There are a few options for S.B. Ltd to consider getting through difficult times. The five main options are firstly, to discontinue the Nottingham division and Leicester and Loughborough divisions could use their spare capacity to produce 60% of Nottingham’s 2010 output in addition to their own 2010 output, close the Nottingham division and outsource Nottingham’s 2010 output, to launch a major campaign for all 3 products to increase their sales, to introduce a transfer pricing system between the division and the head office to increase motivation among the staff in each division and rightsizing the organisation.
As seen Nottingham is not making growth, in response to market forces, the first option is to discontinue Nottingham division by selling its assets and settling its liabilities and shifting production from Nottingham to Leicester and Loughborough. The discontinuation decision is a decision when the division profitability highlights the potential of unprofitable (Drury, 2010, pp.91-92). In this option, assuming that Leicester and Loughborough have some spare capacity to produce 60% of Nottingham’s 2010 output on top of their own 2010 output. According to Drury (2010, p.92), discontinuing the Nottingham division could aid the company in eliminating cost of goods sold, and other variable costs in the division.
Leicester | Loughborough | Derby | ||||||||
Sales - Strawberry jam | 280.00 | |||||||||
Sales - Orange Marmalade | 240.00 | |||||||||
Sales - Raspberry jam (60%) | 96.00 | |||||||||
Total Sales | 616.00 | |||||||||
Cost of goods produced and sold | 173.00 | 153.00 | 326.00 | |||||||
Gross Profit | 290.00 | |||||||||
Advertising costs | 30.00 | |||||||||
Distribution costs | 50.00 | |||||||||
Local administration expenses | 30.00 | 30.00 | 60.00 | |||||||
Head Office Costs | 150.00 | |||||||||
Net Profit | - | |||||||||
Other cost such as advertising costs, distribution costs and Head Office costs remain unchanged and is not affected by the discontinuation of the Nottingham division. O’Hare (2010, Management Accounting Lecture 3) suggested other factors which will affect an organisation to discontinue a division, the division is making a loss, to identify avoidable costs or to discover other saving.
Outsourcing option is also known as sub-contracting option has become increasingly common in organisations, which enables organisations to concentrate on their core performance while outsource other specialist their secondary activities (Collier et al, 2007, pp.220-221). In S.B. Ltd case, according to Oxford University Press (2009), outsourcing could help to get through this hard time by going on a process of business process downsizing. Outsourcing allows operations that have seasonal demands to bring in additional resources in time of needs. Other advantages of outsourcing are, outsource activities will allow S.B. Ltd to focus on important functions without sacrificing quality or service, outsource specialist could help improve the quality and standard of the jam. It may also be able to purchase the jam more cheaply or perhaps more quickly.
Assuming the outsource price for raspberry jam is 20% more then the cost of goods produced and sold for raspberry jam. Hence, the sales of raspberry jam remains the same and Leicester division and Loughborough division have spare capacity which gives them room for expansion of 30% more sales each. All other expenses remain the same for both Leicester and Loughborough divisions. This gives the Head Office a net profit of £76,000
Leicester | Loughborough | Derby | ||||||||
Sales - Strawberry jam | 364.00 | |||||||||
Sales - Orange Marmalade | 312.00 | |||||||||
Sales - Raspberry jam (Outsource) | 160.00 | |||||||||
Total Sales | 836.00 | |||||||||
Cost of goods produced and sold | 182.00 | 156.00 | 338.00 | |||||||
Outsource price | 132.00 | |||||||||
Gross Profit | 366.00 | |||||||||
Advertising costs | 30.00 | |||||||||
Distribution costs | 50.00 | |||||||||
Local administration expenses | 30.00 | 30.00 | 60.00 | |||||||
Head Office Costs | 150.00 | |||||||||
Net Loss | 76.00 | |||||||||
On contrary to the advantages, outsourcing the jam to some specialist could lead to risk of unsatisfactory quality and standard of the jam. Other disadvantages could be leak of procedures and techniques of making the jam, outsourcing usually focuses on short-term cost-saving, and ignores the unchanged overhead burden.
