Advantages and Disadvantages of Activity Based Management on the Example of Profitability of Galvanized Pallet Nails - Essay Example

 Finance and accounting Restatement of profitability of galvanized pallet nails. The Activity based costing recognizes the fact that the size of certain production overheads are influenced by diversified and complexity of products manufactured rather than volume output. The cost drivers are used to assign cost of production which benefited from the hypothesis. Profitability of pallets in 1996-97 Cleaning house had number of tons used as cost driver. The cost was $222000 and the cost driver volume 110000, cost per driver volume (222000/110000) = 2.02. The units consumed during the year are 2817 leading to apportioned cost of (2817*2.02) = 5685.22. Depreciation wire drawing machine had tons drawn as cost driver. The cost was $420000 and cost driver volume of $110000. The cost per driver was (420000/110000) = 3.82. The units consumed 2817 hence the total cost apportioned was (3.82*2817) = 10755.82. Depreciation galvanizer was a cost pool with ton galvanized as the cost driver. The cost pool was $623000, the cost driver volume 45000. The cost per driver volume (623000/45000) = 13.84. The units consumed were 2817. Cost apportioned (13.84*2817) = 38999.8 Depreciation of heading and threading cost pool had the cost of $57500 with a cost driver volume of 2817. The cost per volume was ($57500/2817) = 20.41. The number of units consumed is 2817. The total cost apportioned (20.41*2817) = 57500. The material handling had number of moves as the cost driver. The cost incurred was $350000 and cost volume of 4500. The cost per driver volume (350000/4500) = 77.78. The units consumed was 21 leading to the total cost amounting to (77.78*21) = 1633.33. Dies retooling was cost pool that had toolshops hours cost driver. The cost incurred was $382000 with cost volume of 3300. The cost per volume (382000/3300) = 115.76. The numbers of units consumed were 13. The total cost apportioned was (115.76*13) = 1504.85. Wire drawing changeovers had number of changeovers cost drivers. The cost was $272000 with 700 cost driver volume. The cost per driver volume was ($272000/700) = 388.57. The units consumed were 2 leading to a total cost apportioned to be (388.57*2) = 777.14. Quality inspection had number of inspections as the cost driver. The cost of inspection incurred was $420000 with a cost driver volume of 1000. The cost per driver was computed as (420000/1000) = 420. The units consumed were 4 hence the total cost apportioned was (420*4) = 1680. Order processing had number of orders as the cost driver. The cost incurred was $143000 with cost volume of 3000. The cost per driver was (143000/3000) = 47.67. The total units used is 9 hence the total cost apportioned was (9*47.67) = 429. The total Activity Based Costing is (5685.22 + 10755.82 + 38999.8 + 57500+1633.33+1504.85+777.14+1680+429+276) = $119241.16. The costs that did not have the cost drivers because of the direct link between the cost and the service performed were assigned. They include price and advertising $9000, freight $31000 and labor $416666.67 leading to a total of cost assigned to be $456666.67. The total cost was found by adding the Activity Based Costing to the cost assigned ($119241.16+456666.67) = $575907.83. During the same year, the sales made were 2100000, the material cost were 1100000. Profitability for year 1996-97 = sales – material cost - activity based costing – cost assigned = 2100000 – 1100000- 119241.16 – 45666.67 = $424092.17 Information systems and Economic Value Added are not calculated in this case because the true company’s economic profit differs from the accounting profits hence they are eliminated for improvement in control of cost and hence a competitive advantage. Cost assigned such as pricing, advertising and freight are calculated as there is direct activities that go to them i.e. costs are directly associated to the activity undertaken hence no need for cost drivers for the apportionment of the costs. Forecast of Activity based cost (ABC) for the year 1997-98 Forecast Cost Pool Forecast Cost Driver Forecast Cost (Spending) Forecast Driver Volume Forecast Cost (Spending)/ Driver Volume Units of Driver forecast to be consumed (Cost/Driver* Units to be Consumed) Cleaning house Tons cleaned $234,000 120,000 234,000/120,000 = 1.95 3034 5916.3 Depreciation wire drawing machine Tons drawn $420,000 120,000 420,000/120,000 = 3.5 3034 10,619 Depreciation galvanizer Tons galvanized $623,000 35,000 623,000/35,000 = 17.8 3034 540005.2 Depreciation heading and threading Tons of headed/threaded $64,000 3034 64,000/3034 = 21.09 3034 63987.06 Material handling No. of moves $395,000 5,000 395,000/5,000 = 79 22 1738 Dies retooling Toolshops hours $412,000 3,600 412,000/3,600 = 114.44 17 1945.48 Wire drawing changeovers No, of changeovers $277,000 700 277,000/700 = 395.71 2 791.42 Quality inspection No of inspections $433,000 1,000 433,000/1,000 = 433 4 1,732 Order processing No. of orders $123,000 3,000 123,000/3,000 = 41 8 328 Invoicing Invoices issued $97,000 3,000 97,000/3,000 = 32.33 8 258.64 Total ABC forecasted - - - - - $627321.1 Pricing and advertising Cost assigned $8,000 - - - 8,000 Freight Cost assigned $32,000 - - - 32,000 Labor Cost assigned $432,000 - - - 432,000 Total Costs Assigned - - - - - $472,000 Total Costs forecasted - - - - - $1099321.1 Profitability forecasted for 1995-96 = Sales – Material