Management Accounting: Pronto Plastics Pty. Ltd - Case Study Example

Management Accounting Report For Pronto Plastics Pty Ltd Table of Contents: Executive Summary Introduction Presentation of information and analysisRecommendations Limitations of ABC Model Management Accounting Report For Pronto Plastics Pty. Ltd. EXECUTIVE SUMMARY: Management Report is very essential for taking the appropriate decisions and in most cases it determines the success or failure of an organization. The main purpose of a management accounting report is to provide logical information about the business and its functioning. The Management Accounting Report of Pronto Plastics Pty. Ltd. focuses on whether the accounting system implemented is sufficient or not? As far as the running style of the Pronto Plastics Pty. Ltd is concerned, one needs to lay emphasis on their system of costing and other relevant areas of accounting. Pronto Plastics deal with various kinds of plastics coated kitchen accessories. Due to their high quality and technological perfection, they occupy a dominant market position. However, they faced stiff competition from rivalries, especially New Glamour Range. Pronto Plastics pays attention towards its accounting process to establish an efficient and effective system of accounting. They expect this to fetch them good results to increase the profitability. Introduction: Pronto Plastics Pty Ltd is the manufacturer of plastic covered kitchen accessories. Taking advantage of its technological perfection, Pronto offers high quality products at reasonable prices. But due to the emergence of New Glamour Range, Pronto’s sales volume has begun to register a decline. In order to overcome this problem, they need to make certain changes in the present system. Therefore Pronto Plastics decides to undertake necessary steps for restructuring the system of accounting, either by adopting Activity Based Costing (ABC) System or the Conventional Costing System. Presentation of information and Analysis: Conventional (Traditional) Costing System and Activity-Based Costing System: In Conventional Costing System the calculations are done on the basis of one common overhead rate for all products. This method fixes price for each department and not for each activity. There is a slight variation in both the ABC system and Conventional system from an organization’s accounting point of view. Under conventional costing systems, the product itself is treated as its resources, but in ABC there is a difference in the context of products and resources. “Conventional cost systems are based on unit-level cost drivers (these unit-level cost drivers are often referred to as allocation bases in conventional cost systems) of the product that are directly proportional to the number of units produced. Direct labour hours, machine hours and pounds of material are examples of such unit-level allocation bases. An ABC system, on the other hand, uses cost drivers that can be at the unit-level, batch-level, and/or product-level. Examples of batch-level cost drivers are setup hours and number of setups. Examples of product-level cost drivers are number of parts, number of times ordered, and number of engineering charge orders.” (Bert and Jan 1995). Activity-Based Costing System (Unit cost or cost per output) is effectively used to measure the cost as well as the performance of a particular company. It can also help the company in identifying, describing, assign cost, and also to prepare a proper report. Compared to other traditional cost systems, Activity-Based Costing is better as it facilitate a company to find out opportunities to improve business operations by enabling it to ascertain the true cost of products and services. So far Pronto Plastics Pty Ltd is concerned, Activity-Based Costing is better because it is useful in allocating different resources. This method is applicable for both appropriation as well as revolving funds and it is also used in relating the total cost required in production. It further increases the cost visibility by giving authority and flexibility in cost controlling and by promoting the efficiency of managers. ESTIMATED STATEMENT OF COST- (Amount in $) [Only up to Prime Cost] Plates Cups Containers Bowls Total Direct Material 1,25,000 1,00,000 45,000 15,000 2,85,000 Direct Labour 28,000 20,000 14,000 1,500 63,500 Direct Expenses 1,65,000 1,55,000 25,000 5,000 3,50,000 Prime Cost. 3,18,000 2,75,000 84,000 21,500 6,98,500 There is a direct relationship between material, labour cost and manufacturing overhead. The sum total of these three figures indicates the prime cost. Then, the organization is in a position to workout factory overhead for determining the total works cost. After evaluating the work cost, it can take into account office and administration costs. The sum total of works cost and administration overhead will give the exact cost of production. The total of cost of production and selling and distribution overhead consists of cost of sales or the total cost. Apart from this, for the purpose of evaluating financial viability, it is crucial to give emphasis on operating profit or operating ratio. “Activity-based costing assumes that the steps or activities that must be followed to manufacture a product are what determine the overhead costs incurred. Each overhead cost, whether variable or fixed, is assigned to a category of costs. These cost categories are called activity cost pools. Cost drivers are the actual activities that cause the total cost in an activity cost pool to increase. The number of times materials are ordered, the number of production lines in a factory, and the number of shipments made to customers are all examples of activities that impact the costs a company incurs. When using ABC, the total cost of each activity pool is divided by the total number of units of the activity to determine the cost per unit. The number of activities a company has may be small, say five or six, or number in the hundreds. Computers make using ABC easier. Assume Lady Trekkers, Inc., has identified its activity cost pools and cost drivers (see the following table).” Activity Cost Pools Activity Cost Drivers Purchasing Department Number of Purchase Orders Receiving Department Number of Purchase Orders Materials Handling Number of Materials Requisitions Setup Number of Machine Setups Required Inspection Number of Inspections Engineering Department Number of Engineering Change Orders Personnel Processing Number of Employees Hired or Laid Off Supervisors Number of Direct Labor Hours (Activity Based Costing Activities. 