Budgeted Profit Statements - Assignment Example

Management accounting Prepare and present budgeted profit ments using: Conventional absorption costing TAC YZT ABW XYI Revenue 3,800,000 2,190,000 2,250,000 Variable costs 3,360,000 1,950,000 1,600,000 Gross profit 440,000 240,000 650,000 Assembly overhead 98,943 49,472 288,585 Machine overhead 240,000 144,000 120,000 Total overhead 338,943 193,472 408,585 Operating profit 101,057 46,528 241,415 Activity based costing (ABC) ABC YZT ABW XYI Revenue 3,800,000 2,190,000 2,250,000 Variable costs 3,360,000 1,950,000 1,600,000 Gross profit 440,000 240,000 650,000 Assembly overhead 72,000 36,000 210,000 Machine overhead 170,000 102,000 85,000 Order processing overhead 39,000 78,000 39,000 Purchasing overhead 30,000 31,500 22,500 Set up cost overhead 10,000 10,000 6,000 Total overhead 321,000 257,500 362,500 Operating profit 119,000 -17,500 287,500 Comment on these results Most importantly, one of the main significant that is evident from the results is the fact that the addition of the activity-based costing data is manifested differently in the three products’ operating profits. For example, ABW results show that it incurred a setback since its operating profits goes from £46,528 to -£17,500; this may be due to some factors such as customer orders, supplier orders, and set ups. While relating the ABW results to the other figures, they show that when the ABW had the lowest production volumes, it required the joint highest number of supplier and customer orders and set ups. Consequently, even though ABW required a lower number of production hours, its higher order volumes, and set up means that, under the activity-based costing, it reports a negative operating profit. Primarily, the ABW’s supplier and customer processing costs are double that of the other two products, meaning that it accounts for more than half the difference between the activity-based and traditional absorption costing figure (BRADTKE 2007, p. 6-8). After full analysis on the ABW results in its overheads and all production costs, it may seem that the company would do better if they eliminated or reduced its production, since it does not produce any operating profit for the company (BROADBENT, & CULLEN 2003, p. 204). Nevertheless, this will depend on a specific context, for example, if the company has a 420,000-machine hour factory regardless of the production volumes, then the machine costs will remain high even though the ABW product is eliminated. Therefore, holding back or eliminating the production of ABW is not necessarily attractive; this is because it can reduce the overhead by an amount that would be comparable to the company reducing the revenues and gross profit generated through holding the production of ABW (COKINS 2001, p. 14-17). However, this can be resolved through an alternative method, which is using the activity-based costing data so they improve the efficiency of ABW in relation to the other product to ensure that is making a positive contribution. Particularly, the use of activity-based costing has highlighted the additional purchasing and order processing overheads incurred by the ABW relative to the other products (DYSON, 2010). Using this perspective, the company can decide to drive these costs down through reducing the volume of the supplier and customer orders required in the production of ABW. For instance, the company can offer discounts on the larger value orders, use intermediaries to sell a product, or using smaller orders that can incur additional order fees (GOEKTUERK 2007, p. 8). On the other hand, to satisfy 16,000 customer orders, the company has to produce 30,000 units of ABW; this means that the company can stop serving small-orders customers, and instead focus more on large-orders customers (THUKARAM RAO, 2003). Conclusively, the discussion does not only demonstrate the difference between the two costs of absorption methods, calculated in term of the overhead the products produce, but also demonstrates the most effective way to use this data drive efficient managerial decisions (GERI, & RONEN, 2005). Moreover, for the XYI and YZT products, the same approach can be applied to them, in this case, the machine and assembly overheads being the most significant. The analysis of these results can therefore, be used to focus on the managerial efforts in the reduction of overhead costs, in turn reducing the overall cost of production thus more products are produced (HEISINGER, 2008). 