cost – activity based costing (ABC) - Cost assigned = 2752,000 - 1300,000 – 627321.1 - 472,000 = $352678.9 Forecast cleaning house cost pool will have tons cleaned as the cost driver. The cost predetermined is $23400 and cost driver volume will be 120000. Predetermined cost per driver volume (234000/120000) = 1.95. Units to be consumed are 3034 hence cost to be apportioned is 5916.3. Depreciation wire drawing will incur a cost of $420000 with a driver volume of 120000. The cost per driver volume predetermined (420000/12000) 3.5. Units forecasted to be used is 3034 hence cost to be apportioned is (3034*3.5) 10619. Depreciation galvanizer will have tons drawn as cost driver. Forecast cost is $623000, driver volume will be 35000. The predetermined cost per driver will be (623000/35000) 17.8. Units to be consumed are 3034 hence cost that will be apportioned will be (17.8*3034) 540005.2 . Depreciation heading and threading will incur a cost of $64000 with a predetermined driver volume of 3034. The estimated cost per driver volume is (64000/3034) 21.09. The cost to be apportioned is (21.09*3034) 63987.06. Material handling has a driver as number of moves. The cost predetermined is $39500 and cost volume is 5000 hence the cost per volume driver is (395000/5000) 79. The units to be consumed are22 leading to the cost to be apportioned be (79*22) 1738. Cost per driver volume of dies retooling is (412000/3600) 114.44. Units to be consumed are 17 hence apportionment of cost predetermined is (114.44*17) 1945.48. Wire drawing changeovers have number of changeover as cost driver. The predetermined cost is $277000 and cost driver volume 700. The cost per driver volume will be (277000/700) 395.71. The forecasted units to be consumed are 2. Cost to be incurred is (395.71*2) 791.42. The quality inspections have number of inspections to be cost driver. The forecasted cost is $433000 and cost driver volume is 1000. The cost per driver volume is (433000/1000) 433. The units to be consumed are 4 hence apportioned cost will be (433*4) 1732. The order processing will incur a cost of $123000 and a cost driver volume of 3000 hence cost per volume driver will be (123000/3000) 41. The units to be consumed are 8. Forecasted cost apportioned is (41*8) 328, invoicing will have invoices issued as cost driver. The cost to be incurred is $97000 and cost driver volume will be 3000. The cost per driver volume (97000/3000) 32.33 The units to be consumed are 8. The cost to be apportioned is (32.33*8) 258.64. The total Activity Based Costing is (5916.3+10619+540005.2+63987.06+1738+1945.48+791.42+1732+328+258.64)$627321.1 The cost will have a direct link with services or activities to be undertaken. These are pricing and advertising 8000, freight 32000 and labor 43200. The total cost assigned is (8000+32000+432000) $472000 Advantages of activity based management Interview conducted in 1999 reveals that ABC has been successful in bottom line development despite other factors such as cost of analysis, implementation, and managerial energy invested in the endeavor. It initiated worker involvement, intensive communication and commitment from the sales force and the top management. The ABC information gathered by analysts played a vital role in more profitable gain which is company’s goal and subsequently increases the workers’ wages and salaries. ABC initiative led to high level of visibility within insteel upper management. ABC is the first tool that allowed them to model the effects of labor, product mix, and customer demand i.e. factors other than volume on profitability and financial performance Automated data collection and analysis on a monthly basis provide real-time feedback to managers as they implement new market strategies and pursue operational improvements. The full rollout to all plants has effectively been implemented and supported by a new oracle ERP relational to the database system. ABC facilitates the budgetary and budgetary control to enhance efficiency and effective use of resources. Disadvantages of activity based management ABC does not work efficiently and sufficiently in volume based business as it is difficult to motivate a sales force to stop pushing certain products and even harder to fire unprofitable customers. The ABC data at times may not reveal reliable new information to managers for decision making for instance, those who intuitively know what the system formally captures. Consultants are hired from outside to do the ABC analysis but unfortunately the managers who are the decision makers do not accept the ABC numbers which often differ from the traditional cost numbers. Overall verdict My verdict is that activity based management has been a success overtime despite some setbacks. Insteel managers indicated that the new ABC system influenced operations and also product portfolio, product pricing and customer portfolio sound decisions. Anecdotal evidence, interviews, and review of internal reports reveal an improvement in product and customer related decisions. The 1996 ABC reports list improvements opportunities and identify teams of senior and middle managers responsible for each broad opportunity. ABC has led to the introduction of new product line to increase sales hence profitability this through several changes attributable to ABC study. Interviews with managers and statistical analysis lend support to the hypothesis of changes in managerial decisions at insteel following ABC study. Read More