Cost Management System Of Adairs Company

Understanding Cost Management System of Adairs Company

Question:

Discuss About The Survey Of Factor Influencing Choice Product?

Understanding of cost management system of an organization is important for estimation of the internal management cost for an organization such as Adairs Company. There are various factors that are used in cost estimation and this mostly considers organization characteristics and value chain. Another factor that also plays a critical role in price estimation is the operational processes that add the overhead cost to each product. With this respect, there are two commonly used costing methods and these are traditional and activity-based costing. Traditional costing method involves estimation of overhead cost based on the volume of product produced. Activity-based costing takes into account all the activities that attribute the cost of products when estimating indirect cost on the product. Well, these two cost calculation methods have both benefits to the business and disadvantages (Hansen & Mowen, 2006).  The main focus of this report is exploring the cost management system as applied in calculating the cost of production of Adairs Company.

When looking at the company’s value chain it is important to explore the various aspects of the company starting from the product acquisition to the sales. This, of course, takes into account the characteristics of the company and other operational processes leading to the availability of the product. 

Adairs Company is an independent retail store that deals in homeware and home furnishings. The company has both online and in-house stores where it sells its many products. The company’s head office is situated in Victoria’s Scoresby. The company has also expanded its product range to include other furniture that the company did not sell. By this, the retailer has diversified its products also to consist of general homeware and children ware. This has also led to the formation of another product portfolio called giftware that generally consists of various gifts (Adairs Retail Group, 2017a).

The value chain for Adairs is complex and in order to understand the value chain, it is good to explore sources of the products. Adairs Company value chain can be described as consisting of operations, organization characteristics, and actual products, marketing and sales and after sale services. The products that are sold within the Adirs are acquired from manufacturers such as Abode Living at a price before it is transported to a warehouse for the company (Abode Living, 2017). For instance, Abode Living is good at manufacturing better and quality bed linen. These products are purchased by the company and sold in its many stores including an online shop.

Traditional and Activity-Based Costing Methods

The company deals in homewares that include bedroom products, bathroom products and other home products such as beddings, soft furnishing, children furnishing and furniture. The organization sells has recently started selling furniture that is part of bedroom furnishing and occasionally other general furniture. The store retails in bedroom products such as sheets, pillows, mattress covers and many other bedroom products. The company also sells bathroom products such as towels, bath mats, laundry products and robes. In addition, the retailer also sells giftware such as gift cards, home fragrances (Adirs Company, 2017b).

Adairs Company has categories its operation into product design, development, sourcing, and distribution and retail operations. Firstly, product design is consist of the branding of the products so that it forms the major brands of the company. Over 90% of products sold by the company is sold in company’s private brand with only less than 10% sold under third-party national brands. Secondly, retail operation consist of over 130 stores spreads throughout Australia. These stores are under the name of Adairs, Adairs Kids, Adairs homemaker, Adairs Outlets, and UHR. Within these stores, products are displayed with the intention of selling to any customer interested. Thirdly, Adairs also has an online store that offers the display for all products that are sold to the company. The distribution of the products to various Adairs outlets is done through the distribution department and also ship the products to any customer especially those customers that purchase a product through the online shop. Other operations include online shop maintenance and inventory management. These operations take into consideration various platforms that the company uses to market and sells its products (Adirs Company, 2017b).

The organization markets their products through various avenues that include an online shop, social media, and online website. Social media is one place that the organization exploits for advertising its products for many online users with Australia and beyond. Moreover, the retailer uses its fully equipped website to market its product which is also connected to the online shop. The company has an online shop where the company sells its many products with the ability to do online payment. The company has in-house stores spread in places such as Victoria, Northern Territory, New South Wales, Queensland, Western Australia and South Australia (Bloomberg, 2017).

Activity-based costing is one of the cost-calculating methods that is used by manufacturers to estimate the cost of item produced within an organization. Activity-based costing (ABC) involves the determination of the cost of every activity used in the manufacturing of an item and therefore determines the cost of an item manufactured based on the cost of every activity used in production. This implies that when using the activity-based costing method in assigning of the cost of the product, the cost of the product is the cost assigned to a particular activity used in production (Cleland, 2004).

Factors Influencing Cost of Production

Activity-based costing method differs significantly from the traditional cost calculation method. Activity-based costing allocate price based on the cost of activities involved in the production of an item and this differs from traditional costing method that pre-estimate the overhead cost based on the volume of cost drivers. Traditional costing method uses cost drivers such as machine hours or direct labor that causes the cost to incur and this differs from activity-based costing that uses the cost of activity involved in the production to allocate the cost of item produced (Barrett, 2005).  Traditional costing aligns to the generally accepted accounting principles and therefore easy to implement as compared to activity-based costing. One disadvantage of the traditional costing method is the traditional costing may negate other cost drivers when calculating the cost of an item (Hansen & Mowen, 2006).

