Oars and Paddles Plc. Analysis - Assignment Example

OARS AND PADDLES PLC. ANALYSIS TASK I Paddle type Kayak Canadian Kayak Canadian Kevlar Deluxe Nylon Ash Sales (units) 200 100 200 100 Production (units) 400 400 300 200 Selling price (per unit) 200 150 100 100 Costs per unit £ £ £ £ Direct materials 22 19 16 16 Direct wages: Cutting dept. 6 4 2 2 14 Assembly dept. 9 6 3 3 21 Finishing dept. 12 8 4 4 28 total wage cost per unit 27 18 9 9 63 prime cost 49 37 25 25 total cost of production = Number of units produced * prime cost of production 19600 14800 7500 5000 46900 sales = number of units sold * selling price per unit 40000 15000 20000 10000 85000 direct costs of production 19600 14800 7500 5000 cost of sales 20400 200 12500 5000 other costs - materials 8862 8862 6646 4431 28800 other costs as allocated below 23354 16886 8519 6620 55378 total other costs 32215 25747 15165 11050 84178 profit 7785 -10747 4835 -1050 822 selling and distribution Other costs per month: £ Material purchases 28,800 Production overheads allocated: £ Cutting dept. 2,000 Assembly dept. 4,500 Finishing dept. 2,000 8,500 Production overheads apportioned 11,250 Administration overheads 16,960 Selling & distribution overheads 18,668 84,178 Kayak Canadian Kayak Canadian Kevlar Deluxe Nylon Ash b. value of closing stock of raw materials 40000 45000 10000 10000 c. value of closing stock of finished goods for each product 9800 11100 2500 2500 D. Determination of the overheads absorbed by each product Overhead Absorption Rate (OAR) = Budgeted overheads/ Budgeted level of activity - wages rate 0.43 0.29 0.14 0.14 total cost of production of goods sold 0.42 0.32 0.16 0.11 Kayak Canadian Kayak Canadian Production overheads allocated: £ Kevlar Deluxe Nylon Ash Cutting dept. 2,000 857 571 286 286 Assembly dept. 4,500 1929 1286 643 643 Finishing dept. 2,000 857 571 286 286 8,500 3643 2429 1214 1214 8500 Production overheads apportioned 11,250 4821 3214 1607 1607 11250 Administration overheads 16,960 7088 5352 2712 1808 16960 Selling & distribution overheads 18,668 7802 5891 2985 1990 18668 55,378 23,354 16,886 8,519 6,620 55,378 TASK II Paddle type Kayak Canadian Kayak Canadian Kevlar Deluxe Nylon Ash Sales (units) 196 98 196 98 Production (units) 400 400 300 200 Selling price (per unit) 210 157.5 105 105 Costs per unit £ £ £ £ Direct materials 22 19 16 16 Direct wages: Cutting dept. 6.12 4.08 2.04 2.04 14.28 Assembly dept. 9.18 6.12 3.06 3.06 21.42 Finishing dept. 12.24 8.64 4.08 4.08 29.04 total wage cost per unit 27.54 18.84 9.18 9.18 64.74 prime cost 49.54 37.84 25.18 25.18 total cost of production = Number of units produced * prime cost of production 19816 15136 7554 5036 47542 sales = number of units sold * selling price per unit 41160 15435 20580 10290 87465 direct costs of production 19816 15136 7554 5036 cost of sales 21344 299 13026 5254 other costs - materials 8862 8862 6646 4431 28800 other costs as allocated below 23264 17069 8466 6579 55378 total other costs 32126 25931 15112 11010 84178 profit 9034 -10496 5468 -720 3287 selling and distribution Other costs per month: £ Material purchases 28,800 Production overheads allocated: £ Cutting dept. 2,000 Assembly dept. 4,500 Finishing dept. 2,000 8,500 Production overheads apportioned 11,250 Administration overheads 16,960 Selling & distribution overheads 18,668 84,178 Kayak Canadian Kayak Canadian Kevlar Deluxe Nylon Ash b. value of closing stock of raw materials 42840 47565 10920 10710 c. value of closing stock of finished goods for each product 10106.16 11427.68 2618.72 2568.36 D. Determination of the overheads absorbed by each product Overhead Absorption Rate (OAR) = Budgeted overheads/ Budgeted level of activity Kayak Canadian Kayak Canadian Production overheads allocated: £ Kevlar Deluxe Nylon Ash Cutting dept. 2,000 857 571 286 286 Assembly dept. 4,500 1929 1286 643 643 Finishing dept. 2,000 843 595 281 281 8,500 3629 2452 1210 1210 8500 Production overheads apportioned 11,250 4786 3274 1595 1595 11250 Administration overheads 16,960 7069 5400 2695 1797 16960 Selling & distribution overheads 18,668 7781 5943 2966 1977 18668 55,378 23,264 17,069 8,466 6,579 55,378 Task III Absorption costing method usually links all production costs to the cost unit in order to attain a full cost per unit (Drury, 2007, 234). It is used for budgeting, pricing decisions and valuation of stock. To calculate the full cost per unit, the following steps should be used: 1. All overhead costs are taken from the cost centres. These are then allocated depending on the individual cost centre e.g. indirect materials, supervision etc. to get the specific overheads. The general overheads are distributed to cost centres depending on factors like floor area, number of workers etc. General overheads include rent, electricity etc. which are incurred as a single expense for the entire organisation. 2. Absorption of overheads then follows by using a predetermined overhead absorption rate (Chakraborty, 2004, 624). The following formula is used: Overhead Absorption Rate (OAR) = Budgeted overheads/ Budgeted level of activity, where the level of activity could be labour hours, machine hours or number of units (Hirsch, 2000, 78; Drury, 2005, 145). The absorbed overheads are the obtained by multiplying the OAR with the actual activity (Drury, 2005, 514). Due to the complexity of the production process, the traditional method of absorbing overheads becomes less effective and it is not highly recommended (Horngren et al, 2002, 247). It is quite cumbersome and less self-explanatory (Thukaram, 2007, 257). In OarsandPaddles, direct materials are used to apportion production overheads to the four products under consideration. A further analysis to the use of total cost of production of goods sold is applied to apportion other overheads e.g. selling and distribution. Valuation of stock is also achieved by this method where raw materials and finished goods closing stock are determined. The method however, is time consuming and uses past data. Therefore there is need to explore other methods of absorbing overheads to get effective results. These methods are thus adopted e.g. activity based overheads, activity based budgeting etc. Activity based costing (ABC) This is