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Cost Accounting Assignment Based on Different Case Scenarios

Question

Task: Prepare a cost accounting assignment addressing the following questions:

Question 1:
Hercules Limited is a manufacturer with a large variety of products. One of the most popular products is Product H. In many years, Hercules estimates production cost of product H based on the traditional costing method in which the manufacturing overhead costs are allocated using direct labour cost as the single cost driver. Recently, top managers have been very concerned about declining profitability despite a healthy increase in sales volume of Product H. The declining profitability of Product H was not expected as the company has installed new machine and applied new automation technology to increase production efficiency. As a new management accountant of the firm, you are required to evaluate the costing of Product H. Given that the company also incurs a substantial amount of manufacturing overhead, you have undertaken an Activity-based analysis. You have determined that the company’s total manufacturing overhead can be identified with the following activities:

Activity (activity driver)

Budgeted activity

Total quantity of activity drivers

Purchasing (number of purchase orders)

$2,084,400

3474

Material handling (number of setups)

$2,592,000

5400

Quality control (number of batches)

$518,400

2160

Processing time (number of processing hours)

$3,459,600

288300

Assembling time (number of assessbling hours)

$1,209,600

100800

Packaging time (number of packaging hours)

$936,000

78000

Direct labour cost of the company is estimated at $3,000,000 for the coming year. Other production/sales information regarding one of its popular products is as follows:

Estimated production volume (units)

6000

Direct material cost (per unit)

$10.00

Direct labour cost (per unit)

$0.80

Number of purchase orders

8

Number of batches

6

Number of Setups (per batch)

6

Processing time (hour per 100 units)

1.2

Assembling time (hour per 100 units)

1

Packaging time (hour per 100 units)

0.75

 

Required:
a. Estimate the unit cost of Product H at the estimated production volume using both the traditional costing and the Activity-based costing (ABC) methods.
b. You are advised that selling price of Product H is based on the estimated product cost plus a fixed margin (around 20% of the production cost per unit). Given your estimation results in the requirement 1, is Product H over-costed or over-costed using the current costing method? If there is a cost distortion, is it significant and what would you like to recommend the company to do to improve the Product H’s profitability? Please keep in mind that changes in selling price may affect the customers’ behaviour substantially.

c. ‘Conventional costing will always distort product costs.’ Discuss the validity of this statement.

Question 2: You are required to prepare a proposal on the potential benefits and costs of implementing an Activity-based costing (ABC) system to determine customer profitability for a local bank, Kangaroo Commercial Bank Limited. The bank currently uses a traditional costing system. The clients of Kangaroo Commercial Bank are regional residents in North Australia. The banks considers extending its operation across some metropolitans, such Sydney and Melbourne, to serve the retail banking and investment demands of its clients.

Required:
a. ABC system requires a setting of operational activities and activity drivers. In identifying activity driver which mainly causes costs to be incurred at an activity level, what important factors should be considered? Explain to management why you consider these important.

b. Using at least two academic research articles to support your background research, write a minor report (in 500-600 words) to advise the management of Kangaroo Commercial Bank on the potential benefits and costs associated with implementing an ABC system.

Question 3: MaxiReturn Limited is a fintech company providing accounting solution and financial advice based on Artificial Intelligience technology. The company is one of the first Fintech pioneers in Australia. MaxiReturn has experienced steadily increased sales figures over the last ten years. The company size has also increased to 100 employees currently. Most of them are software engineers and accounting and financial professionals. Adrian Daniels joined MaxiReturn approximately nine months ago as financial controller. His major duties include supervision of the company’s accounting team and preparation of the company’s financial statements. He has noticed that, in the past six months, the company’s sales have actually dropped. This unexpected downturn has resulted in cash shortages. In addition, MaxiReturn has had to postpone the introduction of a new accounting software because one of its business partner, PrintSolution Limited, has not yet delivered the instruction manuals for the new product.