Another option is to launch a major advertising campaign for all three products to increase their sales and keep all three divisions. Advertising could boost awareness and generate demand of the sales of jams of S.B. Ltd. and hence acquiring more orders.
In the advertising campaign, assuming the advertising cost increase by 20% and it bring the sales of each product to an increase of 20% each. It simply boost up the profit of the company to £96,000.
Leicester | Nottingham | Loughborough | Derby | |||||||||
Sales - Strawberry jam | 336.00 | |||||||||||
Sales - Raspberry jam | 192.00 | |||||||||||
Sales - Orange Marmalade | 288.00 | |||||||||||
Total Sales | 816.00 | |||||||||||
Cost of goods produced and sold | 140.00 | 110.00 | 120.00 | 370.00 | ||||||||
Gross Profit | 446.00 | |||||||||||
Advertising costs | 90.00 | |||||||||||
Distribution costs | 50.00 | |||||||||||
Local administration expenses | 30.00 | 30.00 | 30.00 | 90.00 | ||||||||
Head Office Costs | 150.00 | |||||||||||
Net Profit | 66.00 | |||||||||||
The other option is when an organisation chooses to decentralise its divisions, transfer pricing helps decide what price to charge for in-company transactions (Collier et al, 2007, p.38-39) and as a form of promoting divisional autonomy (O’Hare, 2010, Management Accounting Lecture 8). It is useful when goods are transferred between divisions; hence, the performance measurement of each division is not prejudiced by the corporate objectives. The profitability of each business units will be affected and according to Solomon (1965 cited in Collier et al, 2007, pp.38-39), companies might take advantage of the transfer pricing which are suitable for evaluating divisional performance for the corporate interest, instead of the business units. Transfer pricing strategies and can produce substantial tax savings in addition to enhancing operational performance and improving cash flow. In many organisations, in order to avoid de-motivating effects on different business units, negotiated prices are adopted.
Say, each product is transferred to Derby division and it pays each division 70% of the sales it made from selling all the jams and yet still bare the cost of advertising, distribution and the head office costs. The local administrative expenses shall be bare by the respective divisions.
Leicester | Nottingham | Loughborough | Derby | |||||||||
Sales - Strawberry jam | 280.00 | |||||||||||
Sales - Raspberry jam | 160.00 | |||||||||||
Sales - Orange Marmalade | 240.00 | |||||||||||
Total Sales | 680.00 | |||||||||||
Transfer price revenues | 196.00 | 112.00 | 168.00 | |||||||||
Cost of goods produced and sold | 140.00 | 110.00 | 120.00 | |||||||||
Gross Profit | 56.00 | 2.00 | 48.00 | 680.00 | ||||||||
Total cost of transfer | 476.00 | |||||||||||
Advertising costs | 30.00 | |||||||||||
Distribution costs | 50.00 | |||||||||||
Local administration expenses | 30.00 | 30.00 | 30.00 | |||||||||
Head Office Costs | 150.00 | |||||||||||
Net Profit | 26.00 | (28.00) | 18.00 | (26.00) | ||||||||
There are downsides of transfer pricing. The political process in an organisation might affect the transfer pricing between divisions. Incorrect prices adopted can distort reported performance, by making some divisions more profitable at others expense. Opportunities exist to avoid taxes using artificial transfer prices to transfer profits from a high tax division to a low tax division.
Rightsizing, or corporate restructuring, with the aim of reducing costs and improving efficiency and effectiveness is also one option in difficult times. Rightsizing is downsizing in the belief that an organisation really should operate with fewer personnel. The primary reason to engage in rightsizing is to make the daily operations of a business more productive. For example, a company may be able to replace assembly line employees with machines which will be quicker and less prone to error. In addition, rightsizing increases profits by reducing the overall overheads of a business.
S.B. Ltd operates a full cost (TAC) standard costing system. The standard costs set fot the year 31 March 2010 and information about future costs and selling prices are in Appendix 2.
Part 2 (700)
Assuming the company decided to go for the option of keeping all divisions open and launching an advertising campaign, you are required to produce a standard cost card for each product and a budget for the company showing clearly the costs attributable to each division for the year to 31 March 2011. State clearly all assumptions made.
