Wallen Manufacturers Management Accounting - Assignment Example

Wallen Manufacturers Management Accounting Report [Name] [Course] 12th may, 2012 The following is a financial report for the Wallen Manufacturing Company for three of the products. The company is a manufacturer of computer products and lately has been experiencing a decline in sales. The company believes this is due to the pricing approach they used and has taken necessary action to attempt and fix this problem soon. This report is based on financial figures released by the company. Part A: The current approach employed by Wallen Manufacturers is the Volume Based Costing system. As the name suggests, this system of costing uses a single cost driver based on volume. It basically reports on the direct usage during production, this is usually direct material and direct labour involved in the production process and so the cost drivers could be direct labour hours and direct machine hours for the material handled. In our case, all the overheads are allocated to a single cost pool activity. Then the overhead costs are assigned to single products – Jaza, Nance and Meliss – based on the volume-based cost drivers or basically the total quantity of each product manufactured. Part B: This approach to costing has several problems of its own. Firstly the approach to costing that it applies is not efficient. This is because cost drivers such as direct machine hours or labour hours do not necessarily imply to be the only cost generating factors during production. Other factors play – probably bigger - roles in the cost incurred during production process. This method will only apply a single common volume activity across all the products in the production line while ignoring the different characteristics involved in the production process that will affect the final cost of production of an item (Jan, 2010). 1. Answer Part A: Anderson and Kaplan say that an Activity Based Costing system unlike the Volume Based Costing system does not operate on the assumption that costs are caused entirely by products (2007). This system applies costs of production on the activities during the production process. In our case, Wallen manufacturers have several activities taking place during production of Jaza, Nance and Meliss. Some of these activities are inspection, material handling, engineering, machine set-up and what not. Part B: Activity Based Costing system introduces accuracy into the picture during the costing process. This it achieves by considering all facets involved in the production process and that result in cost in one way or another. This way, during pricing to the produced items, the company is able to set a more accurate price that will realize profit for the company after all costs have been covered. Pricing Jaza, Nance and Meliss based on the activities involved in their production ensures that the right pricing for these three products is as accurate as they come. Part C: Applying the ABC system enables the company to effectively set a price for each of their products (budgeted price) and sell without having to adjust this price due to low sales or other unforeseen factors as Baker argues out (1998, p. 70). ABC will also enable Wallen to figure why they have been having a gradual decrease in profit over the last two years and how they ought to go about pricing their products so as to get their profits back in track. 2. Answer Part A: Profit Based on Volume Based Costing Sytem Products Jaza Nance Meliss $ $ $ Actual Selling Price 639.00 762.75 600.00 Product Manufacturing Cost 573.00 508.50 286.50 Gross Profit 66.00 254.25 313.50 Part B: Factory Overheads Calculated from Activity Cost $ $ $ Activity Cost Pool Activity Driver Rates Cost per Set-up No of Units Production Overhead per Unit a) Machinery Jaza 24/100 x 3675000.00 = 882000.00 / 8000 = 110.25 Nance 50/100 x 3675000.00 = 1837500.00 / 15000 = 122.50 Meliss 26/100 x 3675000.00 = 929500.00 / 4000 = 232.38 b) Machine Set-ups Jaza 22/100 x 15750.00 = 3465.00 / 8000 = 0.43 Nance 30/100 x 15750.00 = 4725.00 / 15000 = 0.32 Meliss 48/100 x 15750.00 = 7560.00 / 4000 = 1.89 c) Inspection Jaza 16/100 x 1575000.00 = 252000.00 / 8000 = 31.50 Nance 44/100 x 1575000.00 = 693000.00 / 15000 = 46.20 Meliss 40/100 x 1575000.00 = 630000.00 / 4000 = 157.50 d) Material Handling Jaza 25/100 x 2625000.00 = 656250.00 / 8000 = 82.03 Nance 69/100 x 2625000.00 = 1811250.00 / 15000 = 120.75 Meliss 6/100 x 2625000.00 = 157500.00 / 4000 = 39.38 e) Engineering Jaza 35/100 x 1034250.00 = 361987.50 / 8000 = 45.25 Nance 10/100 x 1034250.00 = 103425.00 / 15000 = 6.90 Meliss 55/100 x 1034250.00 = 568837.50 / 4000 = 142.21 Profit Based On Activity Based Costing System Product Jaza Nance Meliss $ $ $ Direct Material 105.00 157.50 52.50 Direct Labour 48.00 36.00 24.00 Factory Overheads: Machinery 110.25 122.50 232.38 Machine Set-ups 0.43 0.32 1.89 Inspection 31.50 46.20 157.50 Material Handling 82.03 120.75 39.38 Engineering 45.25 6.90 142.21 Total Cost 422.46 490.17 573.36 Actual Selling Price 639.00 762.75 600.00 Total Production Cost 422.46 490.17 573.36 Gross