Cost Accounting: Sodor Water Plc - Assignment Example

Cost Accounting: Sodor Water Plc Introduction The report considers the issues those have been raised in the case itself. It is an effort to get a more insight into the case facts. The analysis has been done through the accumulation of case facts and through a proper analysis of those facts to reach at the solutions. The conclusion has been inferred from the analysis to offer a synopsis of the case study with the addition of some new perspectives. Case Facts The company, Sodor Water Plc, is located in a self governing British Crown Dependency, the Island of Sodor. This company mainly offers water supply and waste water services to almost 500,000 inhabitants staying at that Island. OFWET (Office of Water Energy and Transport Regulation) regulates the pricing of this company services. The control over the pricing is going to more stringent in near future with an enhancement in the quality of the service provided. These have been decided based on certain allegations against Sodor Water Plc. The growing rage in the customers about the continual increase in the price level at a cost of high bonus payments and lucrative stock option schemes for Sodor Water Plc senior management has been the driving factor behind these upcoming decisions. The ineffectiveness of the operational staffs has also contributed to the anger of the responsible regulatory authority. It has been mentioned in the company’s administration manual that all the printing works would be carried out through their in-housing printing department, Impressions. Impressions used to cost some 15 % over the price charged by the other outsider printing organisations. As the rest of the departments in Sodor Water Plc were into reducing the costs and establishing greater autonomy, there were arising questions on the existence of having such an in house printing division. Answer to the question no 1. After joining the company the Director form Support Service focussed his concentration on the Impression division of the organisation. There were raising questions on the financial and operational condition of the respective printing division. Users complain that Users charge higher than the other printing organisations. At the same they were facing allegations of being unresponsive and late at their work. Even they were not operating at the permissible speeds, and hence loosing out on their productivities. Another main problem, the division had to bear is the inefficiency and lack of commitment from their employees. The division was suffering from employees’ absenteeism and that is why they were loosing on their productive hours. In the letter from the Director (Support Service) to the Director (Finance), the former one has raised his concern on the validity of the trading accounts that has been provided by the Impression management. The poor management activities have been mostly responsible for almost all of those factors. The absence of detailed budget has raised questions about the planning capability of the respective management. Another important fact which has been a barrier against getting the value for money has been the division’s poor marketing programme, which have in turn increased the variable cost of the company. As the quantity of the printing will go up, the variable cost per printing would come down giving the division cost benefit on the economies of scale over the other outside competitors. In that case they can also be able to lessen their price offering their users a more cost effective service. Looking at the trading accounts, it has been noticed that the expenses do not include the distribution cost which is a significant part of cost in a large organisation like Sudor Water Plc. The costing of the Impressions products is not appropriate and that is why they end up charging 15 % higher than the other printing facilities outside. However, they must not forget that having such high prices would mean loosing their customers who are significant to their business. As a number of divisions are now moving towards creating a cost effective environment from their divisions, it is preferable that Impressions also contribute to their efforts with offering their service at a more competitive pricing. Activity cost based accounting is significant for this purpose. In traditional costing techniques there can be certain loopholes which can create the distortion risk in product costing. In activity based costing, this distortion risk is supposed to get reduced to a greater extent. In this costing system the division must identifies the cost pools or the activity centres within the organisation and must allocate cost to those activities using the multiple cost drivers (Akyol, Tuncel & Bayhan, 2005). As this costing system considers a number of cost drivers integral to various activities, the distortion risk is reduced to a greater extent, providing suitable cost information (Popesko, 2010). ABC costing is a set of activities relating overhead costs to the products and services offered to the customers. In this costing system the division first needs to identify the company’s significant activities; in this case which are printing, distribution and other activities. The cost drivers in this case would be the labour hours, the space occupied etc. Each of the activities would comprise of multiple cost drivers. The activity cost must be allocated to these activities as per the cost associated with the cost drivers. The last step would be