Appendix 2 - Standard cost data | ||||||
Standard cost cards for the year ended 31 March 2010 (per batch of 40 jars each of 500 grams) | ||||||
Strawberry Jam | Raspberry Jam | Marmalade | ||||
£ | £ | £ | ||||
Selling price | 28 | 32 | 40 | |||
Fruit | 16kg | 4.8 | 16kg | 5.6 | 24kg | 4.8 |
Sugar | 8kg | 1.6 | 8kg | 1.6 | 12kg | 2.4 |
Labour | 1 hour | 6 | 1 hour | 6 | 2 hours | 12 |
Other variable costs | 1 | 2 | 2 | |||
Fixed overheads | 1 hour | 2 | 1 hour | 2 | 2 hours | 4 |
15.4 | 17.2 | 25.2 | ||||
Profit | 12.6 | 14.8 | 14.8 | |||
Other information | ||||||
Demand | With the right promotion the company believe that they could sell 20% | |||||
more of each product at the 2010 standard selling price | ||||||
Material wastage | It is considered that improvements can be made but input weight will | |||||
always be at least 10% more than output weight for jam and 50% for | ||||||
marmalade | ||||||
Labour | Currently operates at 80% efficiency levels | |||||
Prices | Strawberries are sourced from the UK and prices are expected to rise by | |||||
2-5% | ||||||
Raspberries are sourced from the UK and prices could rise by up to 15% | ||||||
due to poor weather | ||||||
Oranges are imported and paid for in euros euro prices are expected to | ||||||
be as 2010 | ||||||
Discounts on all fruit can be negotiated if quantities increase | ||||||
Labour rates per hour have been the same for the last 2 years | ||||||
Variable costs may rise by up to 5 % | ||||||
Fixed overheads may rise by between 5 and 10% |
A standard cost card can be defined as ‘a detailed listing of the standard amounts of materials, labour and overheads that should go into a unit of product, multiplied by the standard price or rate that has been set for each elements’ (Anon 2, 2010). A standard cost card, for example must include the price, specifications, quantity and quality of material required, as well as such factors as the period of credit allowed from suppliers, cash and quantity discounts, spoilage due to wastage and deterioration. A standard cost card demands an investigation of all contributing factors that can constitute a cost before the cost is adopted. According to Drury (2010, p.278), standard costs are ‘predetermined costs’ and they are the target costs that should be incurred under efficient operating conditions. The standard cost card will be subjected to updating caused by revision of standards such as changes in prices, discounts, etc.
Standard costing is a control system which sets standards that are ideal, expected and achievable (O’Hare, 2010, Management Accounting Lecture). Collier (2007, p.36) put forward that standard costing is a control technique which compares standard cost and all of production revenues with actual results. It is to obtain variances of each division and product (O’Hare, 2010, Management Accounting Lecture 8), which are used to stimulate improved performance and to increase motivation of staff in each division. It is a detective control used to prevent problems from reoccurring as it measures variances as it occur, thus allowing management to take necessary corrective action.