Most of MaxiReturn’s printing documents are made by PrintSolution, a small printing company owned by Darren Abbott. Darren has dedicated a major portion of his printing capacity to MaxiReturn’s requirements, because its contracts represent approximately 50 per cent of PrintSolution’s business. Adrian has known Darren for many years, and it was Darren who first told Adrian that MaxiReturn needed a new financial controller. While preparing the company’s most recent financial statements, Adrian became concerned about its ability to maintain timely payments to its suppliers. He estimated that payments to all suppliers, which were usually made within 45 days, were now exceeding 90 days. Benjamin is particularly concerned about payments to PrintSolution. He knows that MaxiReturn has recently placed a large order with PrintSoltuion for printing the new product instruction manuals, and that PrintSoltuion will soon be placing an order with its suppliers for the special paper needed for this new job. Adrian is considering telling Darren about the cash problems of MaxiReturn, although he is aware that a delay in the printing of the documentation would jeopardise his company’s new product.

Required:
In 500-600 words, describe Adrian Daniel’s ethical responsibilities in this situation. Support and analyze your answer with any standard or guidelines you consider relevant.

Answer

Answer 1
Answer a

Identification of Activity and driver

 

 

Activity

Activity driver

Purchasing

Number of purchases order

Material Handling

Number of setups

Quality control

Number of batches

Processing time

Hours of production

Assembling time

Number of assembling hours

Packaging time

Number of packing hours

 

Calculation of cost driver

Activity

Amount

Activity driver

Quantity

Cost driver
(Activity/driver)

 

 

 

 

 

Purchasing

$20,84,400

No of purchases order

3474

600.00

Material Handling

$25,92,000

No of setups

5400

480.00

Quality control

$5,18,400

No of batches

2160

240.00

Processing time

$34,59,600

Production hours

288300

12.00

Assembling time

$12,09,600

No of assembling hours

100800

12.00

Packaging time

$9,36,000

No of packing hours

78000

12.00

 

$          1,08,00,000

 

 

 

 

Computation of Total cost and per unit cost of H As per Activity Based costing

production volume (units)

Estimated

6000 units

Direct Material

60,000

(6000 units*$10)

 

Direct Labor cost

4,800

(6000 units*$0.80)

 

Manufacturing overhead

 

-Purchasing

4,800

( 8 orders@$600 per order)

 

- Handling Material

17,280

( (6*6)setups @ $480 )

 

-Quality control

1,440

( 6batches @$240 per batches)

 

-Processing

864

( (6000/100)*1.2*12)

 

-Assembling

720

( (6000/100)*1*12)

 

-Packaging

540

( (6000/100)*0.75*12)

 

Total cost for 6000 units

90,444

   

Cost per unit of Product H as per ABC

 $                                          15.07

( 90444/6000)

 

 

Calculation of manufacturing overhead rate
based on  traditional method

 

 

 manufacturing overhead

 $                1,08,00,000

 direct labor cost (Estimated)

 $                    30,00,000

 

 

 on the basis of direct labor cost (Other manufacturing overhead rate) = (10800000/30000000)

 $                              3.60

Now we will determine total cost and per unit cost
As per Traditional costing

Estimated production volume (units)

60000

Direct Material

4800

(6000 units*$10)

 

Direct Labour cost

17280

(6000 units*$0.80)

 

Other manufacturing cost

 

( 4800 labor cost*$3.6)

82080

 

60000

Total cost for 6000 units

 

 

 

traditional method will provide cost per unit as

 $                                          13.68

( 82080/6000)

 

   

 

Answer b
The production cost of Hercules is based upon traditional costing mechanism where the overhead cost of manufacturing are allocated by usage of the direct labor cost as the driver of single cost. Here, the company determines the selling by estimates cost per unit followed by a fixed margin @20%

Under the traditional method the cost is $ 13.68
Addition of fixed margin @20% $2.74
Hence we have the estimated SP as $16.42
As per the traditional mechanism the cost per unit is under cost because if we consider the traditional cost the unit price should be $13.68 however ABC costing yields $15.07 and therefore the company is selling the product at a reduced price as the fixed margin @20% is marked up at a lower cost per unit and hence the company is marking the actual profit when the SP is $16.62 and per unit cost is $15.07
Hence in this scenario the profit will be = 16.62-15.07 = $1.55
Margin in terms of percentage will be 1.55/13.68)*100 = 11.33%

When computing cost as per traditional costing and the same under ABC costing have difference. It is advisable for the company to follow the approach of ABC because it leads to effective pricing decision.