1. It has been said that ‘modern developments such as ABC are sometimes implemented because they are fashionable and not because they provide extra information to management According to studies on the modern developments, show that activity-based costing is implemented because they are fashionable and not because they provide additional information to the management reflected in the development of the ABC. As summarized by HANSEN, MOWEN, & GUAN (2009, p. 85), ABC was developed to respond to the errors perceived within the traditional methods. In this case, the ABC was developed in order to resolve such issues, through providing a variety of cost drivers reflecting the actual situation in the modern business. Additionally, ABC also intended to provide a system that would be more efficient if used in performance evaluation and in decision-making, although this would raise questions of whether ABC is a major enhancement in the managerial decisions making process, or is it only considered since it is a better option than other approaches. This section of the essay will therefore, examine the validity of this argument (HANSEN, MOWEN, & GUAN 2009, p. 167). According to HANSEN, & MOWEN (2011), activity-based costing allows better control and understanding in companies of the costs associated with production activities. ABC does it through conveying all costs to significant production activities based on the role of these activities in the production of goods. This approach is evident in the above example, where the recognition of the cost drivers in a company and the process of assigning cost to the various drives, shows the difference in the absorption costs of the products in turn clarifying the main factors that influences the costs of productions. This means that, the company will clearly see how decisions and activities they are responsible in influencing the profitability and the costs of the company in the future, thus will enable the company’s administration control the costs and ensure the products produced maximizes their profits (HANSEN, & MOWEN 2011, p. 548). As it is evident from the example, ABC allows the company identifies their most profitable customers and the products they produce, in their effort to determine the sections that contribute, and which do not contribute to the financial performance of the company. However, this approach can also be used in the diagnosis of a company’s poor financial performance; in an effort of ensuring that they maximize the profits generated by the product, they produce (HANSEN, MOWEN, & HANSEN, 2006). Nevertheless, this approach in real life is limited to success, since ABC fails to foresee the changes in the profit level, which occurs when production changes, for there is no way of assessing how changes in production can influence all production overheads, therefore making ABC limited in the real-life decision making process. In relation to the stated drawbacks, some companies may question the ability of ABC to produce the value predicted in the real life setting. Moreover, the potential realized by the approach will be encountered often by the high level of resources and large amount of time required to implement ABC. Since comprehensive financial records are required in the determination of the actual size of the cost drivers, where the activity analysis is also needed in the determination of the valid cost drivers and how the various costs are assigned to them (GOLDRATT, AND COX, 2004). This approach is significant for the large companies that have different production activities with all of them sharing the same overhead costs. At the same time, choosing the cost drivers it is sometimes a fair arbitrary having no choice of how to allocate overheads. As a result, inefficient choices will result to ABC failing to provide the significant value. Often, these negative aspects have resulted to companies abandoning the implementation of ABC, indicating that the main reason for adopting the