When ABC is applied in calculating the cost of products of Adairs, there are some benefits that can be realized within the organization. Firstly, ABC offers accuracy when determining the cost of various items sold within the organization. For instance, Adairs have branches spread across the Australia and using ABC as cost calculating methods enable the organization to accurately determine the cost due to distribution as an activity. This ensures there is no loss when selling items within branches of the organization. Secondly, ABC method ensures that there are no irrelevant costing when determining the cost of an item. The method allows the true cost calculation with minimal overestimation of cost. Thirdly, ABC costing method ensures the Adairs management understands the overhead cost which is very important for estimating internal management cost (Velmurugan, 2010).

There are also some disadvantages of using the ABC costing method in calculating the cost of homeware sold at Adairs. Firstly, the implementation of the costing method itself requires many resources to be in place to ensure that the costs of various activities that are used in the production of items are allocated.  For instance, when estimating the cost of pillow that is transported from Sydney to New South Wales will require the management of the company to estimate the cost of various activities and this requires resources to calculate. Secondly, interpreting the costing method is sometimes difficult for users. This is also common in online Adairs shopping since customers see the cost of items as overpriced though the cost takes into consideration all activities involved. This can, therefore, drive away customers who feel that the price estimated is high as compared to other companies (Friedman & Lyne, 2013).

Product Categories of Adairs Company

Adairs Company has three product categories and these are bedroom products, bathroom products, and giftware.

Looking at the product categories for the organization, there are both direct and indirect costs that are associated with the product. Some of the direct costs that are associated with products are acquisition cost, distribution cost, labor cost, marketing cost, operation cost and after sale services. The direct cost includes the cost of acquiring the products from Abode Living (Hansen & Mowen, 2006). The products that are sold within the organization are acquired from manufacturers such as Abode Living at a price before it is transported to a warehouse for the company. Products are then taken through various value addition activities that add cost to the products. Another cost is the distribution cost that often results from moving these products from the warehouse in Victoria to another warehouse in Sydney. Labor cost though is part of operation cost can also fall on independent indirect cost. Operation cost is another indirect cost that includes all the cost that is incurred for management and maintenance of both facilities and various operational processes within the business. Operation cost is also added to the cost of items especially when calculating item cost based on ABC costing method (Kaplan & Anderson, 2004).

The activity cost pool within the costing of the organization at the manufacturing is divided into the design; manufacturing and finishing while at the operation process is divided into product classification and product price estimation, product distribution and product marketing & sales. The manufacturing activity cost pool is often not considered since the company purchase product after the price has been set and only activity cost pool within the company is often considered (Larson & Kerr, 2007). Within the company, the first division of the product activity cost pool is product acquisition and is followed by the product classification into bedroom ware, bathroom ware or gifting ware.  Secondly, price estimation is another activity cost pool that brings nearly all department together to determine the cost of a single item that will be used for the final consumer. Thirdly, distribution of these products to various company branches spread throughout Australia. This also consists of very many activities each bearing cost that is transferred to the overall product cost (Leahy, 2004). Finally, marketing and sales are the last activity cost pool that is also used in calculating the cost of a single item. This includes activities such as advertising, personal selling, online shopping and after sale services. Being the final product cost pool, the marketing also factors in the after sale activities that influence the cost of the product (Maher & Rahan, 2005).

Direct and Indirect Costs Associated with Products

Each activity cost pool has many drivers that are used to allocate cost to a product. Firstly, product acquisition has drivers such as units of the product, quality; type and size of the product purchased are some drivers that are used to determine the cost of each item. Another cost driver within this activity cost pool is labor and machine maintenance as this two drivers are part of the process (Meelah & Ibraham, 2007). Secondly, product classification has drivers such as labor, number of units and equipment used in the process. Since price estimation is also classification cost pool, this activity cost pool has drivers such as labor and equipment. Fourthly, distribution has drivers such as transportation, labor, equipment, and carriers. Distribution also includes the machines that are used to load and offloading products into the tracks that mostly charge in terms of hours used. Finally, marketing has drivers such as labor, equipment, and information system and facility maintenance. The labor within this activity cost pool includes personal selling and advertisement labor charges (Blocher & Juras, 2016).

It is important to classify activity cost pool for Adair’s Company in unit, batch, product or facility activity cost pool. Firstly, acquisition of the products from the manufacturer is product activity cost pool. The system that is used by the company can take any form since the acquisition of products though are made from another manufacturer, the product manufacturing can also be factored into the system at unit hierarchy (Omiri & Drury 2007).  Within this cost pool, there are activities such as stocktaking, determination of the number of products purchased and this also involves many different machines. Secondly, classification of these products within the company warehouse is facility activity cost pool. This is due to the operational processes that are performed on the product during classification (Sandison, Hansen & Torok, 2003). For instance, at the classification stage is where products are also branded to add value to the product. Thirdly, marketing and sales are classified into unit activity cost pool since it only considers the number of units that are sold. The marketing as activity cost pool is concerned with the number of units that are purchased. Moreover, at the marketing, the department is also conversant with the number of units that are available for sale at various branches throughout the Australia. Fourthly, distribution is classified as product activity cost pool since it mainly focuses on the cost of moving product from one place to another (Rad, 2002).

