Assessment Of Three Alternatives And Activity-Based Costing In Management Accounting

The Three Alternatives Presented by Bonza Handtools Limited

To,

The Directors of Bonza Handtools Limited,

Date: 18.1.2018

Subject: Assessment of the three provided alternatives

Respected Sir/Mam,

This report has been prepared by representing the advantages and effect of the provided alternatives on the organisation, which are summarised briefly as follows:

The accountant of the organisation proposed that in order to raise profit margin, the selling price per unit should be $140. Based on the above table, it could be seen that the revenue margin of the organisation would rise from $300,000 to $375,000, which would fetch a profit of $75,000. For accomplishing this margin, Bonza needs to incur $125,000 on advertising expense. However, it would increase the overall business risk, if the organisation fails to design its advertising campaign effectively. In such situation, the profit level of Bonza would fall due to the rise in promotion and advertising expense. As a result, it might lead to loss of customer loyalty, as they would be burdened with additional charges for the products.

The production manager of Bonza stated that by raising the sales volume by 25% and variable cost by $5 per unit, there could be enhancement in the overall product quality. For achieving the same, the use of promotional tools could be made amounting to $50,000. However, an increase in variable cost would result in minimisation of the contribution margin per unit. Along with this, due to the lower cost of advertising compared to the first proposal, an additional profit of $75,000 would be made. This is because the product quality would be improved, which would result in greater customer satisfaction. Finally, Bonza might experience increased profit in future due to the creation of new customers.

The sales manager of Bonza stated that there needs to be reduction in the selling price by $10 per unit for the first three months of the fiscal year. Moreover, for making a profit of $60,000, the organisation is required to spend $40,000 in the form of advertisement expense. However, this proposal might lead to customer loss, since they might think that the quality of products has declined with the decline in price. Hence, Bonza might not be able to generate sufficient revenues for maintaining its business operations in future.

According to the above discussion, the directors of Bonza Limited are advised to implement the proposal of the production manager. The reason is that this proposal would enhance the quality of products and volume of sales. This would result in the generation of profit of $75,000, which is equivalent to the proposal of the business accountant. However, the latter proposal contains greater risk, as too much focus is placed on promotional and advertising campaigns. Moreover, despite increased profit could be earned, if the third proposal is adopted, the chance of customer turnover increases in tandem as well. Thus, the proposal of the production manager of Bonza is feasible to increase its overall revenue margin.

Selection of the Most Feasible Alternative

The provided case states that the Tassie Company is currently manufacturing 150,000 units; however, it has the capacity to produce 200,000 units per year. As stated by Becker et al. (2015), if the overall capacity is used, both sales volume and profit margin would rise. In this case, the company does not need to sacrifice its production level for bidding to manufacture 40,000 production units of the governmental department. Thus, the selling price of the product for the Tassie Company is obtained as $10.8 per unit. This is obtained by adding variable cost, fixed cost and 20% mark-up on the cost price (Chak and Fung 2015).  

According to the given scenario, the maximum production capacity of the organisation is 180,000 units per annum; however, the current level of production is 150,000 units per annum. In this situation, it has to compromise 10,000 production units for which it makes profit of $2.50 per unit in order to accept the government contract. Thus, for the initial 30,000 units, the average price is $10.80 per unit and for the extra units; the amount would be $13.30 per unit. The overall average price of 40,000 units is obtained as $11.43. 

In the words of Fourie et al. (2015), for activity-based costing, cost is distributed for activity depending on the amount of time spent in the manufacturing department of an organisation. With the help of activity-based costing and segmented overhead cost pools, suitable decisions could be undertaken in relation to the cost structure for increasing profit. In case of activity-based costing, the direct cost of a specific department is identified and thus, the projected departmental hours are computed (Fullerton, Kennedy and Widener 2014). For arriving at the rate per unit, the direct cost is divided by the projected hours.

The cost pool signifies the direct cost, while the projected hours could be tracked as cost driver (Lavia López and Hiebl 2014). Thus, the cost would be minimised by creating competitive pricing structure leading to increase in profit margin. For instance, supervision expense is allocated based on the number of workers in a particular department.  

