Introduction 2

1 Models and Concepts 2

2 Role of the standard costing and variance analysis and value and limitation of variance analysis 5

3 Evaluation of the Activity Based Costing System 8

4 Conclusion and Recommendation 10

Bibliography 12





Recent years, more and more manufactures and managers pay attention to the management accounting to make the correct decisions. Quinn (2011) claims that accounting management has a critical function by offering information to managers for their accurate decisions. The management accounting information has different character such as a financial nature (product costs), non-financial nature (figure of customer complaints). Author of this report is the financial director of the large company (Manac plc). Generally, this company manufactures and sells many kinds of standard electronic products over certain numbers of countries. This company applies standard costing and absorption costing as the subsection of strategic accounting management. Considering budget goal profits, the managing director thinks that more sales lead more profits for company, while this paper believes that the real reason of this situation could be more complex.


1 Models and Concepts

Firstly, it is necessary to introduce several critical concepts. It is defined by Drury (2009) that standard costs refer to the intentioned costs for a project producing a standard cost. In addition, a budget means the total costs of the whole activities while the standard cost is a cost per unit of an activity.


By focusing on the demand for the product and the level of production output of a company, economic theory can assist in determining pricing decisions of a company. It is well known that in economics demand for a product refers to the elasticity of demand. The definition of elastic demand is that a large decrease/increase in demand can be caused by a small increase/decrease in price. On the other hand, the definition of inelastic demand is ‘the quantity demanded falls by a smaller percentage than the percentage increase in price’ (Quinn, 2011).  It is useful to further understand management with pricing decision by paying attention to the concept of elasticity, because that depending on the concept of elastic demand, if elastic demand exists, decrease in price can cause the rise in revenue. While if increase in price will reduce the revenue (Quinn, 2011).

Microeconomic theory implies that the marginal cost per unit might increase and the marginal revenue per unit might decrease with the output increases. At the end, a level of output will reach the point at which the extra revenue obtained from its sale is less than the extra cost of making one extra unit of output. Obviously, at this point selling that extra unit would be unprofitable. However when marginal cost tends to be equal to the marginal revenue (MC=MR), profits tend to be maximized.


Although it is easy to understand these economic theories, in reality these theories might be difficult to apply. Because that in reality almost every company has many different products, in addition, in the real life it is impossible that price is the only one factor influencing the product demand, such as advertising and quality (Sulaiman, Ahmad & Alwi, 2004).


Another important concept is budget. There are lots of authors who claim that preparing budgets is important for any organization. Budgets as planning and facilitate interdepartmental communication and coordination provide a method for an organization to allocate economic resources more efficiently. However, the other researchers have been present numerous criticisms to traditional budgets. They argue that the budget just a tool that is used to calculate the increase and decrease in the previous year’s spending.


In addition Price-setting firm in short term and price-taking firm with the short period good-mix decisions should also be considered. There are several conditions for short-run pricing decisions to satisfy including accessible ample capacity, a bid price that presents a one-off price without repeat, orders that will use new capacity.


Furthermore, another model is the price-setting firm’s long-period pricing decisions. This scenario has three methods to price. The first approach is to use activity-based cost (ABC) in pricing ordered goods, because the importance of accurate costs in a firm. Activity-based cost could offer a high quality understanding of cost behavior. In addition, the second approach is that direct cooperation with the customer is the basis of pricing non-ordered goods. The third approach is that the selling price is the begin point of the whole process in using target costing for non-ordered goods (Quinn, 2011).


Target costing is one of the modern management accounting tools. It is claimed that target costing could offer a competitive edge, because it could offer continuous enhancement of the design and manufacture phases. Therefore, this method allows companies (especially Japanese factories) to keep their competitiveness (Sakurai, 1989). Target costing has three kinds of approaches. The first approach is to decide the target price which buyers are willing to pay for the good through market research information. Another method is to decide the target cost by deducting an aimed profit margin from the aimed price. The third approach of target costing is to evaluate the real cost of the good. Sometimes evaluated real cost may greater than the aimed cost, and then it is better to find methods of reducing the real costs (Quinn, 2011). Target costing could be really worthy in scenarios while markets decide the price.