a method of assigning costs of goods and services on a basis of the resources they have consumed (Bhattacharyya, 2005, 388). Due to the irrelevance of the traditional method, ABC was adopted since the early 1980’s (Kaplan & Anderson, 2007, 3, Turney, 2005, 15). All costs incurred are apportioned to the various activities that the firm has in progress. ABC is used to date to apportion the overheads or the indirect costs such as rent, lighting etc. to the various activities (Hicks, 2002, 26). Two different activities may absorb the same direct costs i.e. raw materials, labour hours, machine hours etc., but usually consume varying indirect costs (James, 2009, 25). It is in this case the ABC method was adopted in order to analyse individual activities and probably find the differences in costs, and further allow for cost cutting (Grieco, P. & Pilachowski 2009, 234). It is therefore, important for the firm to divide the processes into clear activities to which they relate costs (Needles, 2009, 740). To introduce ABC, it is vital to run a pilot scheme for any organisation before dropping the traditional method (Leitner, 2007, 3). ABC softwares have been produced that make the whole process easier to implement (Cokins, 2001, 279). ABC has been used by companies as a means of comparing with industrial performances i.e. it is used a balanced score card. ABC is a prerequisite of improving OarsandPaddles Plc. because it is used alongside the traditional method and the accounting system, to develop the analysis of the company’s performance. Although it takes a lot of time to implement, the technological advances have developed softwares that helps save on time (Cokins, 2001, 278). Advantages of adopting ABC i. This method is more accurate in product costing as compared to the traditional method of absorbing overheads. Costs are allocated to the specific activities (Drury, 2005, 451). ii. It allows for flexibility in terms of allocation of costs. A change in costs would affect the specific activity to which the cost is related to. iii. ABC method allows users to have a clear understanding of costs and their allocation. iv. It has a more logic approach for allocation of overheads unlike the absorption method discussed above. v. The long run variable cost is easily determined for the products and can be relied upon (Bradshaw & Brooks, 2004, 245). Disadvantages of adopting ABC i. It applies historical data and internal data; therefore, it is not an effective tool for forecasting the future trends (Cobb et al, 2002, 24). ii. A lot of emphasis is laid on allocation the various costs instead of minimizing the cost of the business (Idowu, 2010, 222; Cokins, 2001, 26). iii. A cost benefit analysis shows that the costs involved in undertaking the ABC process is more than the benefits achieved iv. The ABC method has been found not to be very practical in use. It is tedious and time consuming (Rajasekaran, 2010, 278). Conclusion The traditional method of absorbing costs by individual products is complex and irrelevant. It is further time consuming and not highly reliable. It is important to note that although some companies still use this method, others have diverted their ways to the ABC method that helps save on costs. ABC method offers a better look at the company’s undertaking by absorbing indirect costs to the various activities in the production all the way to the last process of selling the product. All direct costs are first absorbed by the production process while the indirect costs like lighting and rent, are absorbs into the activities depending on the cost drivers like number of staff. The biggest problem generated by the two methods is that they both use past data in the analysis of costs. However, ABC has proved more reliable as it is reliable and flexible. Changes in costs would only affect the foresaid activity it relates to. The approach used is clear for users of financial information to understand as well as it follows a logical approach. It is important to note that as much as it can appear very appealing it has cons associated with it. ABC involves a great of costs in determining which costs and activities belong to which area of analysis. Moreover, it is not used in forecasts hence the management has to find a better way of doing so. A review of the absorption costing in the analysis of Oars and paddles Plc. shows that a slight increase in selling prices will result in a fall in volume of sales. This however, calls for more staff to be incorporated hence the increase in direct wages. The overall figures show that the sales increases as well as an increase in the profits. One factor is held constant that all other costs change according to the policies held by the company i.e. the use of overhead absorption rates given in the spreadsheet. Recommendation Throughout the entire process of absorbing the various costs, I found it quiet complicated to clear understand how the process develops. However, an understanding of the ABC method simply means abc learning in school. It is much easier to allocate costs to activities instead of each and every product that is manufactured. ABC approach is logic and clearer to understand. The valuation of costs with the traditional method is difficult but with ABC all the activities do not require such valuations. I therefore recommended that Oars and Paddles Plc adopts ABC method and follow the analytical process of which activities uses more indirect costs. This will help the management to find loopholes of poor management of funds as it the case of Wells Fargo Company. Softwares have been developed that save on time and are easier to interpret and use. Excel adds ins worksheets are just but a few to mention. Any costs change can easily be traced back and related to its respective activity it relates to. v. Bibliography Bradshaw, J., & Brooks. M., 2004, Business Accounting and Finance for Managers and Business Students, Columbia, Juta and Company Ltd. Bhattacharyya, A., (2005), Principles and Practice of Cost Accounting 3th ed., Spain, PHI Learning Pvt. Ltd. Chakraborty, S, 2004, Cost Accounting and Financial Management, New York, New Age International. Cobb. 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