Activity Based Costing And Customer Profitability Analysis Case Study

Activity Based Costing

WN 2: The overheads are allocated on the basis of percentage that is stated above as per activity based costing. Discount is considered to be the cost for the sellers. Therefore, such discount has been added to both the departments.

WN 3:  As per the distribution channel cost report, there are two departments and the cost is allocated to the two departments accordingly. However, the total overhead expense does not appear in the reports.

Louise is famous for the consultation of interior designing and also for window treatment fabrication.  There are two different distribution channels in his business. The first one is the architecture firms and the second one is the commercial window treatments business.  Louise has one client for architecture firms and three clients for commercial window treatments.

The required case study has been provided to us in order to prepare the activity based report, cost report of the different channels and customer profitability also which will help us in assessing the overall profitability that they are able to earn. The cost incurred in the overall business as well as in different departments can be understood with the help of activity cost report.

The customer profitability report is prepared as it helps to understand each customer’s contribution in the profits earned by the company. This report also provides us the information of the total profits of the company. However, the distribution channel report helps us to obtain information about the costs that is incurred in different channel.

On the basis of the calculations made in this assignment, a proper analysis has been carried out and recommendations have been given.

The company has adopted activity based costing as the cost allocation method in which the cost is allocated on the basis of cost that should be allocated to that department. The company does not use traditional costing system but it gives a clearer picture.

On analysis the customer analysis, it is observed that the cost incurred in the windows department is amounting to $ 530980.  But when we look upon the customer profitability report, we observe that the profits that are generated from the architecture department are higher. The analysis shows that more revenues are generated from the windows department when compared with the other department. The company has adopted a strategy in order to attract customers; it gave the customers a discount of 10% which amounted to $23,400. This strategy was adopted by the company to slower down the sales of the competitors. There was also a negative impact because of this which is that the company has to suffer loss or incur extra costs of $23,400.

Customer Profitability Analysis

The company also decided to provide 5% discount to the customers who would make advance payments in cash. This strategy was justified because the cash payments helped the company to shorten the operating cycle. As we know, a shorter operating cycle is considered to be favourable as it beings the company to a good position.

The total profitability of the company is in negative which can be observed in the customer profitability report of the company. Although we can see that the departments of the company are generating profits individually but when it comes to the overall profitability the company is suffering because of the huge overhead costs and the heavy discounts that it is providing to the customers. If the company would not have provided 10% discount to Adams then the profitability of the company would have been positive. It is observed that there are huge overhead costs that are involved in the distribution channel cost report of the company (Atkinson, 2012).

Activity Based Costing is preferred by the company and the reasons for it are as follows:

• Activity based costing helps to allocate costs to the product on the basis of the actual resources that is consumed. Therefore, it helps in allocating the costs correctly.
• It improves the decision making process as the information obtained because of this costing method is true. It helps the firm in deciding whether it should continue producing a particular product or not keeping in mind the profitability.
• The absorption capacity of the individual departments and the department’s contribution helps to know about the cash flows and profits.

Therefore, the company is recommended to use activity based costing in future also.

The company has also provided discount to the customers in order to complete with the competitors which is not appreciable as it has affected the profits. The company incurred losses of $21600 because of this offer but this figure could have been the profit figure if the company would not have adopted such strategy. There were alternative strategies that were available, they were production of market substitutes and own house etc.

The company has a better option which was to shut down the current production of one business, save costs and then invest such money at a place where the cost of production is low and the company is able to generate higher profit.

Conclusion

As we know, market is dynamic in nature and therefore, there is a requirement of certain precise methods in all the fields whether accounting, auditing or costing. The reports that are prepared by the company are used by various users in order to take numerous decisions such as comparison of costs between different competitors and that of the industry rates, investment decisions or raising loan decisions. Therefore, the reports prepared should fulfil the qualitative characteristics of transparency.

In this dynamic environment, the companies loose customers very easily which is highly unfavourable. In the current situation, the companies give more importance to customers than the profits. Customers help the companies to survive in the long run and therefore, customer satisfaction is the main objective of the company. If the primary aim of any company is to earn profits only then it might not survive in the long run. The objectives of the companies should be analysed properly and steps should be taken accordingly. However, preparation and analysis of report is a difficult job but this helps in providing true and fair view about the company which is demanded in the current scenario (Seal, 2012).

This assignment comprises of information about the different approaches that are adopted by the company, its costs and profits from individual customers, department or the entire business. This information is considered to be very important because the management uses this information to take important decisions regarding the business activities.

The company should prefer manufacturing Super Chip as it produces $5 per hour. The maximum number of Super Chips and Oky chips that could be produced taking into consideration the maximum units are shown below.

Therefore, the company should manufacture 15000 units of Super chip.

Case 1: when there is no transfer, profit calculation:

Case 2: When there is a transfer of 5000 Super chips to the process control unit:

Conclusion: On comparing both the cases, it is found that the profits increased by $15000 and therefore, the company can go for the transferring option.

The transfer price for 5000 Super chips would be $80 per unit which would be considered as sales for the first division and cost for the second division.

There is no impact on the profits whether the company has adopted transfer or sale in case of the super chips. But in the case of Process control unit we can see that the profits has increased by $15000.  It is advisable that the company should consider transferring 5000 super chips to the other department and purchase the material at $ 70 per unit. However, the transfer price would be $ 80 per unit.

Case 1: when there is no transfer, profit calculation:

Case 2: When there is a transfer of 5000 Super chips to the process control unit:

Conclusion:  

15000 hours could be used to produce 15000 oky chips where contribution per hour is $4/hour. The case of transfer and without transfer should be analysed.

Atkinson, A. A. (2012). Management accounting. Upper Saddle River, N.J.: Paerson.

Seal, W. (2012). Management accounting. Maidenhead: McGraw-Hill Higher Education.