The standard cost card for the year ended 31 March 2011 (per batch of 40 jars each 500 grams) for Strawberry Jam, Raspberry Jam and Orange Marmalade are as below:
Strawberry Jam | ||||||
£ | £ | |||||
Selling price | 28.00 | |||||
Fruit | 16/kg | 0.31 | 4.90 | |||
Sugar | 8/kg | 0.20 | 1.60 | |||
Labour | 1 hour | 6.00 | 6.00 | |||
Other Variable Cost | 1.50 | |||||
Fixed Overheads | 1 hour | 2.10 | 2.10 | |||
15.65 | ||||||
Profit | 12.35 |
Raspberry Jam | ||||||||||
£ | £ | |||||||||
Selling price | 32.00 | |||||||||
Fruit | 16/kg | 0.40 | 6.44 | |||||||
Sugar | 8/kg | 0.20 | 1.60 | |||||||
Labour | 1 hour | 6.00 | 6.00 | |||||||
Other Variable Cost | 2.10 | |||||||||
Fixed Overheads | 1 hour | 2.10 | 2.10 | |||||||
18.24 | ||||||||||
Profit | 13.76 | |||||||||
Orange Marmalade | |||||||||
£ | £ | ||||||||
Selling price | 40.00 | ||||||||
Fruit | 24/kg | 0.20 | 4.80 | ||||||
Sugar | 12/kg | 0.20 | 2.40 | ||||||
Labour | 2 hours | 6.00 | 12.00 | ||||||
Other Variable Cost | 2.10 | ||||||||
Fixed Overheads | 1hour | 2.10 | 2.10 | ||||||
23.40 | |||||||||
Profit | 16.60 | ||||||||
The principal tool in planning is called ‘a budget’. A budget is a collection of predictions. It is an estimation of the revenue and expenses over a specified future period of time. There are three purposes of budgets as identified by Emmanuel et al (1990 cited in Collier, 2007, pp.39-40), ‘as forecasts of future events’, ‘as motivational targets’ and ‘as standards for performance evaluation’. Budget is a financial plan or qualitative statement for implementing the various decisions to be pursued during a specific accounting period, that management has made in the previous period.
Collier (2007, pp.39-42) suggest that budgets provide a control mechanism through both the feed forward and feedback loops. The control mechanism in the budget is to provide a performance monitoring function to the appropriate managers who are responsible for implementing the various decisions by producing and presenting the performance reports. According to Drury (2010, pp.8-9), the performance report provide feedback information by comparing planned and actual results.
Generally, a functional budget is drawn up for each division of S.B. Ltd. These budgets are, then, merged together into a single combined statement, which is known as the master budget, of S.B. Ltd’s expectations for the future periods. The master budget consists of budgeted profit, which it is expected to convey to everyone in the organisation the part that they are expected to achieve in implementing management’s decisions. The master budget, usually, consists of a budgeted profit and loss, a budgeted balance sheet and a budgeted cash-flow statement. In order to finalised a budgeted profit and loss, other budgets for the individual divisions and produced, such as the sales budget, direct materials usage budget, direct materials purchase budget, direct labour budget, and selling and administration budget.
Master Budget Budgeted Profit and Loss Account for the year ending 31 March 2011 | ||||||||
£ | £ | |||||||
Forecast sales (Schedule 1) | 816,000 | |||||||
Purchases (Schedule 3) | ||||||||
Materials - Fruit | 130,272 | |||||||
Materials - Sugar | 46,080 | |||||||
Cost of raw materials consumed | 176,352 | |||||||
Direct Labour (Schedule 4) | 155,520 | |||||||
Factory Overheads (Schedule 5) | 68,040 | |||||||
Cost of Sales | 399,912 | |||||||
Gross Profit | 416,088 | |||||||
Selling and administration expenses (S6) | 350,000 | |||||||
Variable Costs (Schedule 7) | 40,320 | |||||||
Budgeted operating profit for the year | 25,768 | |||||||
Schedule 1 - Sales Budget for year ending 31 March 2011 | |||||||||||
Product | Batches Sold | Selling Price | Total Revenue | ||||||||
Strawberry Jam | 12,000 | 28.00 | 336,000.00 | ||||||||
Raspberry Jam | 6,000 | 32.00 | 192,000.00 | ||||||||
Orange Marmalade | 7,200 | 40.00 | 288,000.00 | ||||||||
816,000.00 | |||||||||||
Schedule 2 - Annual Direct Material Usage Budget | |||||||||||
Leicester | Nottingham | Loughborough | Total Units | ||||||||
Strawberry | 192,000 | 192,000 | |||||||||
Raspberry | 96,000 | 96,000 | |||||||||
Orange | 172,800 | 172,800 | |||||||||
Sugar | 96,000 | 48,000 | 86,400 | 230,400 | |||||||
288,000 | 144,000 | 259,200 | |||||||||
Schedule 3 - Direct Materials Purchase Budget | ||||||||||
