The current paper examines the issues of strategic management accounting including stages of strategic management process, the roles of management accounting, concept of opportunity costs, concept of relevant and irrelevant costs, cost classification and practical application of breakeven analysis. Besides, it contains examples illustrating some of the above listed concepts. The claims are supported with relevant arguments; the examples reflect the issues associated with running business in contemporary market environment. Each task is divided into sections related to different parts of each question. Each part of the question contains appropriate conclusions.
Main Stages of Strategic Management Process
According to the Anonymous (2012) there are five stages of strategic management process:
1. Establishment of mission and objectives;
2. Carrying out a position analysis;
3. Identification and assessment of strategic alternatives;
4. Selection of strategic alternatives and formulation of plans;
5. Performance of review and control.
More generalized version of strategic management stages includes strategy formulation, strategy implementation and strategy evaluation and control.
Strategy formulation includes establishment of mission and goals in the organization. This process may be called “strategic planning” as well. Strategy formulation can absorb carrying out a position analysis and assessment of strategic options.
Strategy implementation means taking the actions towards realization of strategy set when one alternative option was chosen. Basic strategy-implementation activities include setting annual objectives, allocation of resources and devising policies (Anon., 2012).
Strategy evaluation and control is the final stage of strategic management process. As both internal and external factors are subject to constant changes, the strategy needs to be revised with time. The main objective of revising the strategy is to determine whether chosen strategy complies with the company goals. The purposes of strategy evaluation and control are: review of internal and external factors, performance measurement and making corrections (Anon., 2012).
Red Gate Software Company Strategic Management Process
The stages of strategic management process will be considered on the example of Red Gate Software Company headquartered in UK, Cambridge. The company mission is “to be one of the greatest software companies in the world” (Red Gate Software Company, 2012). The company declared its principle as “ingenious simplicity” and it has been following it since 1999.
Red Gate Software Company pursued the following goals: create unique software which would be a significant technical contribution; create an ethical company promoting high moral values; build relationship between employees on the basement of personal fulfillment. Thus, the strategy was formulated and the goals were set.
In 2008 the management of the company realized that there was a need in innovation. Previously, it was relatively simple to stay the best software company since the product was unique and of high quality. An increased competition forced the company to adopt Agile Scrum product. The Scrum was supposed to accelerate release without degradation of quality. A highly competitive environment made a pressure on the company (Red Gate Software Company, 2012). As a result of brainstorming, the management of the company had chosen the way of further company development. Agile Scrum product was chosen as the best alternative because it helped improve productivity, enhanced cooperative communications, and surfaced impediments in the beginning of the product cycle.
The implementation of the project began with pilot project started in 2008. Firstly, the SQL team adopted a pilot project. Secondly, there was a need to introduce the development teams to Scrum with the help of in-house seminars. The company management identified that in order to take the pilot project to the next level there was a need of expert coaching and teaching (Red Gate Software Company, 2012). Using the experience gained from training, the company began own inner training that made company structure and implementation unique. This approach helped raise employees’ morale and aspiration for continuous improvement.
The fundamental changes in the company strategy occurred when the management realized that the company policy must be more consumer-oriented. The management of the company realized that they had good product, but they did not know anything about their customers, advertising and promotion of the product. Resulted from the review of the current strengths and weaknesses, the company re-evaluated its strategy and corrected their actions. They asked their customers to make suggestions regarding the product quality. As the customers knew the product better as its users, they suggested several alternatives for the product improvement which were taken into consideration by the development department of the company which took corrective actions.
As a result, the company was evaluated by the Times of London as one of the best small-sized companies.
Roles of Management Accounting
The general purpose of management accounting in the organization is to support a process of making a decision by collecting, communication, and processing information which could be helpful in business evaluation and control of business processes verifying the compliance with company mission, strategy, and objectives (Freeman, 2010).
Data collected for management accounting purposes may be useful on each stage of strategic management process. Thus, relevant information may play crucial role in goal setting because often the goals are set on the basement of preceding period reports.
Strategy implementation often refers to developing budgets which is also an accounting management field. The management accounting information plays an important role on this stage since it helps estimate funds that are necessary for implementation of the project. For example, profitability calculation may help to decide whether to undertake a project or not (Freeman, 2010).
On the stage of strategy revision and control the management accounting information can be useful when verifying the compliance of chosen strategy to the goals of the company. This information offers vast financial data for analysis of the company current situation. The information can be useful for both insider and outsider users, such as investors, creditors, government agencies, and stakeholders of the company. The most significant role accounting management information plays in decision making process (Atrill and McLaney, 2009).
