Costing System of Sola System - Assignment Example

Student Name> SOLA SYSTEMS, Costing System Product cost under current accounting system Under the current accounting system the cost breakdown of each panel is given in the (Exhibit 1). The cost allocation system being followed at Sola system is such that it allocates the factory or production cost on the direct labor hour and other period costs such as warehousing, distribution, marketing and administration cost are based on the dollar sales revenues. Total cost as the percentage of sales is less for Panel A and greater for Panel B. Profit & Loss Statement for Products under Current Accounting System The profit and loss statement under the current accounting system is given in (Exhibit 2). The Revenues and net profit figures are greater for panel B but when rate of return is examined then it becomes clear that performance of product A is much better than the Panel B. Rate of return calculated as the profit divided by the cost is 51% for panel A and 38% for panel B under the current accounting system. Profit & Loss Statement for Region under Current Accounting System The profit and loss statement for Regions under the current accounting system is given in the (Exhibit 4) similarly the cost breakdown of each region is also provided in (Exhibit 3). We can see that Southern region is more profitable than the northern region primarily because the sales revenue is much larger in southern region almost 300% more than the northern region. Rate of return for southern region is 76% whereas the rate of return for northern region is in negative and is -12%. This differential in the rate of return for the two regions is arising because of the cost allocation system that is implemented in the Sola system, which distributes cost unequally. Higher Profit Rates for Panel A over Panel B Analyzing the exhibits 1 and 2 would reveal us that Panel A has higher profit returns than the panel B but this analysis without taking into account the cost allocation system being followed at Sola Systems would lead us to wrong decision making regarding the products. So it is critically important to analyze the current accounting system and evaluate whether this system is erroneous or giving correct results. Current system allocates the period costs based on the sales revenues each product is generating therefore the product which has higher sales revenues either because of higher price or higher volume will tend to receive more cost allocation. Making such a system without analyzing the cost drivers properly could prove fatal for the products in terns of wrong decisions. Panel A has been giving more profit returns mainly because of the poor cost allocation basis and inadequate cost driver identification. The period cost which makes more than 50 % of the total product cost is allocated on the sales revenue basis thus inviting trouble. For instance, if Product A requires more price tagging, packing and marketing effort, thus incurring more cost will eventually share less of this cost as some of the cost burden would be borne by the Panel B because it has higher sales revenues. Product cost of each panel under the Activity Based Costing Under the current accounting system the cost breakdown of each panel is given in the (Exhibit 5). These calculations are done on the basis of the data given in the case study. Each cost activity has its cost drivers so it becomes easy to allocate the costs of each product based on the effort that each product requires. If we analyze the exhibit 5 we can see that the earlier unequal cost division is now rectified and the cost division of two panels become around 50-50% rather than earlier 33-66% cost bearing. Profit & Loss Statement for Products under Current Accounting System The profit and loss statement under the activity based accounting system is given in (Exhibit 6). We can analyze the profits that each product is bringing to the organization. Under this activity based costing system we see that panel A becomes a loss while panel B becomes more profitable. Profit rates are also higher for Panel B and less for Panel A primarily because the costing basis is changed and each cost activity is now allocated on the effort that it requires. Rate of return for profit A is -11% and for Panel B is 83%. Activity Based Costing is more accurate than the earlier system ABC system is more accurate than the earlier cost allocation system being followed at the Sola Systems. Period costs are now more