Strawberry | Raspberry | Orange | Sugar | |||||||
(units) | (units) | (units) | (units) | |||||||
Quantity necessary to meet production | 192,000 | 96,000 | 172,800 | 230,400 | ||||||
requirements as per material usage budget | ||||||||||
Planned unit purchase price | 0.31 | 0.39 | 0.20 | 0.20 | ||||||
Total Purchases | 58,752.00 | 36,960.00 | 34,560.00 | 46,080.00 | ||||||
Schedule 4 - Annual Direct Labour Budget | ||||||||||
Leicester | Nottingham | Loughborough | Total | |||||||
Budgeted production (units) | 12,000 | 6,000 | 7,200 | |||||||
Hours per unit | 0.80 | 0.80 | 1.60 | |||||||
Total budgeted hours | 9,600 | 4,800 | 11,520 | 25,920 | ||||||
Budgeted wage rate per hour (£) | 6.00 | 6.00 | 6.00 | |||||||
Total Wages (£) | 57,600 | 28,800 | 69,120 | 155,520 | ||||||
Schedule 5 - Annual Fixed Overheads | ||||||||||
Leicester | Nottingham | Loughborough | Total | |||||||
Fixed Overheads hour | 1 | 1 | 2 | |||||||
Fixed overheads rate | 2.10 | 2.10 | 2.10 | |||||||
Fixed Overheads per batch | 2.10 | 2.10 | 4.20 | |||||||
Total Fixed Overheads (£) | 25,200.00 | 12,600.00 | 30,240.00 | 68,040.00 | ||||||
Schedule 6 - Annual Selling and Administration Budget | |||
£ | £ | ||
Selling: | |||
Advertising Costs | 60,000.00 | ||
Distribution Costs | 50,000.00 | ||
110,000.00 | |||
Administration: | |||
Local Administration Expenses | 90,000.00 | ||
Head Office Costs | 150,000.00 | ||
240,000.00 | |||
350,000.00 | |||
Schedule 7 - Annual Variable Cost Budget | ||||||||||
Leicester | Nottingham | Loughborough | ||||||||
Other variable costs | 1.00 | 2.00 | 2.00 | |||||||
Variable costs per batch | 1.05 | 2.10 | 2.10 | |||||||
Total Variable Costs | 12,600.00 | 12,600.00 | 15,120.00 | 40,320.00 | ||||||
It is now April 2011. The actual results for the year 31 March 2011 are in Appendix 3.
You are required to:
(a) Produce an operating statement for each division based on your own budgets.
(b) Write a report to the board appraising the performance of each division using whichever indicators you feel are appropriate. You should also suggest what other information should be obtained in order to improve your appraisal.
(c) Write a report to the company management accountant on whether the company should change their traditional approach to accounting for overheads to one based on Activity Based Costing.
Appendix 3 S.B. Ltd - Trading results for the year ended 31 March 2011 | |||||||||||||||
Leicester | Nottingham | Loughborough | Derby | ||||||||||||
£'000s | £'000s | £'000s | £'000s | ||||||||||||
Sales - Strawberry Jam | 11000 batch | 330 | |||||||||||||
Sales - Raspberry Jam | 6250 batch | 200 | |||||||||||||
Sales - Marmalade | 6000 batch | 250 | |||||||||||||
TOTAL SALES | 780 | ||||||||||||||
Fruit | 170000kg | 53 | 100000kg | 36 | 140000kg | 30 | |||||||||
Sugar | 84000kg | 21 | 48000kg | 12 | 68000kg | 17 | |||||||||
Labour | 10000 hours | 70 | 6000 hours | 39 | 6000 hours | 39 | |||||||||
Variable costs | 12 | 10 | 13 | ||||||||||||
Fixed Overheads | 10000 hours | 22 | 6000 hours | 12 | 6000 hours | 15 | |||||||||
Cost of goods produced and sold | 178 | 109 | 114 | 401 | |||||||||||
Gross Profit | 379 | ||||||||||||||
Advertising costs | 60 | ||||||||||||||
Distribution costs | 60 | ||||||||||||||
Local administration expenses | 32 | 32 | 32 | 90 | |||||||||||
Head Office Costs | 155 | ||||||||||||||
NET PROFIT | 14 | ||||||||||||||
Note | Sales = Production |
(a) According to Anon 3 (2010) and Anon 4 (2010), an operating statement is a detailed periodic report of the financial reports or a financial statement of a firm’s operations. In many organisations, management rely on the financial and quantitative statement provided to record performance achieved by that area of the operation, for a selected budget period, for which the management is responsible (Oxford University Press, 2009). S.B. Ltd practices a decentralised control over its responsibility centres where Derby division is delegated as the controlling costs centre. Decentralisation means there is a delegation of authority in decision making in the organisation. According to CIMA Official Terminology (Collier, 2007, pp.13-14), the financial control in divisionalised businesses is the divisional performance control by producing a budget and the monitoring of actual performance towards the budget.