Concept of Opportunity Cost
Opportunity cost is forgone cost; it is the sacrifice which relates to the second best option available to someone who is making a choice from several mutually exclusive alternatives. Opportunity costs are often described as the value of an alternative decision that could be made in the given situation. For example, there are two options for starting a business: to start a restaurant or to start a boutique shop. Depending on the choice made, the other option would become an opportunity cost. If one selects starting a restaurant, a boutique shop would become an opportunity cost and vice versa (Anon., 2012).
Concepts of Relevant and Irrelevant Costs
Identification of relevant and irrelevant costs is a matter of crucial importance in decision making. An analysis of relevant and irrelevant costs includes identification of the relevant costs and organizing the costs to indicate the differences between alternatives available. For example, a company needs to make a decision whether to keep the old equipment or to buy a new one. The aim of such an analysis is to identify how costs and revenue differ under each option. If the costs are identical in each alternative, they are irrelevant because they do not make any difference. The costs are considered relevant if, for example, new equipment had higher capacity in comparison to the old equipment. Often the keep-or-replace decisions are based on the strategy of cost minimization (Drury, 2008).
In this case relevant outlay costs are: cost of new equipment, conversion costs, inspection and adjustment costs, sunk costs irrelevance, and equipment maintenance costs. Advertising, selling, distribution costs, as well as common outlay costs and direct materials are irrelevant costs in this example.
Classification of Costs
For the purposes of breakeven analysis costs can be classified by their nature. Thus, classification of costs includes classification by element (material, labor, overheads); by function production costs; and by function nonproduction costs. Additionally, the costs can be divided into direct and indirect (overheads); fixed (stepped fixed) and variable (semi-variable) (Anon., 2012).
Breakeven analysis is designed to determine whether there is a financial loss or profit and if production or sales volume is sensitive to changes in cost. Breakeven analysis includes the following elements: fixed and variable costs, revenues, profit goals, and contribution margin (Wentworth and Cafferky, 2010).
Distinction between fixed and variable costs is the most important categorization for the purposes of breakeven analysis. Fixed costs are the costs that are not directly related to the production volume. They are often called “overhead” costs. They include personnel salaries costs, depreciation, interest, property taxes, and administrative costs. Variable costs are changed with production output or volume of sales. Usually they include raw materials, commissions, labor wages, packaging, energy costs, and freight costs. Proper classification of costs is crucial for conducting a good breakeven analysis since breakeven level of output is identified at the point when the costs are equal to the minimum level of production or sales needed to cover all associated expenses (Foltz and Wilson, 2008).
Variable costs are also important for calculation of contribution margin. Contribution margin can be calculated knowing variable costs and having forecast for production or sales. Subtracting variable costs from revenues will result in contribution margin which is to cover fixed costs (Foltz and Wilson, 2008).
Breakeven output is identified as a breakeven point on the graph. Breakeven point, the point where the costs are equal to profit, can be illustrated in three different ways. First, it can be illustrated with the help of direct profit evaluation. Second, it can be identified with the help of comparison of total cost and total revenue. Third, it can be presented as comparison of price and average total cost (Kimmel, Weygandt and Kieso, 2011).
Practical Application of Breakeven Analysis
The goal of any business in contemporary world is to maximize shareholders value. Breakeven analysis is helpful in making important decisions regarding cost control and profitability, thus aiming to achieve the main goal of the company.
Also, breakeven analysis helps identify which products that make profit or loss. In this case the analysis is essential since identification of profit and loss helps control increment of shareholder equity (Kimmel, Weygandt and Kieso, 2011).
Besides, breakeven analysis is the simplest method of making business decisions, especially in the case of production of limited number of products. Recently, the most essential issue for companies is control of overhead costs. Usually, contemporary production is capital-intensive. The most significant part of costs is associated with overhead costs. Therefore, the role of breakeven analysis cannot be overestimated. A good breakeven analysis enables managers to make effective decisions based on rational approach towards cost analysis. The analysis also offers vast information regarding limiting factors (constructs). It also gives valuable ideas concerning profitability improvement. Besides, it helps trace business dynamics in an uncertain and highly competitive market through cost monitoring, thus stimulating improvement of organizational efficiency in continuity (Anon., 2012).
The current paper relates several topical issues of management accounting in contemporary business environment. The main stages of strategic management process were outlined on the example of Red Gates Software Company. Also, the roles of management accounting were identified and explained.
The second task of the assignment was devoted to the issues of opportunity cost and concepts of relevant and irrelevant cost. The definitions were supported with appropriate examples.
A detailed cost classification was represented in the third assignment. Practical application of breakeven analysis was outlined with detailed elaboration on the roles breakeven analysis play for the cost and profit analysis in contemporary business environment.
Also, the paper contains the information regarding contemporary business decision making process and an impact made by accounting management methods on business development.
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Red Gate Software Company, 2012. About Red Gate Software. [online]
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