Now, we will compute the estimated SP through ABC costing
Per unit cost (ABC method) $15.07
Addition of fixed margin @20% $3.01
Estimated selling price $18.08

Hence, as per the estimation, the SP comes to $18.08 (computed above) and not $16.42 per unit.

Hence, instead of it, the company should enhance the SP of the product to have a better earning, and this helps increase the profitability of the product H. As the company is selling the product at $16.62 per unit, this is creating a dent in the company's profitability, and the company was earning 11.33%. Hence, the company should use the approach of ABC because it will aim to increase profitability. If the increment in the selling price changes from $16.42 to $18.08 leads to a change in the consumer's behavior, then the company must think about the increment in gaps. In this scenario, the company needs to increase the SP in phases, say from $16.42 to $16.92, and then in the same gaps tend to touch the price to $18.08. on the other hand, another way is to reduce the cost per unit by enhancing the efficiency and reduction of the per-unit cost that is $16.42/1.2=$ 13.68 per unit

If the company by utilizing the ABC method can reduce the per-unit cost to $13.68, then even the profitability can be increased, and hence there will be a profit margin of 20%.

Answer c
Conventional costing is only associated with the volume-related mechanism. It is used to allocate overhead cost to the products even because there is no consumption of the indirect resources proportionally to the production of the volume of the product. There are different types of indirect resource costs due to the driven or non driven volume of production and its features such as size and involvement, hence distorting the product's price (Karadag 2015). This implies that higher cost is allocated to some products while little is assigned to the others. Thus, there appears to be a gap in the allocation of the cost. Such distortions are known as cross-subsidiaries. This problem can be solved with the help of the ABC mechanism, which separates the overhead cost into various categories known as cost pools. Costs that happens or driven by similar activity are pooled together. This is allocated to the products by the usage of the measures that link to the activity volume. Similarly, in the case mentioned above, there is a perfect example whereby the use of the conventional method led to under cost and thus, the SP was lower. Hence, the price of the product is destroyed.

Answer 2
Part a

Activity-based costing can be defined as the mechanism that helps identify the activities in the organization and assign the cost of every activity to the product and services as per their actual consumption (Haroun 2015). Hence, this model enables the assignment of indirect cost to the direct costs as compared to the traditional methods. In the provided case, the Kangaroo Commercial Bank will gain utmost advantages in terms of customer profitability if it switches to ABC costing mechanism. Thereby, the activities that the bank should undertake and the associated drivers are:

  • Salaries allocation to the desired department in terms of customer dealt by the employees that are the same would be done on the availability of the employee in the department and not on a single rate basis.
  • Overhead like cost of printing must be done on the pages that are printed
  • The rent cost needs to be allocated as per the area that is utilized by the department (Turney 2010)
  • The cost of electricity needs to be allocated as per the electric points.

The bank needs to be function and understand the activities that are involved in every branch and allocation the cost accordingly.

Part b
When it comes to the service organization, the primary cost is the overhead followed by the salaries. Hence, it is imperative that both the cost be allocated properly between the different services provided by the bank. This helps the bank to compute the actual profit. Hence, in the case of Kangaroo Bank, the bank will be able to allocate the cost between the commercial and retail banking by applying the ABC to arrive at the profit scenario of the commercial and retail bank differently. The chief matter when it comes to ABC is the identification of the activities followed by the drivers. Thereby, if the following are done properly depending upon the activity, then on the basis of activity, every department of the bank would be able to allocate cost utilizing the rate of cost driver; hence the vital aspect is to trace the movements and driver related to manufacturing cost.

Hence, if the bank uses the modern system of ABC, then it would be able to derive the benefit; however it will attract additional cost and process will be more. The utilization of the ABC mechanism is mainly due to the effectiveness of the cost allocation and advantages it provides in the estimation of cost. When it comes to the service sector like banks the overhead percentage cost is more as compared to the direct cost. Therefore, the maximum portion can be tagged in the overhead part. The banking department performs due to the different departments; hence, the same can be properly considered in the ABC system (Tuya 2017). The transaction of the customer passes through other department in order to ensure the financial authenticity. Hence, accurate proportion of the overhead can be easily ascertained with the help of the cost drivers. The bank charges the customers for the services availed. In the absence of a proper costing mechanism, the customer might be charged unnecessarily and hence this might create an adverse impact for the bank.

