1.

0 Title
Impact of fixed overhead absorption to the economic reality

2.0 Background of the Study

From the beginning of commercial activity, merchants have attempted to determine the profitability of their activities. As enterprises began to embark on production activities, a new extension in the area of accounting was required. This extension was the development of cost accounting principles for manufacturers. Along with these new principles came problems that cost accountants wrestle with today, including problems such as accounting for the overhead incurred in the production of the product. Absorption costing and its alternative, variable costing, were developed to fulfill this need, becoming the primary method of accounting for product costs. Under this approach, a rate is determined by which a portion of the fixed and variable factory overhead costs are applied to the cost of each unit. This can be done in one of three ways: by actual costing, in which actual costs and overhead rates are used; by normal costing, in which actual material and labor rates are combined with budgeted overhead rates; or by standard costing, which employs standard costs for materials, labor, and overhead, with the differences being charged to variance accounts. With variable costing, fixed factory overhead is accounted for as an expense of the period, instead of being charged to the product.

Variable costing makes a distinction between variable and fixed costs. The distinction permitted by variable costing allows the manager to understand cost behavior at various levels of production. This better understanding of cost behavior

facilitates internal decision making and is therefore favored by managers. Thus, both systems will probably continue to be utilized by their respective constituencies. With this lack of public scrutiny, cost accountants have often developed their own systems and methods of accounting, unconstrained by the generally accepted accounting principles (GAAP) of financial (externally-based) accounting. Lacking conformity and public accountability, cost accounting procedures have frequently been shrouded under a cloak of corporate secrecy. As a result, there is a lack of documented cost accounting history. Certain practices and theories of cost accounting date back to the fourteenth century. At this time small industrial enterprises started to produce certain trade items of that era, such as books, woolens, coins, and wine. The Industrial Revolution brought new developments in cost accounting systems, but there were no "full-fledged" systems until near the end of the nineteenth century. Before this time, it was likely that most manufacturing firms simply modified their accounts to include the factory charges of direct materials, direct labor and overhead. Usually no sharp distinction was made between the shop burden (overhead) and the commercial (selling and administrative) expenses of the firm. Near the turn of the century, however, cost accountants began to study the overhead element of cost. At this point, the debate between absorption and variable costing began. There was a wide diversity of opinions as to whether overhead assigned to product should be all-inclusive or very limited.

A second change in the manufacturing environment has created changes in how cost accountants ply their trade. Just-in-time (JIT) inventory and production systems are based on the Japanese notion that inventories are evil. The goal of a JIT system is to have the raw materials delivered to the plant just in time to begin production. Each stage of production is completed just in time to move it on to the next stage, and the product is completed just in time for shipment to the customer. With a minimum of raw material, work in process, and finished goods inventories problems regarding inventory valuation and product costing are greatly simplified. Companies are adapting to this innovation with a variety of streamlined costing systems. One of these new costing systems is activity-based costing (ABC). Under this approach, each manufacturing cost is linked with the activity creating the cost. For example, the cost of the purchasing department can be tied to the number of purchase orders prepared. Thus, purchasing department costs can be allocated based on purchased orders issued for various departments. Cost accounting, with its lack of generally accepted accounting principles, has not had the exposure afforded financial accounting. Its history is one of innovation, methods devised out of necessity. This is good, in that innovation occurs unconstrained by some idea of "proper accounting." Yet, this same feature contributes to the lack of a formal "History of Cost Accounting." Only the best ideas see the light of public scrutiny and the

true sources of innovations may never be known. Many modifications or innovations may not be exposed to the public under a cloak of "corporate security." The history of cost accounting was written, and continues to be written every day in the factories and offices of manufacturing America.

3.0 Statement of the Problem

1. What is the basic purpose of absorbing fixed overhead? 2. What are the ways of absorbing over head? 3. Whether fixed overhead absorption reflects economic reality or not? If so what is the benchmark method of absorbing fixed overhead?

4.0 Objectives of the Study

The aim of this study is to draw an evaluative conclusion on the rationality of fixed overhead absorption. The following specific objectives will be addressed.

To evaluate the methods of overhead absorption.

To determine the benchmark treatment for overhead absorption.

5.0 Literature Review

literature

review

will

be

provided

in

the

actual study, which will be put in the second chapter. The study will review documents published and unpublished and present related literatures. This will include literatures from Rasmussen, Deshmukh, Fox, Thierauf and other proponents of financial and accounting software tools as a mean to optimise business endeavors. Literatures about the financial and accounting industry will also be reviewed as well as literatures that depict or reject the importance of software tools in doing business.

For

the

purpose

of

providing

the

readers

to

obtain references about the different concepts and elements used in the study, literatures will be reviewed to increase the knowledge about the topic and to help in the analysis of data. Literatures will be acquired from online journal databases such as Blackwell Synergy, Emerald and Questia. Initially, several related literatures have already been researched for this study.

