2. Back to the future: innovation in manufacturing accounts

3. Report on study carried out by: Professor David Dugdale Professor of Management Accounting Dr T Colwyn Jones Professor in the Sociology of Accounting, Stephen Green Research Associate University of the West of England _________________________________________________________________________________________ Powerpoimt presentation by: M C Pratt, St Martin’s College Back to the future: innovation in manufacturing accounts

4. Presentation Abstract 1  survey of 34 UK manufacturing companies.  manufacturing companies visits led to observation:  some companies’ P&L formats not influenced by either external reporting or ‘mainstream’ standard absorption costing theory.  Chartered Institute of Management Accountants (UK) funding to investigate manufacturing companies’ internal reporting.  Method: review of documentation plus interviews.  specimen profit and loss account format for internal reporting as basis for structured telephone interview

5. Presentation Abstract 2  no claim that sample used is representative and,  if a ‘response rate’ was calculated, it would be low because:  many companies were contacted to find 34 that were willing to participate.  aim of the research was not generalisation but:  identification of innovations in manufacturing accounting reporting.  main findings only are summarised here.

6. Contribution Reporting 1  over 50% (23 from 34) used contribution.  however, depends on careful interviewing and interpretation and  needs careful analysis of ‘margin’ or ‘gross margin’ in several companies  to see that they were ‘really’ using contribution.  full absorption costing is commonplace, but  significant number of companies follow academic advice and use contribution concepts in internal reporting.

7. Contribution Reporting 2  some evidence of disillusion with sophisticated standard cost variances and absorption costing.  However, tend not to use activity-based costing  Instead, they simplify the P&L presentation,  sometimes by using marginal costing.  such presentations (in theory) need to be adjusted for external reporting. Therefore:  evidence that (some) manufacturing companies not dominated by financial reporting requirements

8. Contribution Reporting 3  findings have implications for “Relevance Lost” thesis (by Johnson and Kaplan - J&K)  key view: external financial reporting requirements influenced internal reporting  use of marginal or variable costing methods for stock valuation is not permitted in UK for external reporting purposes  more than 50% of companies not inhibited (in this key respect) by external reporting standards.

9. Contribution Reporting 4  Companies thrown off external financial reporting requirements shackles since 1980s? or  They have always used marginal methods? But:  Some companies consciously chose marginal costing approaches.  Few companies use activity-based methods so:  J&K might be right: companies need to adopt internal business-oriented methods, but:  recommendations to replace absorption costing with ABC (activity-based) not found favour.

10. Budgets and Forecasts 1  typical P&L format includes comparison of actual results with budgeted figures.  almost all (33 from 34) of companies employed budgets and  vast majority of these also produced forecasts.  29 companies described their forecasts  most of these (20) reported that their forecasts were to the end of the current financial year.  the rest (7) generated 12-month ‘rolling’ forecasts.

11. Budgets and Forecasts 2  evidence of impact of financial regulation:  because a number of companies place emphasis on forecasting to the end of the financial year.  and is evidence of budgets giving way to forecasts in importance.  almost half the companies (that expressed a preference) said that the forecast was more important than the budget in financial reporting.

12. Bonus Schemes  companies use executive and/or staff bonus schemes  executive bonus schemes and staff bonus schemes focus on:  ‘profit versus budget or target’ as performance measure or  individual performance objectives (Executives)  some firms also used profit sharing or ‘efficiency of production’.  no residual income or economic value-added performance measures

13. Standard Costing & Variances  Standard costing prevalent  70% of companies set standard costs and  some did not because of the nature of their business  however, analysis of variances calculated and their use in financial reporting led to serious reservations concerning the extent of standard costing use  several companies indicated main use was as convenient means of valuing stock  standards and variances not particularly important in managing the business.

14. Standard Costing & Variances  this observation confirmed by analysis of way financial results were presented.  conclusion that half of the 24 ‘standard costing companies’ were half-hearted in their use of standard costing and variance analysis.  these companies reported actual labour and overhead costs in their Profit and Loss accounts  and employed various combinations of actual and standard material costs.

15. Standard Costing & Variances  variances often not integrated into profit and loss presentation, but  most standard costing companies calculated material and labour variances of various types.  23 companies routinely calculated variances  only 11 reported overhead variances and  5 only reported variable overhead variances.  Of those companies calculating fixed overhead variances, none subdivided volume variance into “capacity” and “efficiency” elements.

16. Standard Costing & Variances Standard Costing & Variances - Conclusions  some companies consider material and, to lesser extent, labour variances to be valuable  overhead variances and, especially, fixed overhead volume variances, not considered useful.  use of standards is commonplace but  may be less emphasis on use of variances for ‘management by exception’.  several companies want to report ‘actual’ revenues and expenses, and, in some cases, in relatively simple formats.

17. Contribution Conclusions  ‘Direct’, ‘marginal’ or ‘variable’ costing been textbook recommendation for many years  but previous research indicates that absorption costing presentations have dominated in manufacturing industry.  Perhaps this research indicates a reversion to simpler methods:  Back to the future?

18. Questions Any Questions ? Powerpoint presentation adapted by M C Pratt, St Martin ’ s College, from: Back to the future: innovation in manufacturing accounts, research study by Professor David Dugdale] Dr T Colwyn Jones]University of West of England Stephen Green] Web page: http://www.eiasm.org/events/Twente-Dugdale.doc