The implementation cost of the system is high. As compared to the traditional method, the system is simple. However, the proper cost of allocation is absent, and hence this makes the system weak. Concerning the ABC analysis, the driver's identification is the central point of consideration (Cidav et al 2020). With the help of the drivers, the cost is distributed to different heads. The driver's records give a proper input to the services utilized by the departments that enhance the recording system at the operational level hence justifying the cost and time to the entity. The incurrence of such cost by the bank are justified because the benefits attained is higher. This enables the decision-making process to be swift and helps in different control functions like the cost curtailment and even the appraisal system (Morris, Kocakulah, and Yeager 2014). Hence, through the design of ABC, the bank can quickly ascertain the cost of the branches and know the profitability. Moreover, it provides the bank an opportunity to look at their cost structure and hence curtail for better profitability

Answer 3
Ethics and governance provides a framework where the employees of the company are required not to reveal any material facts of the business to the outside parties or to use the same to get an undue advantage. Hence, in consideration to it, it is of utmost necessity that the personal interest should not be introduced as that might influence the process of decision making. It is essential that the employee should not have any pecuniary in the company. the internal matter of the company should be kept concealed, and employees must abide by it. If the management is facing adverse situations, the management should trace the solution and ensure that the same is resolved without hampering the smooth running of the organization. The procedures must be dealt with precision, and plans must be prioritized.

In the mentioned case, the partners of the company appointed the financial manager for the company. After the conclusion of the meeting, the company faced an uphill task where cash shortage was noted and hence the creditors were not paid timely. The payment was done at the double the time. Hence, it is a serious concern as it would spoil the company's goodwill in the eyes of the creditors and suppliers. The company can increase its cash flow by introducing the new product, but the same was delayed due to the unavailability of the manuals, which the friend of the owner prints. The vendor's work even depends on the receipt of payments, and further then, purchasing raw materials can be started and work initiated. Thereby,

The company seems to be in a dangerous surrounding of events. It is essential that the vendors or the suppliers needs to be repaid on time so that the work flow remains uninterrupted. Hence, the role of the financial manager is imperative in this scenario whereby a proper evaluation and study provides the justification for the sales downfall in the recent scenario and the ability of the company in generation of cash. Such can happen due to various reasons such as delay in debtors payment, higher company's cost, and higher level of expenses which the company's sales is unable to cover. The justified reason for the delay should be undertaken and hence the corrective measures must be started.

Secondary plans should be initiated, and hence planning must be done to tackle the situation.To solve the short-term cash shortage issue, the company should rest upon different sources such as overdraft, short-term finance, and cash credit so that the workflow remains undisturbed. Agreements should be entered with the creditors for more time. Hence, Darren must be instructed to provide the materials quickly, and even the delay in payment should be negotiated. Thus, in the advent of such a situation where issues with the suppliers persist, the other suppliers might be contacted, and work is allocated to avoid the company's risk. Negotiation with the supplier will fetch better result and helps in ensuring the work is not disturbed.

References
Cidav, Z., Mandell, D., Pyne, J., Beidas, R., Curran, G., & Marcus, S. (2020). A pragmatic method for costing implementation strategies using time-driven activity-based costing.

Implementation Science, 15, 1-15. doi:http://dx.doi.org/10.1186/s13012-020-00993-1

Haroun, A. E. (2015). Maintenance cost estimation: Application of activity-based costing as a fair estimate method. Journal of Quality in Maintenance Engineering, 21(3), 258-270. doi:http://dx.doi.org/10.1108/JQME-04-2015-0015

Karadag, H. (2015). Financial Management Challenges In Small And Medium-Sized Enterprises: A Strategic Management Approach, Emerging Markets Journal, 5(1), 26-40.

Morris, J. T., Kocakulah, M.,C., & Yeager, M. (2014). Evaluating commercial loans with activity-based costing: A solution for banks in current economic times. Journal of Performance Management, 25(2), 40-56.

Turney, P. B. B. (2010). Activity-based costing: an emerging foundation for performance management. Cost Management, 24, 33-42. Retrieved from https://www.proquest.com/magazines/activity-based-costing-emerging-foundation/docview/746043777/se-2?accountid=30552

Tuya, T. (2017). Improving costing methodology based on commercial bank restructuring. Management Review : An International Journal, 12(2), 24-42.

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