allocating the cost to the products in proportion with the contribution of each of those activities to the product division. Activity based costing would enable the management to have better control over the cost and hence pricing of their products and services with a detailed realisation of the overheads. The division is now using a performance measurement of shrinkage performance which considers the quality of paper used and charged to determine the performance of the division. It has been noticed that the absenteeism among the employees have been quite high. To discourage the employees from taking leaves every now and then it is very much important to link their performances with the number of productive hours and no of quality prints produced keeping in mind the quality of the prints. The performance of the managers can be linked with the overall productive hours of the employees under his base, the shrinkage of papers, and cost effectiveness of their department with the preservation of the required quality of the products. To have a more comprehensive performance measurement the authority must introduce Balanced score card approach to evaluate the performance of the employees in that division (Wiley, n.d.). It comprises of four perspectives including financial perspective, internal processes, customer perspective and Innovation and learning and these are measured in compliance with the vision strategy of the organisation (McNamara, n.d.). These measurements are supposed to minimise the overtime of the employees and at the same time would reduce the overhead cost attached to the services. When the performance of the staffs would be linked with the productive hours devoted by them, it is expected that the absenteeism would reduce greatly. The manager himself would look to enhance the productivity and quality in a cost effective manner as his own performance would be linked up with the same. He would be more interested in keeping up control over his employees as a major part of his remuneration would be defined by the productivity and quality delivered by the employee base in his division. In such a scenario, the manager would be encouraged to ensure that the machines are optimally used at their maximum speed to reduce the no of set ups and hence the amount of set up costs incurred. If this does not enhance the efficiency and productivity of the employees and manager in that division, the organisation even can introduce penalty for crossing the shrinkage limits and wasting more machine and labour hours. In purchasing the division must be careful enough to negotiate properly with the suppliers and buy the optimal number of papers to have a balance between the economies of scale and the inventory cost incurred. Stock out of papers has been quite a norm in this organisation. However for this, a proper projection of the next year requirements would be required to zero down on the optimal amount of paper purchased to offer better cost effective service to their customers. Answer to the question no 2 It is quite evident from the case that the ‘Impressions’ division is not interested in doing marketing for their divisions, so that other divisions know about their work and place the orders with the in house facility. This situation is expected to change in near future as the focus has been already centred at the in house printing divisions. As to reciprocate to the customers’ concerns, the concerned authority is expected to bring certain changes in the marketing divisions. As a consequence the demand is expected to see a sharp growth. For an instance from the next time onwards the Corporate Communications divisions are supposed to place their orders with the in house facility of the organisations. A calculation of the accumulated data has been shown above with the new prospective demand addition. As there is no data on the demand growth rate for printing and other services, the projected demand has been drawn down on the base of previous years’ figures. There have been certain issues regarding the jobs which are done by the outside printers. The cost has been quite higher, around £ 283, 713, which means despite having an in house printing facility the organisation have been loosing out money to the outsiders. There have been certain issues raised in this concern. Around 473 jobs have been outsourced outside. There have been 98 jobs which have been allocated outside as there was capacity issue due to staff shortage. Around 199 were outsourced as those jobs seemed to be too technical for the Impressions team. Due to the unavailability of the appropriate equipments, the in house division have reported 176 job losses. These issues are concerning enough as for these reasons the capacity is not being utilised optimally; the in house facility is unable to attain economies of scale. This could be a reason why the cost has grown higher. To make ‘Impressions’, a full-fledged, self dependent in house printing facility, the organisation would have to take steps to resolve the hindrances which are coming on the way of the division to put its impression. Another concern has been that these 98 jobs could have been carried out in house if the users were not in such hurry. A number of people are placing their orders lately at the last moment and then they demand it urgently which can not be delivered by the division. So, the works had been outsourced outside. Now there are two options to resolve this issue. The purchase of a high volume photocopier to handle urgent