2007). Estimated Operating Profit Of Pronto Plastics Pty. Ltd. (Amount in $) Plates Cups Containers Bowls Total Sales 5,00,000 3,25,000 2,00,000 1,00,000 11,25,000 Less: Cost Of Goods sold 3,75,000 2,43,750 1,50,000 75,000 8,43,750 Gross Profit 1,25,000 81,250 50,000 25,000 2,81,250 Less: Operating Expenses nil nil nil nil 55,000 Total Operating Income 1,25,000 81,250 50,000 25,000 2,26,250 Return On Sales (in %) 25% 25% 25% 25% 20.11% So, it is necessary to assume that for every item of Pronto, there should be 25% of sales taken as COG. Similarly, the Return on Sales= Total Operating Income/ Total Sales * 100. This is because for the effective functioning of the company, the experts viewed that it is necessary to undertake a suitable managerial accounting procedures in the ensuing future. As per Activity Based Costing System, Estimated Income Statement (Amount in $) Plates Cups Containers Bowls Total Sales 5,00,000 3,25,000 2,00,000 1,00,000 11,25,000 Less: Direct Material 1,25,000 1,00,000 45,000 15,000 2,85,000 MOH 1,85,000 1,65,000 85,000 25,000 5,15,000 Gross Profit 1,90,000 60,000 70,000 60,000 3,25,000 Less:Sell&Distribution 35,000 15,000 5,000 3,000 58,000 Revenue 1,55,000 45,000 65,000 57,000 2,67,000 Return on sale (in %) 31% 13.85% 32.5% 57% 23.73% This Statement shows that whenever sale increases, it is necessary to maintain an appropriate control over the related expenditure in an effective manner. Recommendations: The managerial analysis arrived at a decision that ABC (Activity Based Costing) system is a better approach for evolving an effective measure for undertaking the business process of Pronto Plastics, as compared to the conventional costing systems. ABC is an effective tool of measuring the costing system and the relevant performance of an organization in a very efficient manner. As per this report, it is recommended that ABC system is more complimentary, because the application of this system leads to proper distribution of resources among all parts of the organization. In addition to the appropriate resource allocation, ABC is also maintaining a relevant controlling of adequate source of funds in a smooth manner. Through the installation of ABC systems, it is possible for Pronto Plastics to maximize their financial feasibility as well as the cost visibility in an effective manner. Therefore, for the purpose of modifying the system to ABC, an organization has to concentrate on various aspects. It is necessary to identify the entire operations and working conditions. After evaluating the organizational procedures, there should be appropriate allocation of resources among various departments. In addition to this, there are a lot of benefits derived through ABC system. It helps to maximize the profitability of the organization as a whole. “Activity based costing starts by matching the resources of the business with the activities that are being performed. This is done by finding out which tasks are performed, and then identifying which personnel and other resources are required to perform each activity. Product costs are then calculated by driving the activity costs down to products based on how each product consumes the activities. Different products require the support of each activity to a different extent.” (John 1998). Thus, it becomes apparent that for the well being of a business entity, it is beneficial to install the system of Activity Based Costing than that of Conventional system of costing. Limitation of Activity Based Costing Even though Activity Based Costing system is more suitable, it is not without same disadvantages. It is more time consuming method because the collection of data is difficult and involves time. Employees have work hard and this leads to high labour cost. It also involves an additional cost with the purchasing cost for modification. Another disadvantage is that it clearly shows wastage in a particular area of production which will affect the managers directly. This system is costly and complex. Hence an ordinary manager finds it difficult to understand. In ABC system updating the rates is must. In addition to this, where certain organizations are following multiple rates of costing, then there is a lack of verification of each item separately. Even though ABC system is recent concept, still it is better to undertake allocation of resources and appropriation of expenses in a traditional manner. Moreover, ABC system is much more complex in nature, due to the frequent changes taking place. Thus it transpires that ABC system is good enough, yet it suffers from limitations. Appendices Estimated Operating Profit:- Return on Sales for every item should be represented on 25% basis, such as- (fixed rate) Plates = 1, 25, 000/5, 00,000*100 Cups = 81,250/ 3, 25,000*100 Containers = 50,000/2, 00,000*100 Bowls = 25,000/1, 00,000*100 As per Activity Based Costing System, Estimated Income Statement- Return on Sales: - (Here the rate is not constant.) Plates = 1, 55,000/5, 00,000*100 Cups = 45,000/ 3, 25,000*100 Containers = 65,000/2, 00,000*100 Bowls = 57,000 / 1, 00,000*100 Bibliography Activity Based Costing Activities. (2007). [online]. Cliff notes. Last accessed 12 October 2007 at: http://www.cliffsnotes.com/WileyCDA/CliffsReviewTopic/Activity-Based-Costing-Activities.topicArticleId-21248,articleId-21225.html BRAS, Bert and EMBLEMSVAG, Jan. (1995). The Use of Activity Based Costing. Uncertainty and Disassembly action charts in demanufacture cost assessments. [online]. Activity Based Costing. Last accessed 12 October 2007 at: http://72.14.235.104/search?q=cache:uKQE13pcqaQJ:www.srl.gatech.edu/education/ME4171/DETC95_Emblemsvag.pdf+conventional+costing+systems&hl=en&ct=clnk&cd=1&gl=in STARK, John. (1998). A Few Words about Activity Based Costing. [online]. Johnstark.com. Last accessed 12 October 2007 at: http://www.johnstark.com/fwabc.html Read More