Introduction
The focus of this journal article by Jack and Jones is aimed at exploring issues of management accounting within the agricultural sector in context of emerging challenges that renders the present cost accounting methods that are being used in the sector inadequate. Throughout this research paper the authors takes a critical review of the current management accounting techniques that are predominantly being used within the agriculture sector and discusses their limitations in meeting the fundamental task of enabling farmers to arrive at evidence based decisions that accurately takes into account the cost elements that have over the years become complex to ascertain due to several reasons. Thus, this research paper takes the position that agitates for the “need of new decision-making accounting tools in the farming industry” that addresses the shortcomings of the management accounting approaches that are currently being used (Jack and Jones, 2007). These are that of gross margin and net margin which the authors deem ineffective in this research study.
To support this assertion the article reviews several hypothetical case scenarios as well as summarizes trends of key data in the agriculture sector over the years thereby providing evidence as to how the current management accounting methods are limited and why new approaches are necessary. In addition, the research article provides a list of five factors which we shall review in later section of this paper that have combined together thereby necessitating a shift in the way that farmers approach the task of farm business planning. One of the key factors that this paper attributes to the significant shift of cost elements in agriculture sector is what it refers as
“decoupling of subsidy from production” brought about by the Common Agricultural Policy (CAP) reform enacted by the government in 2005 throughout Europe (Jack and Jones, 2007).
This “decoupling of support payments” that the authors investigates is a central theme in this article that is critically assessed in order to show evidence of how ineffective the gross margin and net margin accounting methods are limited in adapting to this policy. To address the limitation of the current management accounting methods that are articulately demonstrated in this paper the authors suggests adoption of two management approaches. These are target costing and relevant costing which they hold are more suited to address the costing challenges that farmers must accurately establish in order to achieve a more viable farm business planning in the light of changing circumstances within the industry.
Justification of the Study
The issues of appropriate management accounting approaches especially in the agricultural sector are central to the viability of a farm business plan that the farmer is able to achieve both in the short-term and long-term. Because the management accounting method that the farmer relies on in determining the viability of farming projects has profound implications on the accuracy of profit margins that the farmer is able to project, then it is apparent that the importance of basing farm business plans on relevant costing methods cannot be overemphasized. Indeed, for the better half of the last century all forms of business planning in the agricultural sector has largely been based on accounting management approach that relied on gross margin approach (Barnard and Nix, 1979).
Throughout this period up to the present times, the Farm Business Survey which is a body that has the mandate to shape policies in the agriculture sector in Europe has continued to rely on gross margin and net margin accounting approaches despite the change of various variables within the agricultural sector within the same period which has made these accounting approaches absolute. It is against this backdrop that the present study by Jack and Jones (2007) can best be justified and appreciated which has agitated for a reform of the current management accounting methods in farm business planning.
There are two core issues that are explored in this research paper which have great implications to accounting methods in the agricultural sector; that of costing methods per se and discussion on procedures of apportioning costs to relevant categories for purposes of arriving at a more accurate determination of profit margins and determination of viability for specific farming initiatives. The primary focus of this research paper is to undertake a general overview on current accounting practices that are used in determination of cost elements and consequently the profit margins that result from specific farming initiatives. Towards this end the article identifies five factors which it views as obstacles that complicate the process of accounting procedures using the current methods of cost determination and allocation that are being used in the farming sector. These five factors are; previously fixed costs that are no longer fixed, decoupling of support systems, impact of agri-environment schemes, factor cost changes and the cost-price squeeze (Jack and Jones, 2007).
After a comprehensive discussion on how each of this factor impacts on the costing methods in the farming sector the paper suggest use of two accounting procedures to address these special challenges namely target costing and relevant costing. This is where the paper tackles in detail the ideal cost apportioning approaches that should be adopted in cost determination in the agricultural sector which is the secondary focus of this research study. In the following section we shall explore the accounting concepts that are directly related to these two concepts which are addressed by this study such as Strategic Management Accounting, break-even points, Minimum Efficient Scale, fixed and variable costs a.
SMA Concept
One of the areas addressed by the management accounting issues covered in this paper is Strategic Management Accounting (SMA) which refers to methods of management accounting that applies significant emphasis on aspects of the organization business environment factors from a much wider perspective. In Strategic Management Accounting (SMA) the focus is on generating point specific information on internal and external factors that are cross-cutting on all issues that are pertinent to the operation of the business (Colier and Gregory, 1995). As such, SMA is a management accounting approach that seeks to utilize all forms of information in determination of evidence-based decisions in business management that also includes non-financial data. In the agriculture sector, the concept of SMA entails use of accounting tools that are best suited to empower a farmer to arrive at the most strategic financially viable business farming option that has the greatest profit margin. This concept is central to the two management accounting approaches that are advanced in the study which Jack and Jones refer in the article as part of “alternative methods that need to be considered which demonstrates enterprise viability” (2007).
