Strategic Accounting - Bingley Products - Assignment Example

PART A: Bingley Products a). Solution : Comparing Volume based costing with ABC. (i) Departmental Apportionment of Overhead Costs Product Machining Dept(£) Assembly Dept (£) Widgets 120,000 288,750 Gadgets 240,000 99,000 Helios 144,000 49,500 Total 504,000 437,250 The above calculations were arrived at by multiplying the number of machine hours per unit for each product by the number of units produced and then multiply by the cost per unit. For example the £120,000 for Machine department costs applied to widgets is calculated by taking 2machine hours per unit time 50,000 x 1.2. Mathematically we can write thus: Overhead cost for widgets allocated to machining department = Number of units produced x number of machine hours per unit x machining department machine hour rate = 50000 x 2 x £1.2 per machine hour = £120,000. Overhead cost for widgets allocated to assembly department = Number of units produced x number of labour hours per unit x assembly department’s labour hour rate = 50000 x 7 x £0.825 = £288,750. Widgets (£) Gadgets (£) Helios (£) Sales 2,250,000 3,800,000 2.190.000 Cost of Sales: Direct costs: Direct labour and Materials 1,600,000 3,360,000 1,950,000 Factory Overhead Costs: Machining Department 120,000 240,000 144,000 Assembly Department 288,750 99,000 49,500 Total costs 2,008,750 3,699,000 2,143,500 Gross Margin 241,250 101,000 46,500 Product Profitability Analysis Statement Under Traditional Absorption Costing The figure for sales is calculated by multiplying the number of units by the cost per unit. For example sales for Widgets is calculated as follows: Number of Units produced and sold = 50000 units Sales price per unit = £45 Sales figure 50000 X £45 = £2,250,000 Similar calculations have been done for Gadgets and Helios to arrive at the figures of £3,800,000 and £2,190,000 respectively. The direct labour and materials cost is calculated by multiplying the units produced by the direct labour and material cost per unit. For example the amount for Widgets is calculated thus: Number of units produced = 50000 units Direct labour and material cost per unit = £ 32 Total direct labour and material cost = 50000 x £ 32 = £1,600,000. Similar calculations have been done for Gadgets and Helios. Overhead Absorption based on Activity cost drivers Apportionment of overheads to cost pools Activity Consumption cost driver (1) Cost (2) £ Activity Consumption (3) Activity rate (2)/(3) £ Machine Hours 357.000 420000 0.85 Direct Labour Hours 318.000 530000 0.6 Set-ups 26.000 520 50 Customer Orders 156.000 32000 4.875 Supplier Orders 84.000 11200 7.5 Here the activity rate for each cost driver is calculated by dividing the activity cost by the amount of consumption of the activity. These rates are later used to calculate the costs to be allocated for each product as shown below. Apportionment of Overheads to Products Widgets (50000 Units) Activity Consumption cost driver (1) Activity rate (2) £ Activities (3) Total Overhead (4)=(2)x(3) £ Overhead per unit (5) £ Set-ups 50 120 6,000 0.12 Customer Orders 4.875 8000 39,000 0.78 Supplier Orders 7,5 3000 22,500 0.45 Machining Department 0.85 100000 85,000 1.7 Assembly Department 0.6 350000 210,000 4.2 Overhead Cost per unit 362,500 7.25 As can be seen above, the total overhead arising from each cost driver is calculated by multiplying the activity rate for that cost driver to the amount of activities demanded by the product. The overhead cost per unit is calculated by dividing the total overhead cost for each cost driver by the number of units produced as we can see from the table above. For example, to calculate the overhead cost per unit for customer orders assigned to product (Widgets), we proceed as follows: Number of Units produced 50000 Number of customer orders (activities) = 8000 Activity rate = £4.875 Total overhead = £4.875 x 8000 = £39,000 Overhead per unit = £39,0000/50000 = £0.78 Similar calculations have been done for Gadgets and Helios and for the other cost drivers. Gadgets (40000 Units) Activity Consumption cost driver (1) Activity rate (2) £ Activities (3) Total Overhead (4)=(2)x(3) £ Overhead per unit (5) £ Set-ups 50 200 10,000 0,25 Customer Orders 4,875 8000 39,000 0,975 Supplier Orders 7,5 4000 30,000 0,75 Machining Department 0,85 200000 170,000 4,25 Assembly Department 0,6 120000 72,000 1,8 Overhead Cost per unit 321,000 8,025 Helios (30000 Units) Activity consumption cost driver (1) Activity rate (2) £ Activities (3) Total Overhead (4)=(2)x(3) £ Overhead per unit (5) £ Set-ups 50 200 10,000 0,33 Customer Orders 4,875 16000 78,000 2,6 Supplier Orders 7,5 4200 31,500 1,05 Machining Department 0,85 120000 102,000 3,4 Assembly Department 0,6 60000 36,000 1,2 Overhead Cost per unit 257,500 8,58 Product Profitability Analysis Statement Under Activity Based Costing Widgets (£) Gadgets (£) Helios (£) Sales 2,250,000 3,800,000 2,190,000 Cost of Sales: Direct costs Direct labour and Materials 1,600,000 3,360,000 1,950,000 Overhead