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Accounting can be considered as the identification, measurement and communication of financial information to the various stakeholders in order to contribute to effective decision-making regarding the business strategy of the organisation. When considering the accounting practices followed by business organisations there are three types of systems or parts based on financial, cost and management accounting. The financial and cost accounting principles and systems are undertaken in order to comply with the laws and regulations, whereas management accounting facilities internal processes such as identification, measurement and communication of the processes, projects and their implementation and controlling
Southern and Scottish energy can be considered as a vertically integrated energy company in the United Kingdom, operating power generation plants and distributing power in various forms to the households and businesses in the United Kingdom and mainly in the Northern areas of UK. The company has different divisions which manage electricity generation from hydroelectric power plants, coal based or gas-based power plants. The vertical integration came about after several acquisitions made by the Scottish hydroelectric which combined with Southern Electric in the areas of coal and natural gas electricity generation plants and distribution networks in Scotland and in the northern areas of England.
One of the significant achievements of the company over the last several years has been a sustained dividends pay-out to the shareholders. Due to the vertical integration the company has managed to invest in different areas of its business vertical and has achieved a level of balance in the areas of energy production, transmission and distribution. But in the wake of the negative factors from environmental and economic conditions the company has come under the scanner of Ofgem which is the power regulator of the United Kingdom. In the last one year several factors affecting the business strategy of the company such as the nuclear disaster in Fukushima in Japan, the crisis in northern African countries contributing to increasing oil prices and the current situation or the crisis developing in the Middle East due to the possible blockade of the Gulf by Iran. Apart from this increasing worldwide concerns contributing to an instability and uncertainty in the business environment, there is also increased level of consumer and regulatory scrutiny about the way in which the company handles the pricing policy. There is still mounting concern about the way in which the entire company is offloading some of its losses from certain operations to the profit generating arms of the business and thus able to show reduced profits an overall basis.
Accounting can be considered as the identification, measurement and communication of financial information to the various stakeholders in order to contribute to effective decision-making regarding the business strategy of the organisation. When considering the accounting practices followed by business organisations there are three types of systems or parts based on financial, cost and management accounting. The financial and cost accounting principles and systems are undertaken in order to comply with the laws and regulations, whereas management accounting facilities internal processes such as identification, measurement and communication of the processes, projects and their implementation and controlling (Chadwick, 1998). Along with various considerations of developing business strategy, marketing and operations perspective, the management accounting provides information to the managers in order to understand several factors which could affect the company and from an accounting and management perspective. Every decision taken by any organisation at different levels of the management has financial implications (Atrill and McLaney, 1994). Management accounting facilities the decision-making of managers by providing them with information about the financial implications of different strategies which can be adopted (Lucey, 2003). Moreover management accounting provides various models based on which costing and accounting can be considered. The basis of management accounting is the consideration of cost and using the data with regards to the cost of various activities of the business and there are models such as absorption, marginal, variable, historic, predetermined, relevant and incremental costing methods (Chadwick, 1998).
One important principle or model of management accounting is the activity based costing system which considers all the activities, determination of the resources involved in them and categorises the activities based on value addition to the products and services provided by an organisation (Brimson, 1997). The activity based costing system estimate the cost of producing the products and services in order to identify and reduce those that are unprofitable and make pricing decisions (Cokins, 2001). The activity based costing system also helps in the re-engineering of the processes through the identification and elimination of ineffective and under effective processes leading to enhanced efficiency (Brimson, 1997). Moreover activity based costing provides an understanding of the products and services of the organisation and the cost borne by the customer which provides for the profitability to be allocated not for the specific product and services but also for the performances of the processes (Lucey, 2003). In operational management the activity based costing system allocates the cost based on fixed, variable and overhead costs which help in identifying the cost drivers. For any organisation there are direct and indirect cost and products which use resources from various cost centres in different weightages. The activity based costing system helps the management to better understand the cost drivers and what are the specific factors contributing to the cost drivers.
In the case of Southern and Scottish energy there are direct costs (such as the production of energy, transportation, distribution etc.) which come under several industrial verticals within the same organisation (SSE, 2012). But there are also indirect costs in sales and marketing, servicing the customers, non-performing assets, use of information technology etc. which cannot be directly attributed or allocated to a particular customer segment. The specific customer segments of the company are domestic and non-domestic, electricity and gas (SSE, 2012). The overhead costs are borne by these different segments of the company with different weightages and in order to allocate prices or costs to the customer for each product or service, it is necessary to allocate the costing for each indirect activity based on the activity costing model.
The Southern and Scottish energy provides energy which cannot be stored and the production is based on demand and supply conditions. Almost all the operations of the organisation can be considered as activities starting from the generation of electricity from different resources, distribution, transportation etc. Due to its intangible nature, the power cannot be considered as a particular product when it reaches the customer. Moreover since the company is vertically integrated, the cost to the customer will be based on all the activities in the system such as the generation, transportation and distribution. The vertical integration of the company provides that each unit of the company such as power generation charges the follow on the unit such as power transmission for the revenues and activities and thus the entire company charges the customer based on the different processes. But ultimately when the distribution company charges the customer, there may be unfair cost advantages to certain segment of customers and could result in overcharging or undercharging because the different activities in the value chain are not correctly priced for each product or service.
Taking a particular example, the company produces power from coal, gas and other renewable sources which all have different cost structures and cost drivers. When the distribution and supply company charges the customers for each unit of electricity, it allocates or amortises the different cost structures so that the company can generate an overall profit. Hence the various activities in the value chain of the entire organisation needs to be quantified and allocated the different costs so that each activity can be independently analysed and measured for efficiency.
The strength of the analysis is based on the fact that all the operations of Southern and Scottish energy can be considered as activities which provide or add value to the customer. The activity based costing system is hoping to improve the transparency in the pricing model and which can be explained in a better manner to the energy regulator and the customers. Many service-based organisations follow activity based costing system and particularly in the case of vertically integrated companies. The Southern and Scottish energy itself considers activity based costing to manage the indirect costs arising from the use of information technology, telecommunications and other services which cannot be directly attributed to any specific product or service which the company provides to the customers.
Although certain factors and parameters which relate to the accounting principles and management of the company are available from the published data sources, the actual the activities and operations of the different cost structures and contributions to the value chain are not necessarily and readily available. This has contributed to the vagueness of the recommendation and which maintained that activity based costing system can be adopted by the company based on certain parameters. The vagueness is also stemming from the fact that the recommendation is based on general principles followed and management accounting practices and not based on the specific information which can improve the operations of the company. But overall it is considered that the activity based costing system will help the company to manage the different activities in the value chain and identify inefficiencies.