accurately allocated to each product, for instance, warehousing and handling information cost earlier allocated to Panel A was much less than the now ABC system has allocated to the Panel A. Earlier the system allocated on the basis of sales revenues thus receiving cost which now has 7000$ value was earlier allocated a 3000 $ cost and the rest of the cost of was shared by panel B. Panel A received 120 shipments and each shipment cost 58$ and multiplying the two will give the cost but in earlier system the whole shipment cost was divided between the Panel A and panle B on revenue basis thus allocating more to panel B. Similarly marketing cost which is allocated on customers orders was erroneously divided between A and B as Panel A had more customer orders thus it should have more cost. Another example is the setup cost for both Panel A and panel B, in the earlier system panel A had less setup cost as the total setup cost is based on number of batches and the per batch cost is 100 $ but the total cost was divided on the revenue basis. But the activity based costing system ensures that the setup cost of both panels is divided equally as the per batch cost is same. Limitations Limitation of the Activity Based Costing system is that it is crucially important to identify the cost driver of each activity and these cost drivers should be free from bias and accurate. Failure of this cost driver identification would mislead the managers into making wrong decisions about the products. Recommendations My recommendation would be to use the Activity based costing system to allocate the Cost on the cost drivers' basis. This will ensure that each product's true potential is discerned and the cost allocation is right, thus facilitating the right decision making. EXHIBIT 1 Cost breakup of each panel Current Accounting System Panel A Panel B Production cost Total prime cost 3200 7200 Assembly cost 900 3600 Setup cost 1200 4800 Inspection cost 600 2400 Sub-total 5900 18000 Warehouse Cost Shipment Receiving cost 3103 7337 Pricing and Tagging cost 1248 2952 packing cost 238 562 Depreciation of shipping equipment 268 632 Sub-total 4857 11483 Distribution Cost Rent 357 843 Transportation 743 1757 Sub-total 1100 2600 Admin Cost A/R 268 632 Supplier order, processing and payment cost 89 211 Sub-total 357 843 Marketing Cost General marketing and advertising 333 787 Total Cost 12546 33714 EXHIBIT 2 Profit and Loss Statement (panel) Current Accounting System Panel A Panel B Revenues 19032 45000 Manufacturing cost 5900 18000 Gross profit 13132 27000 Warehouse Cost 4857 11483 Distribution Cost 1100 2600 Admin Cost 357 843 marketing Cost 333 787 Net Profit 6486 11286 Net ROR 51.70% 33.48% EXHIBIT 3 Cost Breakup Region-wise Current Accounting System Southern Region Northern region Production cost Total prime cost $7,600.00 $2,800.00 Assembly cost 3187.5 1312.5 Setup cost 3000 3000 Inspection cost 1500 1500 Warehouse Cost Receiving cost 5220 5220 Tagging cost 2400 1800 packing cost 325 475 Depreciation 450 450 Distribution Cost Rent 600 600 Transportation 1249.9 1249.9 Admin Cost A/R 270 630 150 150 Marketing Cost General marketing and advertising 530 590 Total Cost $26,482.40 $19,777.40 EXHIBIT 4 Profit and Loss Statement (Region) Current Accounting System Southern Northern Revenues $46,653.00 $17,379.00 Manufacturing cost $15,287.50 $8,612.50 Gross profit $31,365.50 $8,766.50 Warehouse Cost 8395 7945 Distribution Cost 1849.9 1849.9 Admin Cost 420 780 marketing Cost 530 590 Net Profit $20,170.60 ($2,398.40) Net ROR 76.17% -12.13% EXHIBIT 5 Cost breakup of each panel Activity Based Costing Panel A Panel B Production cost Total prime cost $3,200.00 $7,200.00 Assembly cost 900 3600 Setup cost 3000 3000 Inspection cost 1500 1500 sub-total $8,600.00 $15,300.00 Warehouse Cost Receiving cost 6960 3480 Tagging cost 1800 2400 packing cost 500 300 Depreciation 360 540 sub-total 9620 6720 Distribution Cost Rent 240 360 Transportation 1667 833 sub-total 1907 1193 Marketing Cost General marketing and advertising 680 440 Admin Cost A/R 180 720 Supplier order, processing and payment cost 167 133 sub-total 347 853 Total Cost $21,153.20 $24,506.60 EXHIBIT 6 Profit and Loss Statement (panel) Activity based Costing Panel A Panel B Revenues $19,032.00 $45,000.00 Production cost 8600 15300 Gross Profit $10,432.00 $29,700.00 Warehouse Cost 9620 6720 Distribution Cost 1906.53333 1193.26667 marketing Cost 680 440 Admin Cost 2587 1633 Net Profit ($2,454.53) $20,906.73 Net ROR -10.49% 82.68% Read More