Profit per Unit 216.54 272.58 26.64 Part C: Profit Contribution of Each Product Based on VBC Products Jaza Nance Meliss $ $ $ Gross Profit 66.00 254.25 313.50 Quantity of Product 8000.00 15000.00 4000.00 Profit Contribution per Product 528000.00 3813750.00 1254000.00 Profit Contribution of Each Product Based on ABC Products Jaza Nance Meliss $ $ $ Gross Profit 216.54 272.58 26.64 Quantity of Product 8000.00 15000.00 4000.00 Profit Contribution per Product 1732320.00 4088700.00 106560.00 In the above calculations, the profitability of each product differs with the costing system used. In volume based costing, Jaza is the least profitable product ($66.00) and Meliss is the most profitable product ($313.50). But in activity based costing, Meliss is actually the least profitable ($26.64) compared to the others with Nance being the most profitable ($272.58). Part D: This variation is due to the difference in application of the cost drivers under each costing system. In volume based costing, the costs are assigned to direct labour but in activity based costing, the costs are assigned to the various activities undertaken in the production by Wallen manufacturers. This two different approaches, result in the different profitability contribution by each product (Leitner, 2007. p. 35). 3. Answer Part A: I strongly recommend the Activity Based Costing system for Wallen manufacturers. This system gives Wallen not just a higher total profit of the three products ($5927580 in total profits) but it also ensures more accurate costing for subsequent times in the future. Part B: Calculated Budgeted Price Product Production Cost x rate Budget Price $ $ Jaza 573.00 x 150/100 859.50 Nance 508.50 x 150/100 762.75 Meliss 286.50 x 150/100 429.75 Nance has maintained its budgeted price of $762.75; therefore Wallen does not need to adjust this price. When it comes to Jaza however, the budgeted price is more than current price. Similarly for Meliss, there is no appropriateness between the budgeted and the current prices, the budgeted price for Meliss is lesser than the current. Part C: For Nance, Wallen better maintain the price at its current level which matches its budgeted level thus bringing in the desired profit at the current production volume. Jaza’s price needs to be lowered even further from the budgeted level so that even if the sales do not pick up, Wallen would not record any losses. Meliss price can be comfortably increased without affecting the demand for the product. This is also because the product seems to have no competition and its consumption will least likely be affected with a slight increase in the price. 4. Answer Limitations of an ABC system An ABC system can be quite complex in implementation. Determination of the various cost drivers can sometimes be hard to distinguish and appropriately allocate factors, in our case, it may be hard to determine all operations involved during production of Jaza, Nance and Meliss. Criteria used for determining activity driver factor rates are also complex to distinguish. This therefore makes it easy to misinterpret the system’s application. According to Marx, the complex nature also results in slowness in the price determination process, but in business, time is of the essence (2009 ). 5. Answer Scribd website. This site offers professional articles covering a plethora of topics. I recommend this site to bill referring to the article titled “Volume Based Costing System” which provides the shebang this and much more. The article is also written in plain language understandable to a layman. It also has plenty of examples that guide one through his reading. This site offers what just Bill might need to get a grasp of what this report implies. The site’s URL is provided below. URL: http://www.scribd.com/doc/25460366/Volume-Based-Costing-System Business Consulting Services is the second site I would recommend for Bill. The site offers articles on business related issues. Bill will find the article Activity Based Costing (ABC) and Traditional Costing Systems by Dr. Marx quite helpful. Unlike the other article, this article does not offer examples but it comprehensively describes the two types of costing discussed in this paper. It outlines in an orderly manner the pros and cons of the two systems and where they could be effectively applied. The site’s URL is: http://financialsupport.weebly.com/activity-based-costing-abc-and-traditional-costing-systems.html Reference List Anderson, S. R., Kaplan, R. S. (2007). Time Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits. Boston: Harvard Business Press. Baker, J. J. (1998). Activity-Based Costing and Activity-Based Management for Health Care. Burlington: Jones and Bartlett Learning. Jan, R. (2010). ABC retrieved May 11 2012 from http://www.emblemsvag.com/abc.htm Leitner, A. (2007). Activity Based Costing. Munich: GRIN Verlag. Marx, C. (2009). Business Consulting Service: Activity Based Costing (ABC) And Traditional Costing Systems retrieved May 11 2012 from http://financialsupport.weebly.com/activity-based-costing-abc-and-traditional-costing-systems.html Read More