How a Management Accountant Can Add Value to FreeAir Skate Pty Ltd - Case Study Example

Table of Contents Table of Contents 1 Introduction 2 How a management accountant can add value to FreeAir Skate Pty Ltd 2 The management accountant 2 Schedule of costs of goods manufactured 3 Income statement 4 Mixed costs 5 The purpose of ABC to FreeAir Skate Pty Ltd and whether it should be introduced in the company 6 Conclusion 7 References: 8 Appendix 9 Introduction There are some shortcomings that have been observed in Free Air Skate Pty limited as far as the accounting department is concerned. First, the fact that there is no full time accountant may mean fraud may be taking place with nobody being aware. Secondly, the management doesn’t seem to understand what some costs and expenses mean and hence no proper decision making that could improve the company’s performance can take place. As such, this paper is mainly aimed at explaining to the management the need to have a full time management accountant as well as the value that would accrue from implementation of ABC. How a management accountant can add value to FreeAir Skate Pty Ltd There are a lot of merits and hence value that a management accountant can add to the company. For instance, the CEO and the production manager seem not to understand various issued related to cost. As such, it could be that the organization is not pricing its products appropriately. Having a management accountant will help iron out these issues hence leading to better priced products and increased efficiency and hence improved profitability for the company. The role that the management accountant will play and hence the value that the accountant will add to the company have been explained below. The management accountant The management accountant will play the role of tracking internal costs for the various business processes that help the company in making decisions that are related to production, operations and making investments say purchasing of the new machine by the company. FreeAir Skate Pty Ltd need a management accountant who will help management know the efficiency of the budgets they prepare, the cost of the company’s operations and in more precisely allocating funds in production, sales and investment activities (Burns, 2013). The management accountant will continually play important roles including collecting, recording as well as reporting financial data from several units of the organization observe and analyze budgets and give suggestions on how they will be funded and how the available funds will be allocated. The functions will range from estimation of costs of raw materials, labor, manufacturing, advertising and sales among other related overheads costs including the cost of the company’s internal operations. As such, the management accountant will have to coordinate with all relevant departments in making an overall analysis of the company’s functioning capital as well as availability of funds before reporting the information to the management so that they can make relevant decisions. The major role that the management accountant will play is in budgeting hence providing a guide to all the company’s expenditures. This he/she does by reviewing historical data as well as the company’s future plans hence preparing an adequate prediction of the company’s future expenses. This will add value in that the budgets will help in coordination between the management and various departments in implementing the company’s plans for the year in question. The management accountant will thus help the company make time bound decisions that are important for the company’s profitability. He helps the company in timely forecasting which is important given the uncertainties in the market (Clinton, 2011). This he does by analyzing everything be it economic or political situations with probability of affecting market, inflation or other market exposures, labor costs, competition, raw materials, coordination among the various departments in the company and internal operations as well as the company’s interaction with the rest of the economic world. In so doing, the management accountant will be able to help the company implement the best costing models for its products thus ensuring they are competitively priced while ensuring that all the activities that the company engages in are profitable. This is achieved by ensuring efficiency in all the operations of the company. In other words, the management accountant will help the company to be more profitable by helping the management make decisions that minimize costs while increasing efficiency without compromising on product quality. Schedule of costs of goods manufactured The schedule shows the total cost of goods manufactured and completed during a certain period. The company transforms raw materials into various types of skateboards through the use of labor in the factory. As such, the company would need to calculate how much has been used in making the skateboards so that it can use this figure to prepare its income statement and hence determine profitability. The schedule using for this calculation is called the schedule of cost of goods manufactured and is shown below; FreeAir Skate Pty Ltd Cost of Goods Manufactured Schedule For the Year Ended 30th December 2014 Direct materials used $ $ Beginning raw materials inventory 300,000 Add: Cost of raw materials purchased 800,000 Total raw materials available 1,100,000 Less: Ending raw materials inventory (50,000) Total raw materials