Flows of the Current Method of Assigning Shipping and Warehousing Costs to Tigers Products - Assignment Example

Running Header: Management Accounting Full name: ID number: Unit name and code Lecturer name: Date of submission Management Accounting 1. Flows of the current method of assigning shipping and warehousing costs to Tiger’s products The current method of cost assignment has a number of flows. Shipping and warehousing costs are assigned by dividing the associated costs by the total number of Tonnes of paper sold. This is despite the fact that some of the company’s products require special handling as well as processing. When assigning the warehousing and shipping costs, such special costs are averaged across the entire product line (Krishnan, 2006). This is despite the fact that all of the company’s high-volume products are sent directly to customers with most of the low volume products being sent to the distribution center. Yet all the products receive a share of the receiving and shipping costs of the distribution center regardless of whether such costs were incurred on them or not. Thus, the current allocation system fails to distinguish between products which spend time in the distribution center and those that do not. The system also fails to distinguish between the receiving and shipping activities at the distribution center thus failing to assign such costs using the number of Tonnes processed. On the other hand, the current system fails to distinguish the shipping activities which are more concerned with the number of shipping items other than tonnage given that shipping may consist of two or three cartons as opposed to pallets. 2. Shipping and warehousing costs per tonne of FK using the new method suggested by Sadia and Debbie Warehousing costs = Receiving and Shipping costs Receiving costs are based on the number of tonnes processed. Sipping costs = Picking and loading Shipping costs are based on the number of items shipped Allocation of warehousing costs Warehousing costs per tonne = Total cost/ Number of tonnes processed = ($900,000+ $802,000)/46,000 tonnes = $1,702,000/46,000 tonnes =$37 per tonne But 30 tonnes were sold, thus; Warehousing costs for FK = Warehousing cost per tonne* Number of tonnes sold = $37*30 = $1,110 Shipping costs per tonne = Total cost/ Number of items shipped = $3,600,000/150,000 shipping items = $24 per item For 30 tonnes = 24*21 =$504 NB// A shipping item may consist of two or three cartons Tonnes sold= 30 Average shipments per tonne = 21 Number of shipments for 30 tonnes = 21*30 = 630 Number of cartons for 30 tonnes = 630*2 = 1,260 But a shipment item is 2 or 3 cartons (2 in this case) Number of shipment items for FK = 1,260/2 = 630 shipment items Shipping costs for the 30 tonnes = 630 items * $24 = $15,120 Thus: Shipping cost for FK =$15,120 or $504 per tonne Warehousing cost =$1,110 or $37 per tonne (Senthil, M2010) Warehousing and shipping cost per tonne = $504+$37 = $541 3. Profit computation for FK Direct materials Quantity Amount Pulp (3 different types) 1112 kilograms $450 Additives (11 different items) 100 kilograms $500 Tub size 38 kilograms $10 Recycled scrap paper (148 Kilograms) $(20) Total direct materials $940 Direct labour $450 Paper Machine ($100 per tonne * 1250 Kilograms) $125 Finishing machine ($120 per tonne * 1250 Kilograms) $150 Total overhead $275 Shopping and warehousing (504+37) 541 Total manufacturing and selling cost ($2,206) Selling price $2,200 Loss on sale per unit $ (6) Using the new method, a tonne of FK realizes a loss of $6 as compared to the old method which put profit at $505 per unit of FK. I think this effect would be realized for other low-volume products since their Shipping and warehousing cost is obviously understated under the old method at $30 per tonne as opposed to the new method that assigns the warehousing and shipping cost on the basis of activity for each of the company’s products (Michael, 2001). 4. A comment on Grace’s proposal to drop some high-volume products and place more emphasis on low-volume products The suggestion by Grace if implemented would be suicidal for the company. This is because as realized in the above computations, the low-volume products have been realizing losses for the company. However, this has all along been mistakenly stated as profitability since the company has been using the long accounting system (Hilton, 2005). If such a decision is implemented, then it means that the company will be abandoning its most profitable products to the loss making ones. It should be noted that the profitability for the company’s high volume products has all along been understated due to the fact that the old accounting system has been assigning them costs that they actually did not incur. As a result of the above computations therefore, I think that Grace should rethink the proposal and either do away with the low-profit products and concentrate on the high-volume products which are actually more profitable than they have been thought to be (Reeve, 2004). It should be noted that the low-volume products have been underpriced all along while the high volume products have been overpriced all along. Thus, probably the company should use the new method in making pricing decisions which will result in more sales and hence more profitability. Regarding the role of accounting systems in making these kinds of decisions, I think that it is proper that a company uses the right accounting system so that it can avoid making the wrong pricing and production decisions that could at times be suicidal for the company as the case could have been if Grace’s proposal was implemented. Use of the wrong accounting system will lead to some products being underpriced while others are overpriced. Consequently, the company will always make the wrong decisions regarding decisions whether to continue production of some products or to drop others (Kurt and Hoyle, 2016). Such decisions will also lead to the company making losses due to underpricing some of its products while losing some sales due to some products being overpriced. Thus, it is always vital that companies adopt the right accounting systems in making production decisions to ensure that the right decisions are made to the company’s best interest as far as profitability is concerned as this is the ultimate goal (Bouwman, 2002). 