Each division management will carry out a significant function in analysing and interpreting financial information and will achieve the target given. Below is the operating statement for the individual division based on the budget prepared in part 2.
Operating Statement for S.B. Ltd | |||||||||||||||||
Description | Leicester | Nottingham | Loughborough | Derby | |||||||||||||
Sales - Strawberry Jam | 336,000 | 336,000 | |||||||||||||||
Sales - Raspberry Jam | 192,000 | 192,000 | |||||||||||||||
Sales - Marmalade | 288,000 | 288,000 | |||||||||||||||
Total Sales | 816,000 | ||||||||||||||||
Cost of Sales | |||||||||||||||||
Purchases - Fruits | 58,752 | 36,960 | 34,560 | ||||||||||||||
Purchases - Sugar | 19,200 | 9,600 | 17,280 | ||||||||||||||
Labour | 57,600 | 28,800 | 69,120 | ||||||||||||||
Variable Costs | 12,600 | 12,600 | 15,120 | ||||||||||||||
Fixed Overheads | 25,200 | 12,600 | 30,240 | ||||||||||||||
Cost of goods produced and sold | 173,352 | 100,560 | 166,320 | 440,232 | |||||||||||||
Gross Profit | 162,648 | 91,440 | 121,680 | 375,768 | |||||||||||||
Operating Expenses | |||||||||||||||||
Advertising costs | 60,000 | ||||||||||||||||
Distribution costs | 50,000 | ||||||||||||||||
Local administration expenses | 30,000 | 30,000 | 30,000 | 90,000 | |||||||||||||
Head office costs | 150,000 | ||||||||||||||||
30,000 | 30,000 | 30,000 | 350,000 | ||||||||||||||
Net Profit | 132,648 | 61,440 | 91,680 | 25,768 | |||||||||||||
Solomon (1965 cited in Collier, 2007, pp.13-14) highlighted three purposes for financial reporting at divisional level; to guide divisional managers and top management in decision making, and to enable top management to appraise the performance of divisional management.
(b) TO: The Directors of S.B. Ltd
From the earlier budget, the performances of all four divisions are appraised. The overall company’s performance as seen on Derby division operating statement seems to have achieved the budgeted gross profit. However, all the other costs, such as the advertising costs, distribution costs, local administration expenses and head office costs, influence the net profit not achieving the budgeted figure. The overall sales, although did not attain the budgeted sales, did make a good number and managed to produce the goods at a much lower price compared to the budgeted figure.
Operating Statement for Derby Division | ||||
Description | Current Period | Budgeted | ||
Sales - Strawberry Jam | 330,000 | 336,000 | ||
Sales - Raspberry Jam | 200,000 | 192,000 | ||
Sales - Orange Marmalade | 250,000 | 288,000 | ||
Total Sales | 780,000 | 816,000 | ||
Cost of goods produced and sold | 401,000 | 440,232 | ||
Gross Profit | 379,000 | 375,768 | ||
Operating Expenses | ||||
Advertising costs | 60,000 | 60,000 | ||
Distribution costs | 60,000 | 50,000 | ||
Local administration expenses | 90,000 | 90,000 | ||
Head office costs | 155,000 | 150,000 | ||
365,000 | 350,000 | |||
Net Profit | 14,000 | 25,768 | ||
The performance of Leicester division is seen not to be performing to the budgeted figures in the operating statement. The actual sales of the strawberry jam was just £6,000 less than thee budget and managed to pull off a noteworthy net profit, although not as expected as in the budget. According to ACCA (1988, p.54), preparing a set of costing will be a waste of time unless it has a purpose. Comparing the current period figures with the budgeted figures, in order to establish costs control and efficiency in the division and to prevent unnecessary use of services.