The idea behind the concept of SMA is informed by the need to provide an integrated framework on information for management accounting that is crucial in development of the farming business operation strategy. In this context, the importance of SMA as a management accounting tool is that it provides the farmer with realistic methods of establishing the actual cost elements that impacts on a particular farming initiative.
Relevant and Irrelevant Costs
Another accounting concept that becomes apparent in this discussion pertains what are referred as relevant and irrelevant costs which are also functions of Strategic Management Accounting. There are two types of relevant costs from a SMA perspective; opportunity costs and what are referred as “future differential cash outflows and inflows” (Gulati, 2006). Irrelevant costs on the other hand are divided into three major categories; sunk costs, future, non-differential cash flows and finally allocated indirect costs (Gulati, 2006). Differential costs refer to costs that tend to change with the kind of business decision that is arrived at while incremental costs/revenues are based on the degree of change that affect such costs. Incremental costs could be the amount of money that one would hope to spend on gasoline if one was to till 1 hectare of land for instance; the fuel costs associated with tilling is thus proportional to the area of land that is being cultivated. In SMA, data is considered to be relevant only under those circumstances that it is seen to have a direct impact on future costs or revenues; otherwise it must be considered to be irrelevant (Gulati, 2006).
In decision making under the framework of SMA model one of the first step that one needs to undertake is to separate the cost and revenues into either relevant or irrelevant categories. For instance any costs must be considered to be sunk costs where future anticipated cost have been determined to have no bearing to previous costs that have already been incurred. For this reason sunk costs are considered to be irrelevant because they have already been incurred in the past and are not a factor to present circumstances (Gulati, 2006). As such, what is notable about these costs from SMA perspective is that the relevance or irrelevance of a cost is something that is relative rather than fixed; which is a notion that this study seek to address through the concept of relevant costing method. The implication of the relevant cost accounting method in the farming sector is well utilized in financial decision making that enables a farmer to ascertain the profit viability of a particular farming project more accurately than is currently possible.
Fixed and Variable Cost
In principal fixed cost are expenses that are not influenced or affected by the scale of services or goods that a company undertakes such as rent, utilities and employee salaries (Gelles and Douglas, 1996). Variable costs on the other hand are company expenses that vary with change in scale of company operations such as overtime employee allowances and transport costs among others (Gelles and Douglas, 1996). Variable costs are therefore considered to be expenses that are incurred during product manufacturing or during sales of services or goods; in this case it will be the costs that are associated with the increased production of farm products that would not otherwise be incurred if no farming took place. Ideally, variable costs are taken to be all types of expenses that tend to fluctuate with levels of farm business operations, this way it is much easier to separate fixed cost from variable costs.
One of the strategies that is being explored in this research paper on both target and relevant costing are several concepts of lowering the costs of production which in principle involve significant reduction of the variable cost while effectively utilizing the fixed cost that the farm must still meet regardless of whether production takes place or not. Alternatively the research study provides a working framework that farmers can apply in order to reign in what are considered fixed costs to a level that would make farming a profitable venture. Some of the issues discussed under these two concepts in the research paper are use of machinery rings which economizes fuel, machinery contracting which would cut on maintenance costs and application of precision farming methods (Jack and Jones, 2007). This practices that ideally aim at regulating production costs are well captured by another concept referred as the Minimum Efficient Scale (MES) which is most suitable for determining the ideal production level of a company at which production is most cost efficient.
Minimum Efficient Scale
Minimum Efficient Scale (MES) is a concept primarily used in industrial organization to describe a point in production whereby a manufacturing plant produces the least amount of units that are able to minimize the Long Run Average Costs (LRAC) of the plant (MacAuliffe, 2004). It is the point where minimum efficient scale of a plant is attained since the least production of units at the lowest opportunity cost is attained, below this point a plant is not able to produce goods and meet the long run average costs of the plant. It is usually indicated as the first point of the LRAC curve when the variables of production and costs are graphically represented. In fact this is one of the major reasons that the research study advocates for ditching of the current accounting practices because they are fundamentally unable to offer farmers with the ability to determine the MES of a farming viability.
This advantage is what Jack and Jones refers to as the available forms of conventional accounting practices which they advocate for in the agriculture sector because they view them as adequate in “break-even analysis and the making of marginal decisions such as whether to make or buy in an element of service or production” (2007). In the same way that these concepts are used in decision making in the mainstream industries, so can the farmers apply them reliably to determine the least levels of farm production that should be financially viable as well as the point at which the maximum farm output should be pegged on. This is more so the case when you consider the effects that the “decoupling of subsidy from production” has had on the agricultural sector in general.