Costs: Set-up cost 6,000 10,000 10,000 Order processing cost 39,000 39,000 78,000 Purchasing cost 22,500 30,000 31,500 Machining Department 85,000 170,000 102,000 Assembly Department 210,000 72,000 36,000 Total costs 1,962,500 3,681,000 2,207,500 Gross Margin 287,500 119,000 (17,500) (ii) Profitability analysis statements have been prepared using two costing methods, including the traditional absorption costing method and activity based costing method for three different products Widgets, Gadgets and Helios. One of the most important differences we can observe is that the product Helios proves to be profitable under absorption costing whereas it returns a loss under activity based costing (ABC). Also, the products Widgets and Gadgets are more profitable under ABC than under absorption costing. Therefore we can conclude that under absorption costing, some of the costs, which ought to be allocated to Helios, were allocated to Widgets and Gadgets and thus the product proved that it was profitable. The reason for this difference is that volume-based costing tends to under-cost low volume products at the expense of high volume products. (Blocher et al, 2005: pp 145). We can see that only 30000 units were produced for Helios while 50000 and 40000 units were produced and sold for Widgets and Gadgets respectively. This is consistent with the latter assertion that volume based costing system under-costs low volume products at the expense of high volume products. According to Bocher et al (2005), activity based costing differs from volume based costing in two ways: First under ABC cost pools are defined as activities or activity centers and not production plant or department centers. Second the cost drivers used by ABC to assign costs to products are drivers based on an activity or activities performed for the product. The traditional costing method on its part uses an arbitrarily selected cost driver that often bears little or no relationship to the consumption of resource cost by the products to assign costs to the product. Using the two-stage allocation of products adopted in ABC, it is possible to better identify the costs of activities of a firm. Thus costs are assigned to products based on the demand the product makes for activities. Since products consume activities and activities consume resources, it is essential to assign costs to products based on the activity demands by the product. b). i. The information is useful in that it has indicated that product Helios is currently unprofitable under its current conditions, and therefore its costs and selling price needs to be revised. The information can be revised by setting new targets for the product Helios. The company needs to identify the resources spent on customers. This can be done by either increasing the price of Helios or by facing out the product completely. The information can be expanded by taking a closer look and the manufacturing process of the product such as studying the cycle time, labour efficiency, machine efficiency, amount of waste and rework, and scrap. The firm should also take into consideration the flexibility in the setting up machines, machine capacity. ii. Other relevant information that could be used is to look at the industry for the product and competitors position. A customer analysis on the products should also be carried out. By studying competitor’s prices and by studying carrying out a customer profitability analysis, the firm can make better decisions on whether to face out the product, revise it, or increase its price. It will be able to identify unprofitable customers. Unprofitable customers are customers who buy customized products at very low volume and who demand a lot of warranties or after sales services. By identifying such customers, the firm can increase prices to them while reducing prices for profitable customers. Profitable customers are customers who buy large volumes of the standard product and less often demand warranty or after sales services. PART B: SHIPLEY CONFECTIONERIES Applicability of activity based costing to Shipley Confectioneries’ manufacturing environment. Since SHIPLEY CONFECTIONERIES produces a wide variety of different products and considering that each manager’s earnings is tied to the profitability of his/her products, I am in line with the managing director’s views that applying activity based costing will solve the problem between product managers. Blocher et al (2005: pp 138) states firms that have areas with large increasing expenses or have numerous products, services, customers, processes or a combination of this can be greatly impacted by an activity based costing system. These include plants that produce standard and custom products, high-volume and low-volume products, or mature and new products. Also, firms that accept small and large orders, offer standard and customised deliveries, or satisfy all customers including those who demand frequent changes either before or after delivery and those who hardly ever demand