Operating Statement for Leicester Division | ||||
Description | Current Period | Budgeted | ||
Sales | 330,000 | 336,000 | ||
Cost of Sales | ||||
Purchases - Strawberries | 53,000 | 58,752 | ||
Purchases - Sugar | 21,000 | 19,200 | ||
Labour | 70,000 | 57,600 | ||
Variable Costs | 12,000 | 12,600 | ||
Fixed Overheads | 22,000 | 25,200 | ||
Cost of goods produced and sold | 178,000 | 173,352 | ||
Gross Profit | 152,000 | 162,648 | ||
Operating Expenses | ||||
Local administration expenses | 32,000 | 30,000 | ||
Net Profit | 120,000 | 132,648 | ||
The actual sales of the raspberry show a positive comparison. However, the gross profit figure is slightly lower than the budgeted figure. Unfortunately the increase in local administration expenses razed the actual net profit figure. The cost of purchasing sugar was expected to be lower in the budget as well as the labour costs was projected to be lower. Auspiciously, the current period net profit has achieved a positive figure.
Operating Statement for Nottingham Division | ||||
Description | Current Period | Budgeted | ||
Sales | 200,000 | 192,000 | ||
Cost of Sales | ||||
Purchases - Raspberries | 36,000 | 36,960 | ||
Purchases - Sugar | 12,000 | 9,600 | ||
Labour | 39,000 | 28,800 | ||
Variable Costs | 10,000 | 12,600 | ||
Fixed Overheads | 12,000 | 12,600 | ||
Cost of good produced and sold | 109,000 | 100,560 | ||
Gross Profit | 91,000 | 91,440 | ||
Operating Expenses | ||||
Local administration expenses | 32,000 | 30,000 | ||
Net Profit | 59,000 | 61,440 |
The Loughborough division, on the other hand, is making a good profit from the sales of marmalade. The sales of marmalade were projected to be higher; however, the current period gross profit and net profit are more than the budgeted figure mainly attributed to competitive purchase prices of oranges and sugar, low labour costs, low variable costs and low fixed overheads.
Operating Statement for Loughborough Division | ||||||||
Description | Current Period | Budgeted | ||||||
Sales | 250,000 | 288,000 | ||||||
Cost of Sales | ||||||||
Purchases - Oranges | 30,000 | 34,560 | ||||||
Purchases - Sugar | 17,000 | 17,280 | ||||||
Labour | 39,000 | 69,120 | ||||||
Variable Costs | 13,000 | 15,120 | ||||||
Fixed Overheads | 15,000 | 30,240 | ||||||
Cost of good produced and sold | 114,000 | 166,320 | ||||||
Gross Profit | 136,000 | 121,680 | ||||||
Operating Expenses | ||||||||
Local administration expenses | 32,000 | 30,000 | ||||||
Net Profit | 104,000 | 91,680 |
(c) TO: The Management Accountant
The traditional costing approaches were developed in the early 1900s and they are still widely used by organisations today. They rely broadly on arbitrary cost allocations. These approaches rely on an essentially arbitrary allocation of indirect costs. Such approaches do not give managers accurate product cost information; therefore, accurate production profitability calculation is not possible. The overhead rate in traditional costing approaches would typically by calculated using direct labour hours, machine hours or units. Consequently, this could lead to accurate product costs when direct costs were high and indirect costs were low.
According to Collier (2007, p.60), under the traditional costing approaches, organisation production runs to obtain the lowest unit of cost production and support the mass production model that seeks economies of scale. The overhead rates calculation to the traditional costing approaches is relatively straightforward; hence, they are widely understood in the business. Although, they are relatively cheap to operate and were seen as fairly accurate until the rise of activity-based costing in 1987, many other organisations are using them after many decades.
