Analysis Of Activity Based Costing, Cash Budget, And Offer Acceptance

Analyis on Activity Based Costing

Brendan had a very less knowledge about activity based costing cash budget. He wants to know what activity based costing actually means and what the purpose of using it is. Does it really have certain benefits to the company? There were other areas also for which Brendan was keen to know about one of which was cash budget. He doesn’t know the exact use and importance of preparing it so he needs to know whether he should prepare it or the accrual budget is enough (Alex 2012).

Here is the question to his answers relating to activity based costing and cash budget. Activity based costing is the procedure of allocating the expenses that has been incurred to the various departments after analysing the extent of use of service. Hence, the department which does not use any service will not have to bear any kind of expenses. This method is usually preferred by companies that produce different and goods of specialised nature. With the help of this system, it becomes easy to identify the cost incurred in a particular department or the process. Brendan should also know about the various advantages and disadvantages of adopting this system (Ball 1995).

 The following are the advantages of using activity based costing system.

1. This method helps to identify and differentiate between the wasteful and useful cost that has already been incurred. This is considered a big advantage because it helps in cost reduction (Berman, Knight and Case).
2. The pricing policy of the company is being helped by this method as this method helps to allocate the cost in various departments and ascertain the cost per unit. Therefore, it helps to make decisions regarding the price of the product.
3. A detailed study of working of all the departments has to be done in order to allocate the cost. While studying the working the company also comes to know about the efficiency of the departments.
4. The activity based costing is a wider concept and therefore can be used for all the departments of the company whether manufacturing or administrative.

There are also some disadvantages of using this system. They are –

1. The activity based costing is a little expensive method as it requires proper supervision initially (Bragg 2014).
2. This method takes involves huge time for implementation as a detailed study has to be done for all the departments and various processes.
3. This method is not fully utilised if the overhead has a very small proportion in the total costs. If the overhead is in any way related to the volume then the chance of cost reduction gradually decreases.

As we can see that there are both advantages and disadvantages in the method. We would recommend Brendan to adopt this method because all the disadvantages are related to the initial implementation (Brigham and Ehrhardt). Later on, It will have positive impacts for the company.

Brendan also wanted to know about cash budget. In simple terms, Cash budget is a plan made by the company of its various cash receipts and cash payments. The cash receipts include activities like cash sales, collection from debtors, dividend and interest received or any other kind of miscellaneous income (Cafferky 2014). The cash payments include any kind of expenses that is paid in cash such as payment to creditors, cash purchases and payment for various kinds of expenses such as wages, salaries, rent, etc. Cash budget helps the company to manage its funds properly and efficiently. Proper information relating to the opening cash balance and closing cash balance along with the various cash transactions is available.

It is very important for a company to manage its funds properly so that it can make maximum utilisation of such funds. The company can plan for maintaining a minimum cash balance and if there is any surplus money left at the end of the period then the company can invest that money somewhere so that it does not loses the opportunity to earn interest thereon. However, if the company is falling short of money and is unable to maintain minimum cash balance then it comes to know that there is a requirement of raising loans because the company cannot run if it does not have liquidity (Gitman and Zutter 2012). Cash budget helps in minimising the cost and maximising the profits. It creates a better understanding and coordination between different departments because a plan is ready for them.

Advantages Of Activity Based Costing

Cash budget helps to know about the inflow and outflow of the cash and therefore, we can recommend to Brendan to prepare it. He should know that along with the accrual budget the cash budget is equally important (Holmquist).

Brendan is confused regarding the acceptance of offer by hills west surveyors. The production manager advices him not accept the offer. But he wants a suitable reason for the rejection (Hoyle, Schaefer and Doupnik). Therefore, a comparison of profitability has to be done in order to draw a conclusion. The company was currently producing 30000 units although the installed capacity was 60000 units. So, the profitability in the current situation after taking into consideration all the costs are as follows-

So, from the above calculations it is clear that when the company produces 30000 units then it earns a profit of $2430000. Since, the company is not operating at its maximum capacity it can produce beyond 30000 units but not more than 60000 units because that is the maximum capacity level (Hoyle, Schaefer and Doupnik). If the company accepts the offer then it will have to increase its production by 20000 units as per the requirements of hills west surveyors. There will be some additional cost incurred on production of such extra units. Hills west surveyors want some changes to be made and such changes will reduce the variable cost to $380 which before any modification was $420. The offer price per unit is $ 500. However, the fixed cost remains the same irrespective of volume of production (Kinney and Raiborn).

If the company will accept the offer it will have to increase its production from 30000 units to 50000 units. Therefore, it is necessary for the company to determine whether it will be profitable and whether the reduced offer price help the company to earn sufficient profits (Koster 1997).

The above table shows that the profit of the company will increase if it accepts the offer by hills west surveyors (Nolop 2012). Although the company sells at price lower than normal selling price it will earn profits as the variable cost is also decreasing after certain modifications.

We would advice Brendan to accept the offer by showing him the above calculations (Pratt 2014). The company previously earned a profit of $2430000 but after it accepts the offer the profit increases to $4830000.

It is the policy of the company to manufacture the video cameras and 3sixty in-house. The company now thinks to give order for such cameras to a well reputed company known as elivestream. The company should consider various factors while choosing between the two. It should make a comparison between the purchase price of such video cameras if it purchases it from outside and the variable cost that it would incur if it carries out in house development. If the purchase price is considerably low then the company should surely go for outsourcing but if there is not a big variation or the purchase price is more then the company should obviously not think of purchasing the video cameras from outside (Pratt 2014).

Disadvantages Of Activity Based Costing

There are also other factors that should be kept in mind before taking a final decision. It is advisable to the company to avoid outsourcing if there is a very minimum variation in the purchase price and the cost of development because if we buy it from outside there will be a risk of losing special orders. Many times there may arise a situation when the company will be unable to provide with the video cameras timely and hence we may lose the order (Ramsey and Ramsey). Losing orders not only results in losing profits but it also damages the reputation of the company. However, if we manufacture it ourselves then we can manage and maintain the stock level accordingly. The following table shows that the company should go for outsourcing on the basis of financial grounds:

 The company incurs $325 per unit when it manufactures the video camera in-house but if it buys video cameras from elivestream then the cost per unit of video cameras will be only $255. This means that if the company buys video cameras from elivestream it would be able to solve cost of $(19500000-15300000) = $4200000.

There are many factors that have to be considered. Only considering cost and taking decision on its basis is not wise (Tansky and Heneman 2006). The company has to look after various aspects before taking a decision because apart from earning profits, the company also has to satisfy their customers and maintain a healthy relationship with them. If the company only considers profit and ignores all the other factors then it may lose its reputation in the market and this will affect the company in the long run .

All the questions that Brendan asked has been answered. It will provide him details of activity based costing and cash budget. It has also provided him with an advice about the hills west surveyors offer which according to us be accepted (Weil 2014). The situation when Brendan was in confusion that whether to manufacture the video camera or he should produce it has been analysed properly. It is always very necessary to analyse the situation and then take decisions. So, all the aspects must be considered before taking a decision.

Conclusion:

The report discloses all the material fact about the activity based system along with its advantages and disadvantages. The cash budget has its own importance and should be prepared to ascertain the cash position and the transactions. The accrual budget is also important but the cash budget has its own importance. The company needs to analyse any offer before taking a final decision. Therefore, the calculations have to be made. The company may produce itself or do outsourcing. It depends on them but they should first see both financial and non financial grounds.

Reference:

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