impressions, which would put another cost burden on the trembled financial condition of the company without fetching many benefits for the same, does not seem to be a feasible solution. The situation can be handled from the human resource management perspective. The authority can take an account of those divisions which are mostly placing these urgent requirements. If it is found that most of the urgent works are placed due their sheer negligence, they can be penalised. Doing this would send a message to others to prevent themselves from doing such careless jobs. In this way, the number of urgent works can be reduced and at the same time the overtime cost can drastically come down. The support service has proposed to keep the outsourcing of work at a minimal level which would be only possible if the in house division is self sufficient in itself. Acquiring better equipments with an assessment of the cost benefit analysis would be preferable. Most of no of works those have been given to the outside printing facilities is due to the fact that the jobs were too technical. Impression must give a though in this matter. It must consume the fact that to fulfil the objectives of its firm and establish itself as an essential part of this company, it is very much significant that the division has the required qualified people on board. The division has been spending some £103,669 in the employee cost. It is very much desired that the cost has been spent on the right qualified and experienced people. The machines are not being utilised at its optimal usage. The speed the staffs at Impressions are using is quite less than the optimal speed guided by the machine manufacturer. This means that there would be more set ups to handle a certain no of jobs. A new set up of machines would demand more cost and time to be involved in this. The analysis support the facts that operating the machines at the optimal level would reduce the operational cost incurred. The division must introduce a flexible working environment to operate in a tight schedule, and that too in a cost effective manner. There have been a number of requirements which demand new machineries to be acquired. No doubt that this would incur higher initial cost. However this is expected that the operational cost would be quite lower in the coming years. As a consequence in future, the price for their products and service are supposed to decline. However the acquisition of the machines must be decided using the cost benefit analysis of the respective machines. At the same time the usage and maintenance must be done properly, so that the depreciation of the machines can be minimised. Overall it needs the proper commitment of the people in there to proof the necessity of the division’s existence by developing it as a self sufficient in house printing facility which can stand on its commitment to its customers. Answer to the question no 3 Being an in house printing facility for Sodor water Plc, there are certain objectives of Impressions which it is committed to fulfil. Impressions is set up to offer its customers with quality service at a cost effective price. Some of the activities which the division is supposed to carry on include printing, offering of graphics full design service, binding, laminating which are parts of finishing, distribution of papers and placing certain works with the outer printers which would not be possible to be accomplished in house due to different limitations. Some of the works are outsourced to other outside printing organisations due to certain limitations like customers need them in insufficient time period and the unavailability of the staffs in the division. There are certain types of machines with bear with different types of work loads. Printing can be performed in Lithograph presses and a Risograph or high volume copying. The later one would have enabled the department to have fast turn rounds. Although the cost per copy is bit higher, but the high copying machines would require less efforts from the employees, which mean the employee cost would come down with a certain reduce in the overtime cost incurred. The demand for printing and other graphical designing services is quite high. As per figures, in 2009, the demand for this year has been 9,069,000 papers. However there is every chance that the figure would be higher in the nest year as more and more departments would be aware of their products and services. In such a scenario, it would be preferable to lower the set up cost. The set up cost would be reduced, when the machine would be able to take more load at one go which means at one set up. At the same time as the machine would require less efforts from the staff members, the surplus productivity hours can be used in other operational works which means reducing the employee cost all together. However this would require a cost benefit analysis in both cases. A new machine should only be introduced if only the cost savings offset the higher expenditure that the company is expected to incur if it acquires the machine. There are two machines available, Rainbow Miniprint and Rainbow Maxiprint. The former one is meant to handle some 2 million impressions annually, while the annual capacity of the later one is 3.5 impressions annually. The below table accumulates the cost figures for each of the machines. The cost here has not considered the variable cost of those machines. For an instance lets assume that the printing demand is as same as that has been in the last