approach was due to its fashion ability and not due to its intrinsic value it provides (HICKS, 2002). Nevertheless, these negative aspects mean that, important efforts have been invested in ensuring that there is an improvement in the ABC approach and it relevance in the real life setting. The efforts invested in the success of ABC have resulted in a greater focus on linking cost distribution with most important production activities and developing effective and rigorous algorithms that identify the cost drives in an ideal manner (KAPLAN, & ANDERSON 2007, p. 4-8). These approaches have shown to produce results that are more effective for companies; for instance, ABC has helped companies grow to be cost leaders in challenging economic conditions something relevant in the modern environment. Finally, businesses have used concepts applied in the ABC approach on several occasions. For instance, in cases of product and brand extensions and the analysis of the product life cycle, in order to consider how costs vary across the company’s different product mixes and in assessing the cost of different marketing options so, they can make optimal decisions that can improve efficiency (WEYGANDT, KIESO, & KIMMEL 2010, p. 151). Conclusively, these sections of the essay have provided a variety of evidences. They indicate that, as with several modern developments, companies have implemented ABC because of its fashionability and not because of the valuable information provided. Meaning that, this lack of the initial value of ABC, resulted to companies that had adopted the approach neglected it because the benefits did not justify the costs of the investment. According to the recent research carried out on the issue, shows successful efforts in enhancing the value of ABC through the application of algorithms and system also through applying the approach to a broader range of managerial decisions. Meaning, even though ABC is fashionable with no ability to produce valuable information on its own, the approach can be applied efficiently in other several cases hence becoming a valuable academic concept. References BRADTKE, D. (2007). Activity-Based-Costing. München, GRIN Verlag GmbH. http://nbn-resolving.de/urn:nbn:de:101:1-2010081812530. BROADBENT, M., & CULLEN, J. (2003). Managing financial resources. Amsterdam [u.a.], Butterworth-Heinemann. COKINS, G. (2001). Activity-based cost management: an executives guide. New York, Wiley. DYSON, J. R. (2010). Accounting for non-accounting students: 8th edition.Financial Times/ Prentice Hall. GERI, N. AND RONEN, B. (2005). Relevance lost: the rise and fall of activity-based costing. Human Systems Management; Vol. 24, p. 133-144. GOEKTUERK, H. (2007). Activity-Based Costing (ABC) - advantages and disadvantages How ABC can be applied to institutions of higher education. München, GRIN Verlag GmbH. http://nbn-resolving.de/urn:nbn:de:101:1-201008158968. GOLDRATT, E. M. AND COX, J. (2004). The Goal: A Process of Ongoing Improvement: 3rd Edition. Gower Publishing. HANSEN, D. R., MOWEN, M. M., & GUAN, L. (2009). Cost management: accounting and control. Mason, Ohio, South-Western. HANSEN, D. R., & MOWEN, M. M. (2011). Cornerstones of cost accounting. Mason, OH, South-Western, Cengage Learning. HANSEN, D. R., MOWEN, M. M., & HANSEN, D. R. (2006). Managerial accounting. Mason, OH, Thomson/South-Western. HEISINGER, K. (2008). Introduction to managerial accounting. Boston, Mass, Houghton Mifflin. HICKS, D. T. (2002). Activity-based costing: making it work for small and mid-sized companies. New York, Wiley. KAPLAN, R. S., & ANDERSON, S. R. (2007). Time-driven activity-based costing: a simpler and more powerful path to higher profits. Boston, Harvard Business School Press THUKARAM RAO, M. V. (2003). Management Accounting. New Delhi, New Age. WEYGANDT, J. J., KIESO, D. E., & KIMMEL, P. D. (2010). Managerial accounting: tools for business decision making. Hoboken, NJ, Wiley. Appendix: Overhead cost (machine hour per unit) = total overhead cost/ budget activity level Machine department = £504,000 Budget activity level = (XYI machine hours * XYI sales and production units) + (YZT machine hours * YZT sales and production units) + (ABW machine hours * ABW sales and production units). Budget