaccurate cost allocations. As a going concern, assets are valued differently thanthey would be if the company under review had filed for bankruptcyprotection or any other crisis. These are costs that cannot be reasonably associated with any particular product or service produced. The Matching Principle states that a company must match the appropriate costs against revenue in the same accounting period. The goal is to determine whetherthe product or service makes a profit. "An investigation of the effect of qualified audit opinions on the trading volume and bid-ask spread of over the-counter firms." Review of Financial Economics 3 (1993): 41.Freimark, Herbert. An unqualified opinion issued by an independent auditor is not a"clean bill of financial health" for the company under audit. Total cost visibility, which takes into account all the costsinvolved in a product or service is clearly the most effective way todecide which products companies should drop and which should be emphasized.ABC is a leap forward in the ability of a company's management team to makebetter and more informed business decisions. Cost objects consume activities . For example, a company trying to get abank loan or applying for open account credit terms may want to make itsfinancial statements look better than they are to improve the chances ofgetting a loan or a line of credit. ABC focuses on indirectcosts - overhead. . ABC is accepted as improvingoperational efficiency and enhancing decision-making through better, moremeaningful cost information. It then assigns specific cost to cost objects, such as productsor customers, based on their use of activities. . doing the product cost calculation ABC principles are used to focus marketing management and seniormanagement's attention on the total cost to produce a product or service,and as the basis for full cost recovery. . direct labor, . 2. It is not enough to know a customer's financial weaknesses by analyzing published financial statements. . . Fundamentally traditional accounting systemsare inaccurate in the way that they allocate costs. Calculate actual product cost based on this information. Some of the mostcommon misconceptions include: . Identify the cost drivers . Reality: If the Enron bankruptcy has reminded us of anything, it is that audited financial statements are not always reliable. If inventory remains at the end ofan accounting period, then the fixed manufacturing overhead costs includedwithin the inventory valuation are transferred to the following period. Work stoppages, and . Basicaccounting concepts include: . For example, it is beendemonstrated that high volume products and services typically incursignificantly less overhead than they are assigned under traditional costaccounting methods, while low volume production runs tend to incur farhigher overhead than is assigned to them. However, certain arbitrary assumptions exist regarding absorptioncosting about the apportionment of costs. If this paper is not what you are looking for, you can search again: Search for: or Click here to request an essay written just for you.

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