5. Why Grace’s strategy changed so dramatically Grace’s strategy changed so dramatically since all along, she had thought that the low-volume products were highly profitable while blaming the high-volume products for losses. After changing the accounting system, it was established that the opposite was actually the truth. The old system was overpricing the high-volume products by assigning them some of the warehousing and shipping costs that they never incurred as they did not require such services. This made the products unattractive to the markets thus resulting in fewer sales. As such, lowering their prices to acceptable levels would increase sales volumes and hence profits. On the other hand, the low volume products used to be underpriced and hence they were being sold at a loss (Hicks, 2009). This is the reason why their price was increased so that the company can make some profit on them. Some of the low-volume products had to be dropped since their prices had been so much understated. Furthermore, increasing their prices would not have been realistic as the price would be so high to attract any market interest. In other words, the dramatic strategy was necessary to bring the company to profitability. 6. Benefits and Limitations of ABC accounting system There are many benefits for which companies like Tiger’s products adopt and implement ABC accounting systems. Such benefits are explained below; i) ABC ensures that product costs are determined more accurately and hence more reliably. This is because it focused on cause and effect relationship of costs as well as activities throughout the process of producing the goods. ii) ABC systems ensures that proper and accurate pricing decisions are made. This is especially so for companies that produces multiple products by ensuring that overheads are allocated on the basis of relevant cost drivers (Jackman, 2003). This is essential in avoiding cases of some products being overpriced and others being underpriced which at times lead to wrong production decisions and even losses. iii) Under ABC system, sufficient information necessary for making informed decisions on the profitability of the company’s different product lines is obtainable. As such proper decisions can be made with loss making lines being dropped or their prices being adjusted accordingly. iv) Under ABC system, there is fair allocation of overheads that form a considerable part of the total cost component of the products. Fair allocation of overheads in turn leads to fair pricing. Limitations Despite the benefits outlined above, ABC has been blamed for a number of its limitations as explained below. i) The system has been blamed for expensive implementation and the fact that it is time consuming. This is because business activities have to be broken down into their individual components with such a process consuming valuable resources since data has to be collected, measured and entered into the ABC system. In addition, there is need for consultants who specialize in setting up such a system adding into costs. ii) ABC may lead to misinterpretation of data (Wilkinson, 2013). This is because ABC systems may contain data such as product margins which may vary from information contained in the traditional cost systems. ABC costs may also be irrelevant in some decision making cases and it is also not applicable for external reporting. Interpreting data from such a system, with regular accounting information could be confusing and may lead to bad decisions being made. Application of ABC An ABC system is most applicable in manufacturing industry where production involves more than two activities. However, it is not suitable for application in service industry. References: Krishnan, A2006, An application of activity based costing in higher learning institution: A local case study, Contemporary Management Research, vol. 2, no. 2, pp. 75-90. Senthil, M2010, The success and failure of activity based costing systems, Journal of Performance Management vol. 23, no. 2, pp. 3-18. Michael, C2001, The complete guide to activity based costing, London, Rutledge. Hilton, W2005, Managerial accounting: this century and beyond. Management Accounting Research, vol. 6, pp. 281-286. Reeve, R2004, Adoption of activity management practices. A note on the extent of adoption and the influence on organizational and cultural factors, Management Accounting Research, vol. 15, pp. 323-350. Kurt, H&, Hoyle, J2016, Using activity based costing (ABC) and Activity Based Management in service organizations, Retrieved on 25th April 2016, from; http://catalog.flatworldknowledge.com/bookhub/reader/4402?e=heisinger_1.0-ch03_s05 Bouwman, J2002, The association between activity-based costing and improvement in financial performance, Management Accounting Research, vol. 13, pp. 1-30. Hicks, M2009, Activity based costing: Making it work for small and medium-sized companies, New York, John Willey & Sons. Jackman, M2003, Note on a New Zealand replication of the Innes et al. UK activity- based costing survey, Management Accounting Research, vol. 14, pp. 67-72. Wilkinson, J2013, Activity based costing (ABC) vs. Traditional costing, Retrieved on 25th April 2016, from; http://strategiccfo.com/activity-based-costing-abc-vs-traditional-costing/ Read More