activity level= 2(hours) * 50,000 + 5h * 40,000 + 4h*30,000 = £420,000 So, overhead cost (machine hours per unit) = 504,000/420,000 = £1.2/ machine hour. Overhead cost (direct labor hours per unit) = total overhead cost/ budget activity level Assembly department= £437,000 Budget activity level= 7h*50,000 + 3h*40,000 + 2h*30,000= £530,000 So, overhead cost (direct labor hours per unit) = 437,000/530,000 = £ 0.8245283/direct labor hour. Conventional absorption costing: (W1) XYI: XYI Revenue = 50,000 * 45 =£2,250,000 XYI Variable cost = 50,000 * 32=£ 1,600,000 Gross profit= 2,250,000 – 1,600,000 = £650,000 Machine overhead= 50,000 * 1.2 * 2h= £120,000 Assemble overhead = 50,000 * 0.8245283 * 7h = £288,585 Operating profit= gross profit – total overheads XYI operating profit= 650,000 – 408,585= £241,415 YZT: YZT Revenue= 40,000 * 95 = £3,800,000 YZT variance cost= 40,000 * 84 = 3,360,000 Gross profit= 3,800,000 – 3,360,000 = £440,000 Machine overhead = 40,000 * 1.2 * 5h = £240,000 Assemble overhead = 40,000 * 0.824523 * 3h = £98,943 YZT Operating profit = 440,000 – 338,943 = £101,057 ABW: ABW Revenue = 30,000 * 73 = £2,190,000 ABW Variable cost = 30,000 * 65 = £1,950,000 Gross profit = 2,190,000 – 195,000 = £240,000 Machine overhead = 30,000* 1.2 * 4h = £144,000 Assemble overhead = 30,000 * 0.824523 * 2h = £49,472 ABW Operating profit = £240,000 - £193,472 = £46,528 Conventional Absorption Costing TAC YZT XYI ABW Revenue 3,800,000 2,250,000 2,190,000 Variable costs 3,360,000 1,600,000 1,950,000 Gross profit 440,000 650,000 240,000 Machine overhead 240,000 120,000 144,000 Assembly overhead 98,943 288,585 49,472 (W1) Total overhead 338,943 408,585 193,472 Operating profit 101,057 241,415 46,528 Activity Based Costing (ABC): (W3): Machine overhead Cost per machine hour = cost / cost driver = machine services / machine hours = 357,000 / 420,000 = £0.85/hour So, XYI machine overhead = machine hours per unit * sales and production * cost per machine Hour = 2 * 50,000 * 0.85 = £85,000 YZT machine overhead = 5 * 40,000 * 0.85 = £170,000 ABW machine overhead= 4 * 30,000 * 0.85 = £102,000 (W4): Assembly overhead: Cost per labor hour = assembly services / direct labor hour = 318,000 / 530,000 = £0.6/hour So, XYI Assembly overhead= direct labor hours per unit* sales and production * cost per hour = 7 * 50,000 * 0.6 = £210,000 YZT Assembly overhead = 3 * 40,000 * 0.6 = £72,000 ABW Assembly overhead= 2 * 30,000 * 0.6 = £ 36,000 (W5): Set up cost overhead: Cost per set up cost = set up cost / set ups = 26,000 / 520 = £50/set up So, XYI set up cost overhead = number of set-ups * cost per set up cost = 120 * 50 = £6,000 YZT set up cost overhead= 200 * 50 = £10,000 ABW set up cost overhead = 200 * 50 = £10,000 (W6): Order processing overhead Cost per order processing = order processing cost/ customer orders = 156,000/ 32,000 = 4.875/ order So, XYI order processing overhead = customer order * cost per order processing = 8,000 * 4.875 = £39,000 YZT order processing overhead = 8,000 * 4.875 = £39,000 ABW order processing overhead= 16,000 * 4.875= £78,000 (W7): Purchasing overhead Cost per purchasing = purchasing cost / suppliers orders = 84,000 / 11,200 = £ 7.5/order So, XYI purchasing overhead = suppliers order * cost per purchasing = 3,000 * 7.5 = £22,500 YZT purchasing overhead = 4,000 * 7.5 = £30,000 ABW purchasing overhead = 4,200 * 7.5 = £31,500 ABC operating profit: Operating profit = gross profit – total overhead XYI operating profit = 650,000 – (85,000 + 210,000 + 6,000 + 39,000 + 22,500) = 650,000 – 362,500 = £287,500 YZT operating profit = 440,000 – (170,000 + 72,000 + 10,000 + 39,000 + 30,000) = 440,000 – 321,000 = £119,000 ABW operating profit= 240,000 – (102,000 + 36,000 + 10,000 + 78,000 + 31,000) = 240,000 – 257,000 = (£17,500) ABC YZT ABW XYI Revenue 3,800,000 2,190,000 2,250,000 Variable cost 3,360,000 1,950,000 1,600,000 Gross profit 440,000 240,000 650,000 (W3) Machine overhead 170,000 102,000 85,000 (W4) Assembly overhead 72,000 36,000 210,000 (W5) Set up cost overhead 10,000 10,000 6,000 (W6) Order processing overhead 39,000 78,000 39,000 (W7) Purchasing overhead 30,000 31,500 22,500 (W2) Total overhead 321,000 257,500 362,500 Operating profit 119,000 (17,500) 287,500 Read More