year 2009, around 10 million impressions. The underlying assumption is that all the impressions are going to be produced either using the miniprint or else using the maxiprint. If this has been the case, the maxiprint is supposed to incur less cost than the miniprint ones. The calculations have been accumulated in the table below. Moreover more enhanced machines are supposed to require less efforts from the staffs and at the same time would be able to handle more jobs at one set up, minimising the set up cost and time. In that context, the maxiprint is supposed to reduce the employee over time cost as well as the set up cost and time as that would be requiring lesser set ups to handle the same no of impression than that handled by the miniprint. So the variable cost is supposed to be quite less for the maxiprint machine, though the initial cost may be higher if lesser no of machines are acquired. As mentioned earlier, the marketing of this division has been poor enough to be unable to attract more printing jobs from a number of departments. In later years as more and more departments would know about the printing division, it is expected that the demand would see a sharp rise. Due to unavailability of data the accurate computation of the cost benefit analysis can not be taken forward. However looking at the data available and the increasing demand in the organisation, it seems that it is better to acquire the Rainbow Maxiprint. Looking at the increasing demand of printing, it has been proposed that the division needs to acquire new machines, so that the division would be more enabled to handle certain types of urgent and technological requirements which have been passed towards other outsider printing organisations. In such a way Impressions is loosing out on its economies of scale and thus incurring more cost resulting in charging higher prices for their products and services. Though acquiring new machines would incur more cost at the beginning, the operational cost would be quite lower with this machine. As the business environment is getting more competitive, the organisations are looking at their marketing departments to acquire more customers. In this context, no doubt that Sodor Water Plc would require a higher no of multi coloured leaflets and other coloured products. To meet this requirement it is very much preferred to have a multi coloured machine on the board. Conclusion The functionality of ‘Impressions’ has been facing questions from their customers. The infrastructure facilities in the divisions were not matching the customers’ demands. At the same time, it has been noticed that there is a lack of commitment from the employees’ perspective. The financial condition has been trembled with a little financial information available. To ensure the commitment of the employees, it has been proposed that the performance of the employees must be measured using a balanced score card approach which includes performance measurement approaches from a number of perspectives. The costing of the department has certain loopholes. Distribution has taken into account. Proposal has been provided to use activity based costing methods which can allocate cost in different activities like printing, binding, distributing etc. In such a way, the division can even make out if there is any activity which is incurring excess cost than the others. The division should market its products and services, so that they can reap the outcome of having more customer demands. As the establishment of Impressions has taken place and there has been quite a good demand to be handled, it is preferable that it is better to develop this as a better in house facility rather than dropping the same. A well developed and maintained in house facility would be more profitable for the company in long run. The division must contribute in the cost savings of other departments through the development of cost effective environment in the division itself. “Happy customers are good, but profitable customers are much better” (HBS, 2005). Reference Akoyl, D., Tuncel, G. & Bayham, M., G. 2005. A comparative analysis of activity-based costing and traditional costing. Available at: http://www.waset.org/journals/waset/v3/v3-11.pdf [Accessed on April 16, 2010]. HBS. August 8, 2005. A Balanced Scorecard Approach To Measure Customer Profitability. [Pdf]. Available at : http://hbswk.hbs.edu/item/4938.html [Accessed on April 16, 2010]. McNamara, C. No Date. Balanced Scorecard. [Online]. Available at: http://managementhelp.org/org_perf/bal_card.htm [Accessed on April 16, 2010]. Popesko, B. February, 2010. Utilization of Activity-Based Costing System in Manufacturing Industries – Methodology, Benefits and Limitations. [Pdf]. Available at: http://www.bizresearchpapers.com/1.%20Boris.pdf [Accessed on April 16, 2010]. Wiley. No Date. Introduction to the Balanced Scorecard. [Pdf]. Available at: http://media.wiley.com/product_data/excerpt/89/04714232/0471423289.pdf [Accessed on April 16, 2010]. Bibliography Horngren, T., C., Foster, G. & Datar, M., S. Cost accounting: a managerial emphasis. Hong Kong: Pearson Education, 2001. Maher, M., Stickney, C. & Weil, R. Managerial Accounting: An Introduction to Concepts, Methods and Uses. USA: Thomson Higher Education, 2008. Needles, B., Powers, M. & Crosson, S. Financial and Managerial Accounting. USA: South West Cenage Learning, 2008. Smith, A, J. Handbook of Management Accounting. UK: Cima Publications, 2007. 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