The overhead segregation could be advantageous to determine cost not revealed in the normal course of business while estimating the costs of overhead; however, there is close association between them. The incomes and expenses are allocated to all the production departments to gain an understanding of the most profitable business segments (Nuhu et al. 2017). On the other hand, if the concentration is above a single product, there could be effectiveness in overhead cost. As a result, it would allow the managers to anticipate the profit margin of the product line. Along with this, it is possible for the accountant of the organisation to detect overhead, which could lead to either positive or negative effects on the profit level of the products. The overhead costs could be divided into different expense heads and this would help to determine the individual job or service cost. Few examples are provided in a tabular form as follows:

Indirect overhead	Variable overhead	Administration overhead	Manufacturing overhead
· Telephone and office expenditure · Research and development cost · Administration salaries · Audit and accounting fees · Legal expense	· Equipment utilities and production supplies · Wages for managing materials	· Office supplies · Front office expense · Wages or commission · Legal and external audit cost · Selling and administrative utilities · Administration lease and sales office	· Factory rent · Salaries of managers and maintenance personnel · Property tax · Factory utilities · Janitorial staff wages

Overview of Activity-Based Costing in Management Accounting

The overhead cost could be explained with instances. For instance, the use of computer system is made in Melbourne Private Hospital in order to fix treatment timing and this is utilised at the nurse station on the part of the physicians (Otley 2016). Moreover, there is requisition of treatment of materials and orders and charges and costs are recorded systematically in line with the duration of the patients’ stay in the hospital. The costs related to bed fees, medicines, patient meals and X-ray reports are considered. Thus, after the recovery of the patient, the hospital authority is required to provide bills to the patient comprising of doctor fees, medicines, direct and indirect overhead costs. Thus, the costs are presented in an effective manner in the form of subsidiary ledger including episode number and medical numbers related to the patients.

Redmond Gary, another Australian manufacturing firm, allocates the labour hours in order to allocate the accurate costs to the employees to generate costs, which the organisation is expected to incur. Moreover, the lawyers and accountants are involved in maintaining other direct costs and labour hours related to workers. At the time the cost is distributed to distinct services and jobs, it is simple to identify the accurate cost amount needed to be incurred. As a result, it helps in making decisions related to pricing policy (Velasquez, Suomala and Järvenpää 2015). At the time the cost is distributed to different services and jobs, the total cost of each department is tracked with the benefit derived from each department. 

References:

Becker, S.D., Wald, A., Gessner, C. and Gleich, R., 2015. The Role of Perceived Attributes for the Diffusion of Innovations in Cost Accounting: The Case of Activity-Based Costing. Comptabilité-Contrôle-Audit, 21(1), pp.105-137.

Chak, S.C. and Fung, H., 2015. Exploring the effectiveness of blended learning in cost and management accounting: An empirical study. In New Media, Knowledge Practices and Multiliteracies (pp. 189-203). Springer, Singapore.

Fourie, M.L., Opperman, L., Scott, D. and Kumar, K., 2015. Municipal finance and accounting. Van Schaik Publishers.

Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2014. Lean manufacturing and firm performance: The incremental contribution of lean management accounting practices. Journal of Operations Management, 32(7), pp.414-428.

Lavia López, O. and Hiebl, M.R., 2014. Management accounting in small and medium-sized enterprises: current knowledge and avenues for further research. Journal of Management Accounting Research, 27(1), pp.81-119.

Nuhu, N.A., Nuhu, N.A., Baird, K., Baird, K., Bala Appuhamilage, A. and Bala Appuhamilage, A., 2017. The adoption and success of contemporary management accounting practices in the public sector. Asian Review of Accounting, 25(1), pp.106-126.

Otley, D., 2016. The contingency theory of management accounting and control: 1980–2014. Management accounting research, 31, pp.45-62.

Velasquez, S., Suomala, P. and Järvenpää, M., 2015. Cost consciousness: conceptual development from a management accounting perspective. Qualitative Research in Accounting & Management, 12(1), pp.55-86.