warranties can benefit substantially from activity based costing. (Blocher et al, 2005: pp 138). SHIPLEY CONFECTIONERIES can therefore benefit greatly from adopting ABC. According to Innes and Mitchel, (1995), ABC makes costs more visbible since it details the organization's activities and their respective costs. Instead of simply recording costs by the type of input, which they represent it, categorizes them by the way in which they are consumed. From the foregoing, three possibilities of cost reduction have arisen which include: Value added analysis: Activities are screened to identify non-value added activities which result in no customer benefits through the enhancement of final product or service and should therefore be targeted for elimination. (Innes and Mitchel, 1995). Core I support: In this tripartite classifica­tion of activities priority is given to the freeing of resource from the latter two categories either to augment the former or to simply eliminate cost. Activity mapping: Activities are recorded on a two dimensional map showing the flow of work by location; and in terms of its duration. The identification of complexity and duplication is facilitated and a basis for process re-engineering is provided. SHIPLEY CONFECTIONERIES will therefore reduce its costs through the above cost reduction processes by adopting ABC. SHIPLEY CONFECTIONERIES can also benefit from ABC in that it will automatically adopt activity based budgeting (ABB), which has been developed from the basic framework of activity based costing. (Innes and Mitchel, 1995). This is because it will be possible for SHIPLEY CONFECTIONERIES to match activity budgets to relevant individuals, which will support the operation of practical responsibility accounting. Also when setting budgets SHIPLEY CONFECTIONERIES will be able to make use of available cost driver statistics which will assist in assessing future resource needs by giving and indication of existing and planned work throughout. SHIPLEY CONFECTIONERIES will also make use of the variance feedback available from an ABB system. Innes and Mitchel, (1995) assert that the variance feedback includes detailed information including all individual cost pools. This can be very helpful when carrying out budget flexing, which is based on cost drivers. It will also provide information to SHIPLEY CONFECTIONERIES on capacity utilisation. (Innes and Mitchel, 1995). (ii) ABC information can be used as a means of re-pricing products to customers so that revenues can exceed costs used in producing products for individual customers. (Cooper et al, 1992). As earlier discussed, ABC can help identify unprofitable customers as well as unprofitable products. As such prices can be lowered to customers ordering standard products in high volumes and increased to customers ordering highly customised products in low volumes. (Cooper et al, 1992). Using this pricing strategy SHIPLEY CONFECTIONERIES can increase its profit through changes in product and customer mix. SHIPLEY CONFECTIONERIES can begin by increasing prices of unprofitable products and if this strategy fails then it should eliminate unprofitable products. Thus SHIPLEY CONFECTIONERIES should consider incremental revenues and spending consequences of adopting the ABC method before developing the system. Using ABC as a performance measurement tool on the other hand can also be beneficial since it will help SHIPLEY CONFECTIONERIES’s better measure the performance of its managers. This is so because by adopting ABC it will be possible for the company to gather more information on both financial and non-financial performance measures. Financial performance measures include cost per unit output, return on sales, and cost of every department’s high value-added activities and low-value added activities. Non-financial performance measures on the other hand evaluate operating characteristics of manufacturing processes and measures of or feedbacks from customers. They include the number of customer complaints, customer satisfaction, number of defects, number of output units, cycle time, on-time delivery rate, number of employee suggestions and scores on employee morale. By adopting the ABC SHIPLEY CONFECTIONERIES will be able to gather the above information, which the company can use to better evaluate the performance of its managers. Therefore SHIPLEY CONFECTIONERIES by adopting the ABC will benefit from both improved profitability and improved performance measurement systems, which will help eliminate the rivalry between product managers. BIBLIOGRAPHY Cooper, Robin; Kaplan, Robert S. (1992). Activity-Based Systems: Measuring the Costs of Resource Usage. Accounting Horizons; Vol. 6(3); pp 1-12. ABI/INFORM Global Innes J., Mitchel F. (1995). A survey of activity-based costing in the U.K.'s largest companies. Management Accounting Research., Vol. 6, pp 137-153 Blocher E., Chen K., Cokins G., Lin T. (1995). Cost Management. A Strategic Emphasis.(3rd International Edition). McGraw-Hill Read More