Rasmussen,

Eichorn,

Barak

and

Prince

(n.d.)

present Process Improvement for Effective Budgeting and Financial Reporting the impact of recent technology trends on how firm approach their financial and accounting. They also discussed the analytics applications and the role of software tools.

The

second

book

which

will

be

of

immense

significance is that of Jack Fox (2001) entitled Building a Profitable Online Accounting thriving Practice. Fox describe practice proven and strategies for establishing coverage of the the

virtual

accounting

presents

in-depth

several accounting and consulting services offered by accountants over the Internet.

Handbook will be

of the

Technology third book

in to

Financial be used

Services to

draw insights from. Written by Jessica Keyes in 1998, the book discloses the calculus of IT in support of the banking, securities and insurance industries. The problem-oriented book which is taken from both technology and business perspective also presents challenges and solutions associated with the financial industry.

6.0 Research Plan

Research Perspective

According consist the of

to three

Saunders parts, the In

etal

(2003), of I

research the will

perspectives

usually and

perspective my research

positivist, be using

interpretivist the

realist

approaches.

Interpretivist

approach, (in between the continuum), as my research is exploratory, wherein, I will be exploring improve the the degree accounting to which and the software processes tools of identified organisations. could On

generally

financial

the other hand, how and why these companies rely on these software tools to contribute to their business will be also explored. Thereby, using an Inductive approach to form a theory as to why and how companies resort to software tools utilisation towards the improvement of internal processes.

Research Strategy

The

research

approach

is

exploratory

as it intends to explore and compare the effectiveness of the software tools to

the advantage of the companies that are currently using it. This approach is a preferred mean of finding out what is happening to seek new insights or to ask questions or to assess phenomena in a new light (Saunders et al, 2003). This study will use the principal search; ways of conducting to experts exploratory about the

research,

which

include:

literature

talking

subject; and conducting focus group interview.

Research Design

My

research data

will on

operate more

within than

the

Cross-Sectional case, using

Design,

as

will

be

collecting interviews,

one and

questionnaires, analysis. The

semi-structured benefit of this

structured

observation,

document

would be that would be able to focus on the breath and depth of the research. Moreover, by exploring the breath of the topic, I am increasing my validity and the truthfulness of my research, and thereby minimize the confounding variables.

Data Collection

The

research the using

will study the

utilise will

both survey

primary

and of

secondary five as

research.

In

primary are A

research, currently

employees as well

organisations on

which experts.

software

tools

interviews will

structured questionnaire will

be developed and it

be used as

the survey

tool for the study. It is planned that the questionnaire will have a 5 point Likert Scale, as well as ranking, probing and hypothetical questions.

A the

secondary study.

research Sources in

will

also

be research

conducted will

in include

secondary

previous research reports, newspaper, magazine and journal content. Existing findings on journals and existing knowledge on books will be used as secondary research. The interpretation will be conducted which can account as qualitative in nature.

Sampling Strategy

The

sampling

will

be

on

two

stages:

first

for

the

organisation

and

second

for the financial and accounting personnels. The first sampling technique to be used is the purposive sampling. This non-probability sampling refers to sampling with specific criteria which they are are in mind. As using be such, the or study will sample software. five The

organisations software tools

currently using

financial

accounting Analysis

should

Technical

Software,

Straight

Thought Processing and/or Microsoft Office Accounting. In the second stage, the employees will be sampled through a simple random sampling. 300 questionnaires must be accomplished with the hope that 50% will be returned.

Analysis and Presentation of Data

The

secondary

data

will

be

analysed

through

qualitative analysis. The primary data, on the other hand, will be analysed using the frequency analysis with the following formula:

1. Percentage to determine the magnitude of the responses to the questionnaire.

% = -------- x 100

n number of responses

N total number of respondents

2. Weighted Mean

f1x1 + f2x2 + f3x3 + f4x4 + f5x5

x = --------------------------------------------- ;

xt

where:

f weight given to each response

x number of responses

xt number of responses

total

The

dissertation

will

be

presented in written form with the addition of data charts which will present the projects results. Pie charts and network charts will be needed to

illustrate some of the analyzed data. This cannot be confirmed, however, until the research data have been analyzed.

7.0 References

Fox, J. (2001). Building a Accounting Practice. John Wiley and Sons Publishing.

Profitable

Online

Keyes, J. (1998). Handbook Financial Services: 1999. CRC Press.

of

Technology

in

Rasmussen, N. H., Eichorn, C. J., Barak, C. S. and Prince, T. (n.d.). Process Improvement for Effective Budgeting and Financial Reporting. Wiley Publishing.

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