In previous articles, we’ve discussed the fact that as we learn more complicated accounting skills and techniques, our ability to communicate them to colleagues, managers and clients without financial expertise, becomes a bigger challenge because the gap between their understanding and ours widens.
This is particularly so at professional level as we have now covered a significant range of accountancy topics, within both financial and management accounting, and can work at higher levels within organisations on a more strategic basis. However, in order to be able to contribute successfully at this stage we have to draw on the foundation of knowledge, understanding and experience that we’ve acquired along the way.
In part one of this series on active verbs (foundation level) we covered the most common command verbs at foundation level; identify, describe and explain.
In part two we added the advanced level verbs; analyse, compare, discuss and recommend.
All of these are still relevant at the professional level and are often incorporated into questions which include a number of active verbs across all levels. For example, you could be asked to identify an issue, recommend a range of solutions and then justify how you reached your decision.
Before we look at the final verbs we need to complete our series, let’s give ourselves an imaginary context because at this stage the level of detail required can only be successful achieved by being specific.
Let’s say we work for a manufacturing organisation that needs to rationalise the number of products it makes. It has two similar products so wishes to discontinue one. The following information is available:
Overheads are recovered on the basis of machine hours and the last review of the allocation of overheads to products was five years ago. Both products use a raw material that is frequently difficult to source.
The managing director is proposing discontinuing product A as product B returns a significantly higher operating profit. A meeting between the managing director, the sales director and finance director has been arranged to come to a final decision.
So, now let’s look at our verbs:
Consider the evidence presented and come to a reasoned judgement based on relevant facts
You may be asked to assess the managing director’s proposal. Your answer could be:
The managing director has based his proposal purely on the reported profits of each product and on the face of it this seems logical as product B generates over £10,000 more profit than product A. However, using operating profit alone as the basis of a decision about which product to discontinue, does not take a number of issues into account. Firstly, the operating profits include fixed overheads that have been allocated on a basis that is five years out of date and apportions £21,900 to product A, which is significantly more than the £9,000 apportioned to product B. This means that the accuracy of the operating profit figures is questionable. Another issue concerning the fixed overheads is that they are irrelevant to this particular decision anyway because they will be incurred regardless of which product is discontinued. The operating profits are also not the best basis for the proposal as they are calculated on sales volumes and as these are not the same for the two products then an accurate comparison is not possible. Finally, the proposal also ignores the fact that product B uses more of the raw material that is often in short supply, than product A. After considering all the information available I would suggest reassessing the proposal using a different approach before making a final decision.
Make a judgement on something based on a range of factors, using available knowledge/experience/evidence
You could be asked to evaluate the possible consequences of the managing director’s proposal, making particular reference to the implications of materials being limited. In this case, your answer could include additional calculations to help your evaluation as well as using your wider knowledge and experience:
The current proposal is to discontinue product A and continue manufacturing product B. The consequences of implementing this proposal would be positive under normal production circumstances when there is no shortage of materials. This is because the contribution per unit for product B is £43 which is £4 per unit more than product A. Using a contribution per unit approach to deciding which product to discontinue solves the issues associated with the operating profit basis as it is comparable regardless of sales volumes and only includes variable costs. However, as both products use a raw material that is often difficult to source, it is important that the implications of frequently having a limiting factor are taken into consideration.
Every unit of product B uses four metres of material, whereas three metres are required for each product A. When resources are limited, profits are maximised by manufacturing the product that generates the highest contribution per limiting factor. In these circumstances product A would provide a contribution of £13 per limiting factor (£39 ÷ 3m) in comparison to £10.75 (£43 ÷ 4m) generated by product B. That said, because both products use the same raw material, there may be a fundamental issue with the supply regardless of which product is discontinued – an investigation into its sourcing would be of benefit as part of the decision-making process.
In addition, consideration should also be given to the wider implications of only producing one product, for example, as they are similar would sales increase of the retained product or would customers look at competitors’ products for comparison instead?
In conclusion, further consideration should be given as to which product should be retained because discontinuing a product is a long term strategic decision. Currently there are unknown factors that should be explored and evidence which supports both products in different circumstances.
Give supporting arguments for actions or decisions made using evidence
You might be required to make recommendations for the management meeting to consider, giving justifications for your suggestions. Your answer could be:
In order for an informed decision to be made about which product to discontinue the frequency of materials being in short supply should be quantified and alternative suppliers should be investigated. If the supply of materials can be improved so that normal production can operate, then product B should be retained as it generates the highest contribution per unit. However, if the supply of materials cannot be improved and manufacturing will continue to operate with limited resources, then product A should be retained as it generates the highest contribution per limited factor.
In addition to the above recommendations, other commercial and marketing factors should be taken into account. For example, how price sensitive the market is, because product A retails at £88 and product B at £152. It would be advisable to conduct some market research to help predict how discontinuing one of the products may affect sales of the other. The hope is that total sales would be maintained and profitability increased due to the rationalisation of costs, however, the possibility that only having one product on the market will actually reduce sales, as customers choose competitors’ products instead, should not be ignored.
Finally, whilst it has no bearing on this decision, the allocation and apportionment of fixed overheads should be reviewed as it is five years out of date. This would improve the accuracy of the operating profit figures which would make them more valid and useful to the decision making process.
That completes our set of active verbs.
We have also considered; BUG to help analyse questions, structure to make sure we present our written work appropriately, and the reader we are communicating with to ensure our language is suitable.
The final element to add is planning.
You need to plan your work so that it ends up the right length, with the right amount of detail and has taken the right amount of time to compose and proof read. My planning has not worked out this week as it has been the start of the school holidays, my computer got a virus and I have builders working at my house who require lots of tea.
Therefore this article has taken four attempts to write, rather than the one that I had diarised for Monday.
I am happy it has the right level of detail though, although it would be helpful to have the equivalent of a mark scheme to indicate how you, the reader, may judge it. I have re-written sections over the week to clarify and polish them so am hopeful your will find it easy and useful to read.
That said, it is a little on the long side, so my final study tip is, that if you do have an indication of how your writing will be marked, use it to help your planning.
- Understanding fixed overhead variances
- What’s the difference between ROCE & RONA?
- Study in chunks with AAT’s study timetable
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.