Management Accounting: Analysis And Recommendations

Activity-Based Costing

MANAGEMENT ACCOUNTING

ACTIVITY BASED COST REPORT
PARTICULARS	ARCHITECTURE FIRMS	WINDOW TREATMENTS Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	TOTAL	TOTAL OF BOTH THE OPERATIONS
ADAMS	BETZ	TOTAL	CHATHAM	DEDHAM	ELM
Direct Costs	147000	117200	264200	218400	115720	57040	391160	655360
Overhead Costs (WN1)			85100				136160	340400
Discount Cost (WN2)	23400		23400			3660	3660	27060
Total Cost	170400	117200	372700	218400	115720	60700	530980	1022820

CUSTOMER & TOTAL PROFITABILITY REPORT
PARTICULARS	ARCHITECTURE FIRMS	WINDOW TREATMENTS	TOTAL	TOTAL
ADAMS	BETZ	TOTAL	CHATHAM	DEDHAM	ELM
Gross Revenues	234000	188800	422800	357380	147840	73200	578420	1001220
Direct Costs	147000	117200	264200	218400	115720	57040	391160	655360
LESS :
Overhead Costs			85100				136160	340400
Discount	23400		23400			3660	3660	27060
PROFIT	63600	71600	50100	138980	32120	12500	47440	-21600

DISTRIBUTION CHANNEL COST REPORT
PARTICULARS	ARCHITECTURE FIRMS	WINDOW TREATMENTS	TOTAL
Direct Costs	264200	391160	655360
Overhead Costs	85100	136160	221260
Discounts Given	23400	3660	27060
Total Costs	372700	530980	903680

WORKING NOTES :
WN1 :
Overhead basis of Allocation
	($)
OVERHEADS	340400
ARCH	25%
WIND	40%
GENERAL	35%
WN2 :
In case of activity based costing, the overheads have been allocated as per the percentage stated above. Also, discount is
a cost for the seller. Therefore, it is added to the cost of the two departments.
WN3 :
In case of distribution channel cost report, since there are two departments, the cost shown is associated with the
at particular department. Therefore, overhead expenditure spent generally is not shown in that report.

Solution 2:

Louise, popularly known for interior designing consulting and window treatment fabrication business is operated by Louise. Her business of operation is through two different distribution channels where in first case, there are architecture firms and in second case, a commercial window treatment business is there where construction of window treatments take place. There are two clients in case of first case and three clients in case of second one (Atkinson, 2012).

The required case study required us to prepare an activity based cost report, distribution channel cost report and customer profitability report where the overall total profitability has been assessed too (Berry, 2009). The activity cost report helps in understanding the costs associated with each business and the total cost of both the departments.

The customer profitability report helps in understanding the contribution of each customer to the profits of the company. Such report also shows us the total profits of the company. The distribution channel cost report helps in understanding the costs of each channel that the firm is bearing.

On the basis of various calculations, a lot of analysis are being made and recommendations are prepared on the basis of that.

ANALYSIS:

The company prefers using activity based costing where the fixed overhead cost is allocated on the basis of percentage. This percentage means that part of the cost which is associated with the department. The company doesn’t believe in traditional costing method which gives a better picture of profit and cost (Boyd, 2013).

Coming to customer costing analysis, we see that there are more costs in case of windows department, that is, $530,980. However, when we see the customer profitability report, we see more profits are generated from the architecture department. However, analyzing the gross revenues, we see that the windows department generates more revenues than the first department. The reason of having higher profit in the first department is because of the overheads costs which is high in case of windows department. Also, we see that for the sake of attracting Adams, the company gave a discount of 10% which was equal to $23,400 which is unnecessary (Taillard, 2013). This is because such discount was provided to cut off the competitor’s sale. However, because of that, the company overall suffered a loss of $23,400 or an unnecessary cost of $23,400 (Girard, 2014).

However, the company’s action of providing discount of 5% for advance cash payment is justified as cash payments leads to circulation of cash in the operating cycle and the company would be at a good position if there is frequent cash circulation in the operating cycle.

Customer Profitability Report

From customer profitability report, we can also visualize the total profitability which is negative. Where the departments individually are making profits, the overall company is suffering loss due to high overhead costing and due to firm practice of giving discount for attracting customers. Had the company not provided 10% discount to Adams, the overall profit of the company would have been profitable or positive.

Coming to distribution channel cost report, we see that there are huge costs associated with window treatments department with high overhead costs (Horngren, 2012).

RECOMMENDATION

It is recommended that the company’s policy of applying activity based costing is totally correct as activity costing method :

• Helps in allocating the cost only to that extent which is associated with the particular activity. Thus, helps in assessing the true cost of an activity.
• Helps in making better decisions as the management gets a true picture of all the costs and revenue associated with activities and thus, the firm can decide whether to continue an operation or discontinue it or make such changes that would help in generating the maximum possible profits.
• Helps in understanding the absorption capacity of each department individually and the contribution of each department in the company’s overall profits and costs.

The company’s approach for costing is totally recommended to proceed in future with the same approach.

However, the company’s smartness of providing a discount of 10% is not appreciated as that was solely for luring a customer from its competitor. Such action could encourage other customers to adopt the same strategy for enjoying discounts from the customers. Also, because of this the overall profitability of the company is $(21,600) which could have been a positive figure if such a strategy wasn’t adopted. Also, the firm could go for strategies like production at the own house, market substitutes etc.