Activity Cost Pool in Adairs Company

When using the ABC costing method, there are many things to consider. The data that is used to calculate the cost of products sold at Adairs factor in units produced and sold, sales revenue and direct cost (Krumwiede, 1998).  When calculating the cost direct and indirect cost of various activities in the Adairs is used to estimate the cost of items. In addition, cost pool activities provide the basis for calculating the cost of all activities that are tied to indirect operational cost especially at manufacturing of the product or general cost estimation of products in Adairs. Calculation of direct cost that is associated with the product at the Adairs is as shown below using two products which are Mattress topper and Spot Flannelette (Adirs Company, 2017a).  This can be summarized in a table as shown below

Table 1
Product Compared	Mattress topper	Spot Flannelette	Total
Units produced and sold	1100	2030	3133
Selling price per unit	$96.89	$18.99
Direct labor cost per unit	$ 2.5	$ 1.5
Direct materials cost per unit	$ 3.50	$ 3.0
Sales revenue	$ 106579	$ 38549.70	$ 145128.70
Direct cost
Direct labor cost	$ 27500	$ 3045	$ 30545
Direct material	$ 3850	$ 6090	$ 9940
Total direct cost	$ 31350	$ 9135	$ 40485

Indirect costs are calculated based on the activity cost pool for various operational activities. To estimate the cost associated with different activity pools, the organization’s operational processes are divided in different activity cost pool. This is then used to calculate the cost that is allocated to activity-based cost for these products sold within the organization. At this stage of ABC costing method, cost drivers are also factored in as they play a critical role in the calculation of activity cost pool (Allott, 2004).

Table 2
Activity pool	Cost driver/ activity unit	Cost driver/ unit cost	Total activity Mattress topper	Total indirect
Product acquisition	Units purchased	1100	100	$ 110000
Product classification	No of products classified	2	70	140
Machine maintenance	No of batch runs	800	50	$ 40000
Distribution	The unit distributed	100	$ 1000	$ 100000
Total

The same method is also used to calculate the indirect cost for the second product sold at Adairs. Most of the operational activities that are used in the calculation of the cost due to activities performed on a Spot Flannelette are the same except for the units and the price due to units (Horngren & Foster, 2003).

Table 3
Activity pool	Cost driver/ activity unit	Cost driver/ unit cost	Total activity Spot Flannelette	Total indirect
Product acquisition	Units purchased	1100	100	$110000
Product classification	No of products classified	2	70	$140
Machine maintenance	No of batch runs	800	80	$ 64000
Distribution	The unit distributed	200	$ 1000	$ 200000
Total	374140

Another step in the determination of cost assign to an item is also the determination of cost per product. When calculating the cost of each product of the organization the activity cost pool is divided by the number of each unit produced within the organization. This, of course, considers the number of unit visa vie the activity cost pool that is part of the production of that product. This is referred to the cost allocation at the product level in ABC costing calculation (Barrett, 2005b).

Activity pool	Total indirect cost for Mattress topper	Cost for each product unit for Mattress topper	Total cost/ unit Spot Flannelette	Cost/ unit Spot flannelette	Total indirect cost
Product acquisition	$ 110000	$ 2	$ 110000	$ 10	$ 110
Product classification	$ 140	$ 7	$ 140	$ 2	$ 70
Machine maintenance	$ 40000	$ 4	$ 64000	$ 8	$ 800
Distribution	$ 100000	$ 10	$ 200000	$ 20	$ 200
Total	$ 250140	$ 23	$ 374140	$ 40	$ 1180

Finding the overhead cost when using ABC costing calculation takes into consideration gross profit and gross margin. This also used to estimate the revenue per unit of the product that is sold at the facility of Adairs (Horngren, George & Srikant, 2005).  With this cost calculation, the total product cost per unit of the two products of Adairs corresponds to each product cost of the indirect drivers when calculating the product cost based on traditional cost method.

Benefits and Disadvantages of Activity-Based Costing in Adairs Company

Calculation profitability of each product, the summation of total unit produced and sold will give the total number of product unit that is available for sales within a trading period. Direct cost for each unit is given by total direct cost divided by units produced and sold within this period of time for the two products (The Value Creation Group, 2008). Overhead cost for each unit, on the other hand, required the division of total overhead cost by a total number of each product that was available and sold. Therefore, gross profit for each product is calculated by subtracting direct cost for each product from revenue for each product. Finally, the profit margin is given by dividing gross profit for each unit by revenue from each product (Mocciaro, Picone & Minà, 2012).

Conclusion

In conclusion, the Adairs Company product value chain includes product acquisition from Abode Living and performing various activities that provide the basis of calculating the cost of a single product. The product value chain for the organization is divided into several activities oriented stages that form activity cost pool. Within this activity cost pool, there are both direct and indirect cost drivers. This offers an avenue for calculating the cost of the product based on either traditional or activity-based costing. When using activity-based costing, the method takes into consideration various cost pools when estimating product cost. Adairs company value chain is divided into product acquisition, classification, distribution, marketing, and sale. At each stage, the cost is incurred on the product until it reaches the final consumer either through its online shop or in-house premises.

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