However, full cost-plus pricing are also presented with several problems. There are three problems in this approach. Firstly, there may be a profit-maximising dilemma between price and demand, because demand could decide the price. Secondly, sometimes it is necessary to modify prices to demand and market situations. Finally, a appropriate basic of overhead absorption system should be choose when a organization manufacture two or more goods. Practically, price is significantly influenced by the cost. Many factories decide price on the basis of cost-plus rules by estimating costs (Quinn, 2011).


Marginal cost-plus pricing decides the retail price with sum of profit and marginal cost of production or selling. Positively, this approach is simple and easy to apply in management accounting. Moreover, the portion of mark-up could be changed. Practically, mark-up pricing is applied in organizations where variable cost is recognized easily. Negatively, this approach neglects fixed overheads in deciding price.

2 Role of the standard costing and variance analysis and value and limitation of variance analysis

An overview of standard costing system which includes several critical steps (Drury, 2009).



Purpose of standard costing system could be divided into five points. First point is that standard costing system could offer anticipated future costs of decision making targets. Traditional or other activity-based costing systems could provide standard costs. For example, products will be priced on a bid basis if there are no competitive prices in markets. Standard costs could offer much more suitable information because of the purpose for avoiding unnecessary costs by competitors. The second point of purpose is that standard costing system provides ambitious and motivated goal. For instance, there are evidences that explicit target could stimulate good performance (Drury, 2009).


Furthermore, the third purpose of standard costing system is that stimulating budgets and estimating managerial performance. Because powerful and sufficient data source is obtained, standard costs are especially worthy in budget process. Finally, standard costing system could act as a control device by reminding managers of those activities without control. In the standard costing system, variance analysis could be provided in details. Therefore, efficient feedback information could be obtained with this model (Drury, 2009).


Actually, standard costing system also suffered from a great number of criticisms. Nowadays, standard costing systems have been difficult to satisfy the needs of business situation. Variance analysis has been doubted for its value in today’s business situation and researchers have anticipated that standard costing variance analysis could be disaster because of the several things which include changed cost structure, contradiction with the modern management method, overemphasized the value of labour, long time of feedback report (Drury, 2009). Because of the varied producing environment, the value of standard costing and variance analysis is decreasing (Drury et al., 1993; Lucas, 1997).


The pitfalls of the standard costing system are presented specifically.

Firstly, changing cost structure leads the overhead costs to become the critical manufactory costs and also leads majority costs of a firm to become the fixed cost in short period. The value of standard costing system is doubted for the reason that it is appropriate in the controlling direct and variable costs rather than the indirect or fixed costs. However, the point that overhead costs are the prevailing factory costs is not evidenced by recent surveys. Up-to-date surveys have reported the identical outcomes of many vary countries on the basis of cost structures. In the majority of manufacturing factory, direct materials are the main source of costs and are about averagely 60% of total costs. Direct labour costs are not so important and are settled in short-period. Nowadays, short period variable costs only include the direct materials and variable overheads (energy costs). Therefore, standard costing variance analysis tends to be suitable for variable overheads and direct materials (Drury, 2009).


Secondly, standard costing system is criticised for its contradiction with the modern management method. Nowadays, great numbers of companies have utilised novel management methods by concentrating on reducing inventories, perfect production, higher level of goods and services. It is suggested that variance analysis could not back up recent management theory. Specifically, evaluating the management performance with the price variances, managers are more likely to concentrate on achieving the lowest materials which may lead several harmful results. The harmful results include the use of a great numbers of suppliers, a lot of purchases, inferior products and delay in delivery. However, material price variances have essential influences. With the volume variance managers are motivated to increase output and inventories (Drury, 2009).