The importance of the minimum efficient scale concept is that it is able to determine the point at which the maximum effectiveness of the plant is attained (McConnell, Brue and Flynn, 2009). Ideally since the minimum efficient scale is a specific point in the production curve its value is often expressed quantitatively as an exact figure; nevertheless it can take various ranges as well as values (Frisch, 1980).
This is because the long run average cost (LRAC) curve is basically influenced by two major variables: economies of scale and diseconomies of scale (Frisch, 1980). Hence minimum efficient scale is not necessarily a single value of quantity but may also include range of values for which the point of minimum efficient scale can be said to occur.
Study Methodology
The research process for this paper is undertaken in a standard approach that is similar to the way that many types of high quality academic research studies are undertake. Foremost the authors of this paper undertakes an in depth literature on the subject of management accounting that are used in cost methods and decision making in the agriculture sector which they admit to be “sparse academic literature” (Jack and Jones, 2007). At the end of this section a total of more than 20 relevant academic resources that have been written on the subject including other similar research studies have been cited in the paper to support the theories that are discussed in the paper. The paper starts by exploring the background issues that are pertinent to the topic of study which in this case include current accounting practices used by the farmers, timeline on adoption of other accounting methods and a preview on the impact of the Common Agricultural Policy (CAP) in the farming sector which sets the stage for a more detailed analysis of this issues throughout the paper.
In the latter section of the paper, the authors relies on survey interviews with key peoples of interest which in this case include farmers and other stakeholders such as policy makers, bankers and financial advisors. Finally, the authors also use hypothetical case presentations and data from the agriculture sector to elaborate on the suitability or weakness of particular concepts of accounting methods which are discussed throughout the paper. As such, the methodology that is used in this paper is a combination of literature review, interviews and hypothetical case studies.
Conclusion of the Article
To address the challenges of costing methods in the farming business that has been compounded by the five factors which have been articulately discussed in the study, the authors advocates adoption of two accounting approaches; that of relevant costing and target costing. There are several reasons that are discussed in the paper to support the urgency and importance of introducing accounting methods that are reliable and effective in enabling farmers to make evidence based decisions in the wake of policy and other changes that have taken place in the agriculture sector. One is the key reform that the current costing methods have been unable to address which is the Single Farm Payment subsidy contained in the recently enacted CAP regulation. This is because neither the gross margin nor the net margin cost analysis methods can effectively enable a farmer determine the farming viability in such a manner that is possible when using target costing and relevant costing account principles.
Two, the importance of introducing these two accounting approaches in the agriculture sector is because of their ability to apportion costs into relevant categories and allow for a more wide variability of fixed costs than is currently possible when using current costing methods that are being relied in the sector. Three, the introduction of the concept of target costing in the agricultural sector opens in new opportunities for farmers as it offers the advantage of basing prices to predesigned farm products that targets specific market segments. The implication of this is that farmers are able to produce certain farm products that are pegged on specific prices around which these products can be designed and produced. Finally, the introduction of CAP reform in the agriculture sector implies agitation of farming practices that is both sustainable and meaningful; both of these accounting approaches that are being advanced in the study support this notion in that profit viability of a farming initiative is not pegged on its productivity alone but also on the cost effectiveness of doing so.
My Opinion of the Article
The authors in this paper provides a strong case for the argument on why it’s overdue for the policy makers to introduce new accounting approaches to guide decision making in the farming sector. The research study is well designed, researched and presented in a way that is not only convincing but also very professional and consistent with the standard way of conducting and writing academic research studies. My assessment of this paper in general is that it is very systematic, organized, consistent and factual in every aspect, for this reason this paper meets and exceeds my expectations in the way that it raises and discusses pertinent issues that are talked in its subject matter and I concur with both the subject matter of the paper as well as its conclusion.
References
Barnard, S. & Nix, J.1979. Farm Planning and Control. Cambridge University Press, Cambridge.
Colier, P. & Gregory, A. 1995. Strategic management accounting is being increasingly used in hotel groups, both in planning and evaluating market conditions and in competitor analysis. International Journal of Contemporary Hospitality Management, 7(1): pp 16-21
Frisch, R. 1980. Theory of Production. California, CA: Drodrecht Press.
Gulati, R. 2006. Decision Making: Relevant Costs. Web.
Gelles, G. and Douglas, W. 1996. Returns to Scale and Economies of Scale: Further observations. Journal of Economic Education, 27(5): pp 259-261.
Jack, L & Jones, J. 2007. Facing up to new realities: The case for using relevant cost and target cost approaches in agriculture. Journal of Applied Accounting Research, 8(3): pp116 – 145.
MacAuliffe, R. 2004. Minimum Efficient Scale. Web.
McConnell, C., Brue, S. & Flynn, S. 2009. Economics: Principles, Problems and Policies. 18th ed. New York, NY: Mcgraw-Hill.