Traditional costing approach is a systematic costing approach that prevailed before the rise of the activity-based costing in 1987. Since then, the traditional costing approaches weaknesses were fairly visible. Their reliance on arbitrary rather than cause-and-effect allocation of overheads and their inability to produce accurate product costs in multiproduct companies were very much clearer. Their failure to analyse non-manufacturing costs made it less appropriate for modern costing approach in organisations.
As proposed by Professor Johnson and Kaplan in their book Relevance Lost: The Rise and Fall of Management Accounting (1987 cited in Oxford University Press, 2009), they question the widespread misconception exists that using accounting information and the inadequacy of conventional approaches arises from a lag in replacing the modern cost accounting approach. The new approach is designed with modern information and accounting systems for financial reporting and tax purposes, hence it recognises that costs are incurred by each activity that takes place within the organisation and that products should bear costs according to the activities use.
In Professor Johnson and Kaplan’s method, the cost drivers are identified, together with the appropriate activity cost pools, which are used to charge costs to products. The fundamental of this approach is the view that the forces which drive overheads, undeniably most organisational costs arise from specific activities (Miller and Vollmann, 1985, p.144 cited in Ashton, 1991, pp.52-32). As a result, overheads control must focus on the management of these activities. The purpose of the activity-based costing approach are to stabilise unit costs of production per period and the reported gross profit per unit will be comparable from one period to the other by stabilising unit costs.
In this time of rapid technological change, vigorous global and domestic competition, and enormously expanding information processing capabilities, management accounting systems are not providing useful, timely information for the process control, Johnson and Kaplan (1987, pp.144-146) suggested that the activity-based costing approach has catalysed an enthusiasm for motivating every member of the business organisation to meet profit goals. Also according to Johnson and Kaplan (1987, pp.144-146), present-day critics often note that successful Japanese and German manufacturing firms use this approach.
Both traditional costing and accounting-based costing vary in their level of sophistication (Drury, 2010, p.165). The traditional systems often tend to be simple and straightforward while activity-based costing tends to be sophisticated and more accurately assigning indirect costs to cost objects. Although the traditional accounting is simpler to prepare while the activity-based costing is highly sophisticated to prepare, the activity-based costing tend to result in lower costs of errors and high level of accuracy. The downside of activity-based costing is that it is expensive to operate and they are sophisticated. However, they minimise the costs of errors which will save the company a lot in profit in the longer run. The activity-based costing extensively use the cause-and-effect cost allocations compared to the traditional costing approached extensively use the arbitrary cost allocations.
ACCA (1988, p.171) recommended that the choice between the traditional costing approaches and activity-based costing approach in budgetary control depends on the method of accounting used in S.B. Ltd’s cost accounting system. If the operating expenses were charged to the respective divisions, it would reflect the use actually made by each division. Then, the overhead costs of the divisions will be established more accurately.
Traditional cost system often report inaccurate product costs and the company tend to lose out due to over priced products, incur hidden losses due to under priced products. The benefit of activity-based costing is that when it comes to improving productivity, it opens up for a much wider array of measures or methods. By examining the activities systematically, one will not only be able to identify surplus capacity if it occurs, but also lack of capacity and misallocation of capacity. A result of this might be that costs are cut the customary way, but might as well lead to a reallocation of capacity to where it is needed most which will yield better productivity.
The rapid pace of today’s technological change continues to shorten product life cycles, thus our company do not have the time to make cost adjustment once errors are detected. Today computer technology prices are decreasing and are more affordable, the cost of adopting and operating an activity based costing system has also decreased.
Therefore, the company should adopt the activity based costing in order to facilitate cost management and improve financial management. According to Karolefski (2004, p.18) “activity based costing works better if it is kept simple”. Nevertheless, when implemented properly activity based costing yields benefits to the company, its business partners, and to consumers.
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Evaluation of the options available. (2017, Jun 26).
Retrieved December 12, 2024 , from
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