This is inconsistent with a philosophy of minimizing inventories. Favourable volume variances are reported whenever actual production exceeds budgeted production and hence profit centre managers can manipulate monthly profits by expanding output and increasing profits. Attention has already been drawn to the fact that volume variances are inappropriate for short-term cost control and performance measurement purposes. If volume variances are being used for these purposes then the problem arises because of the faulty application, rather than the inadequacies, of standard costing (Drury, 2009).


Thirdly, standard costing system is also criticised for over accentuating on direct labour. Certain researchers point that variance analysis over accentuate on direct labour which has less importance and is merely a subsection of whole factory costs.

Nevertheless surveys suggest that direct labour is the most largely utilised overhead basis. For diminishing distributed costs, managers are encouraged to diminish hours of direct labour, because direct labour is the basic part of overheads. The influence of direct labour is overemphasized; this over-accentuating on direct labour is driven by the default apply of standard costing with concentrating on volume variances for short period cost control and the evaluation of performance. Hence, it is suggested that volume variances could be applied for satisfying financial accounting request rather than cost control (Drury, 2009).


Final criticism of standard costing and variance analysis is that the occurrence of delayed feedback report. It is claimed that the report of performance is usually delayed in efficiently dominating production process. Long time period of performance report is not valued in controlling daily operations. With the controlling target material and labour variances should be notified in ‘real time’. For instance, Majority of factories now gather internet information of manufacture, hence variances could be reported immediately (Drury, 2009).


The criticism of (Drury, 2009) is in line with the view of Zoysa and Herath (2007) who state that new technologies have dramatically influenced the manufacturing environment of Japan. Hence these variances in the manufacturing environment have decreased the importance of standard costing particularly a cost controlling system. Kaplan (1990, p. 4) also has the view that “Japanese companies have been quicker to abandon standard cost system for variance analysis and control in the new manufacturing environment.” Moreover, Sulaiman et al (2005, p. 110) point that standard costing has suffered from severe criticism since the mid-1980s. There are many researches to support the view that the utility of standard costing and variance analysis as a planning and control method is diminished by the result of the varied manufacturing environment (Lucas, 1997; Browich and Bhimani, 1994; Kaplan, 1983). Because of the nowadays’ manufacturing processes, standard costing system is no long advantageous compared with past. However, there are also researchers with completely different arguments of standard costing system. (Lyall and Graham, 1993; Joshi, 2001) believe that still many factories choose to apply standard costing system for decision-making, good-costing, plan and control and the estimate of performance in the developed countries as well as the developing countries.


3 Evaluation of the Activity Based Costing System

As the two important factors of calculating the selling price of a product or service, both direct and indirect cost have to be concerned in a company. Direct costs refer to the costs that are readily known, such as the labor and material costs. On the other hand, indirect costs are quite different, which is difficult to be numerical, such as overheads. To solve exactly the question, activity-based costing (ABC) system, a method of attributing overhead cost to products or services, is developed. ABC is used to identify the factors that cause the costs of major activities in an organization. In terms of this aspect, allocating indirect costs of ABC to cost centre based on activities instead of departments (Quinn, 2011).


Furthermore, Quinn (2011) argues that as the traditional method of product costing, absorption costing system aims to allocate an appropriate percentage of manufacturing overhead in the total cost of product or service in an organization. The traditional technique includes two stages to apportioning overheads: The first is allocating the overhead to cost centres using a fair basis of apportionment. Another stage is allocating the costs of service cost centres to product cost centres. It is clearly that one major difference between the traditional absorption costing method and ABC method of overheads is related to the two stage allocation process. CIMA’s 2009 annual survey of management accounting practices reported that approximately 45% of respondent organizations still use absorption costing, with approximately 30% using ABC. Compared with the traditional method – absorption costing, activity based costing technique has some advantages and disadvantages.