Also, considering the fact that there are more revenue in first case, the company could consider shutting down one business and investing such cost savings in the business giving better profits and absorbing minimum overhead costs or at least lesser than the other department.

CONCLUSION

The dynamic environment in the current world demands for most précis methods whether in case of accounting or costing or auditing or ethical norms. It is important for the books or reports to deliver the transparency to all the intended users so that they can make the best possible decisions such as investment decisions, raising loans decisions, comparison of costs with the industry rates or with their competitors or with the market (Parrino, 2013).

The high dynamic environment is facing everyday changes where losing customer in a day is not a big deal and where customers are more precious than profits because for a long term sustainability, long term profits are desired and for such goals, a fruitful and loyal relation is required to be formed and maintained with the customers. An analysis is important for fulfillment of such long term objectives of the companies. The analysis part through preparations of various reports could be complex but the current scenario demands a true and fair view of operations in terms of both performance and money.

The above case is an analysis of various kinds of approaches to get the most transparent picture of all the costs and profits whether from their individual customers or whether from the overall company or whether from a particular business or department. Such number of analysis only helps an owner or the top management in making the decisions that could result in the best possible conclusions at the end.

Scenario 2.

Solution 1:

Particulars	Super Chip	Okay Chip
Sale Price per unit	80	26
Less :
Direct Materials per unit	5	2
Direct Manufacturing Labour p.u	60	20
Contribution per unit	15	4
Hours Required	3	1
Contribution/hour	5	4

So, our preference for manufacture would be Super chip as it produces $5 per hour. Considering the maximum units that can be produced in case of Super chip, that is, 15000 and the maximum hours is the semiconductor division is 45000 hours, the number of Super chip and Oky chip that should be produced.

Particulars	Hours p.u.	Maximum Units	Total Hours
Maximum Available			45000
Super Chip	3	15000	45000
	1	–	–
Available Capacity			–

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

Solution 2.

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

Particulars	Super Chip	Okay Chip	Process Control Unit	Total
Sale Price p.u.	80	26	132
Less :
Direct Materials p.u	5	2	70
Direct Manufacturing Labour p.u	60	20	45
Contribution p.u	15	4	17
Units Proposed to be Sold	15000		5000
Total Contribution	225000		85000	310000

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

Particulars	Super Chip	Okay Chip	Process Control Unit	Total
Sale Price p.u.	80	26	145
Less :
Direct Materials p.u	5	2	–
Direct Manufacturing Labour p.u	60	20	45
Transfer Price                       (5000 Super Chips are t/f to Process Unit Cost @80/unit)			80
Contribution p.u	15	4	20
Units Proposed to be Sold	15000		5000
Total Contribution	225000	–	100000	325000

CONCLUSION: Comparing both the cases, we can see an increment in the profits by $15000 and therefore, it is advisable to go for transferring option (Seal, 2012).

Working note:

The transfer price of the 5000 super chips would be $80/unit which would be deemed as sales for the first division and the cost of second division.

Solution 3:

Particulars	Super Chip	Process Control Unit	Total
Profit when there is a transfer	2,25,000	1,00,000	3,25,000
Profit when there is no transfer	2,25,000	85,000	3,10,000
Difference			15,000

As we can see, whether there is a transfer or not, in case of Super Chip, there is no effect on the profits earned
Through the sale or transfer. However, in case of Process Control Unit, there is an increment of $15,000
In profits. Thus, for the objective of goal congruence, we would be preferring transfer of 5,000 super chips to the
Other department and not purchasing materials from the market at $70 p.u. Thus, the transfer pricing would be
$80 p.u.

Solution 4:

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

Particulars	Super Chip	Okay Chip	Process Control Unit	Total
Sale Price p.u.	80	26	132
Less :
Direct Materials p.u	5	2	70
Direct Manufacturing Labour p.u	60	20	45
Contribution p.u	15	4	17
Hours Required	3	1	3
Contribution/hour	5	4	5.67
Units Proposed to be Sold	15000	15000	5000
Total Contribution	225000	60000	85000	370000

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

Particulars	Super Chip	Okay Chip	Process Control Unit	Total
Sale Price p.u.	80	26	145
Less :
Direct Materials p.u	5	2	–
Direct Manufacturing Labour p.u	60	20	45
Transfer Price                       (5000 Super Chips are t/f to Process Unit Cost @80/unit)			80
Contribution p.u	15	4	20
Units Proposed to be Sold	15000	15000	5000
Total Contribution	225000	60000	100000	385000

Conclusion :
When there are 60000 hours, after production of 45,000 super chips, 15000 hours could be used to produce 15,000 okay chips where
contribution per hours is $4/hour. We analyzed both the cases with transfer and without transfer. We concluded that there
Would be no effect in the profits when compared to answer in number 3. Thus, the profit increment would be same as before,
that is, $15,000.

References

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

Berry, L. E. (2009). Management accounting demystified. New York: McGraw-Hill.

Boyd, W. K. (2013). Cost Accounting For Dummies. Hoboken: Wiley.

Girard, S. L. (2014). Business finance basics. Pompton Plains, NJ: Career Press.

Horngren, C. (2012). Cost accounting. Upper Saddle River, N.J.: Pearson/Prentice Hall.

Parrino, R. (2013). Fundamentals of Corporate Finance, 2nd Edition. Milton: John Wiley & Sons.

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

Taillard, M. (2013). Corporate finance for dummies. Hoboken, N.J.: Wiley.