According to Kaplan and Anderson (2005), the major advantage of activity based costing is that the ABC method is able to calculate the cost of individual services and products accurately. Kaplan and Anderson (2005) highlight that ‘By transferring overhead costs to individual units of products or services, ABC helps identify inefficient or non-profitable products or activities that eat into the profitability of efficient processes or highly profitable products.’ Thus, ABC system makes pricing of products or services become more equitable and scientific by increasing or reducing prices of products or services that use more or less of the organization’s activity resources respectively.


Secondly, it is useful to select profitable product line because of eliminating unnecessary cost and unprofitable products depending on the results of ABC method. Thirdly, ABC technique allocates more resources to profitable products or less resource to unprofitable products, which help organization reduce inefficiency and waste to improve the productive. Moreover, identifying and eliminating the activities that do not contribute to the profitable products or product process is useful to plan and estimate the future of an organization. Finally, ABC system providing the actual cost incurred for an organization helps the organization choose the profitable product line actually (Kaplan and Anderson, 2005).


However, although there are many advantages of ABC system, the major disadvantage of activity based costing is that activity based costing is a scientific approach, however since the process of data collection and data entry needs substantial resources, and remains costly to maintain, the method of ABC system is complex, time consuming, and costly (Kaplan and Anderson, 2005).  Furthermore, Kaplan and Anderson (2005) also claim that ABC reports are not generally accepted accounting principles (GAAP), hence these organizations that follow ABC system have to apply two cost systems and accounting books: both internal and external reports.


Another primary disadvantage of ABC system is that it is difficult to identify some overhead costs. For example, the chief executive’s salary on a per-product usage basis, additionally employees rarely devote 100% of their working hours to productive activities, and not all productive activities add value to the product or process of the firm. Take the time using as an example, the ABC method fails to concern the time employee attends a first aid awareness campaign, which lead to substantial ‘cost leaks.’ There is no appropriate method to allocate such the costs to products on a percentage basis, and products and services share such costs equally.


Finally, penny wise and pound fool. Managers pay too much attention on the detail and control might obscure the bigger development of an organization. Moreover, make the firm lose sight of strategic objectives in a quest for small savings. For instance, ABC might identify one distribution channel as non-remunerative, or an inspection as non-value adding. These processes put attention to acquiring some other advantaged target although they are possibly not profitable.


4 Conclusion and Recommendation

To sum up, management accounting techniques has been developed dramatically in the last decades. With the changing manufacturing environment, some firms still use the traditional models while other manufacturers choose to apply new technologies. For the current question of company (Manac plc), it is apparently that only with a great number of sales could not obtain budget profit. As discussed in the above, pricing decision is really significant in management accounting to get the considerable profit for companies. Without correct price-setting, more sales could be disaster for company rather to get considerable profits. It is necessary to acknowledge that this paper is in defect of rigorous statistical analysis of the outcomes of previous researches.





Drury, J.C., Braund, S., Osborne, P. and Tayles, M. (1993), A Survey of Management Accounting Practices in UK Manufacturing Companies, Certified Accountants Educational Trust, London.


Kaplan, R.S. (1990), “Introduction”, in Kaplan, R.S. (Ed.), Measures for Manufacturing Excellence,

Harvard Business School Press, Boston, MA, pp. 1-12.


Kaplan, Robert, S, & Anderson, Steven, R. (2005). Rethinking Activity Based Costing. Harvard Business School.


Lucas, M. (1997), “Standard costing and its role in today’s manufacturing environment”,

Management Accounting, Vol. 75 No. 4, pp. 32-4.


Quinn, M. (2011). Strategic Management Accounting. The University of Sunderland.


Sakurai, M. (1989), “Target costing and how to use it”, Journal of Cost Management, pp. 39-50.


Sulaiman, M. B., Ahmad, N. N. N., Alwi, N. (2004). Management accounting practices in selected Asian countries. Managerial Auditing Journal, 19, 493-508


Zoysa, A. D., Herath, S. K. (2007). Standard costing in Japanese firms: Reexamination of its significance in the new manufacturing environment. Industrial Management & Data Systems, 107, 271-283.

原文链接:Management Accounting 管理会计