used 1,050,000 Direct labor 400,000 Total direct costs 1,450,000 Manufacturing overheads Indirect labor 200,000 Depreciation –Plant and equipment 90,000 Miscellaneous manufacturing overhead 100,000 Plant supplies used 60,000 Property taxes on plant 10,000 Plant utilities 50,000 Total manufacturing overhead 510,000 Total manufacturing costs 1,960,000 Add: Beginning work-in-process inventory 100,000 Less: Ending work-in-process inventory 80,000 Cost of goods manufactured 2,040,000 Income statement The company’s income statement plays a vital role since it shows the company whether it operated at a profit or loss during the year under review. In other words, how much income did the company generate for the ending financial period (Johnson, 2015). This is does by reflecting and comparing the revenues and expenses that the company generated or incurred for the period. Hence, the management will be able to understand how well the company is running and where changes are needed. Hence, an income statement is an important decision making tool for the management. FreeAir Skate Pty Ltd Income Statement For the Year Ended 30th December 2014 Revenues $3,500,000 Finished goods Jan 2014 $400,000 Less cost of goods manufactured $2,040,000 Goods available for sale $2,440,000 Less finished goods Dec 31st 2014 (120,000) Cost of goods sold ($2,320,000) Gross income $1,180,000 Less Expenses Retail store utilities $20,000 Depreciation-Retail store equipment $55,000 Miscellaneous retail store overhead $70,000 Marketing, distribution and customer services costs $190,000 Council rates for retail store $3,000 Sales salaries and commissions $350,000 Total expenses $688,000 Net Income $492,000 Mixed costs These are costs that consist of a fixed and variable component. The general formula is y=a+bx where a is the fixed component, b is the variable component per unit and y is the number of units sold. From the appendix attached below, the following costs were identified as mixed costs. a) Advertising - This is a mixed cost implying that the company has to pay a minimum advertising cost every month while the other portion is incurred per every unit sold. This is given by the formula y = 32,543.5+0.15x b) Insurance – this is a mixed cost implying that the company has to pay a minimum insurance cost every month while the other portion is incurred per every unit sold. This is given by the formula y = 1500+0.2x c) Warranties – this is a mixed cost implying that the company has to pay a minimum Warrantycost every month while the other portion is incurred per every unit sold. This is given by the formula y = 210+6.4x The purpose of ABC to FreeAir Skate Pty Ltd and whether it should be introduced in the company In the current costing system applied by the company, costs are allocated on the basis of machine hours and labor hours. However, this kind of allocation may not be the right one since some of the activities involved in production do not entirely depend on machine hours or labor hours. For instance, the ordering costs would be better assigned on the basis of the number of orders while machine set up costs would be better assigned using the number of set ups. As such, the company may benefit much from implementing an ABC system (Jared, 2008). Activity based costing has the purpose of providing a more accurate view of product cost since the allocation basis used in activity based costing differ with those used in the current traditional absorption costing basis being used in the company. This system determines all the activities associated with the production of an item say a specific type of a skateboard and allocates costs to this activity. The cost assigned to the activities is then assigned to only those products that require the activity for their production. Thus, this will result in better costing of the products. For instance, supposing a certain type of skateboard does not require a certain activity, the overhead cost related to such an activity will not be allocated to the type of skateboard. This is unlike in the current system where overheads are allocated evenly on the basis of labor cost and machine hours whether or not these costs have been incurred in producing the type of skateboard. Thus, implementing the ABC system in the company would add value to the company in the following respect; 1. ABC makes is an equitable and scientific pricing method since it will allow the company to adjust the prices of our products based on the level of activity resources production. Thus, the type o skateboard that uses more resources will cost more while the one that uses fewer resources will cost less proportionately. In the same vein, the company can be able to provide value added services to existing products depending on the actual cost incurred which is likely to increase quality and thus revenue. 2. ABC will help us discover whether we have been producing and selling some of our products at a loss and hence eliminate them or adjust their prices accordingly thus increasing the company’s profitability. In the same vein, the system will help us to do away with the cost of maintenance of non-remunerative activities which will also increase overall productivity since resources will only be allocated to profitable items or that hat use less resources (Ivyn, 2011). The system will add to profitability through identification of waste and inefficiencies in our production process while eliminating non value adding activities which do not contribute to the company’s final productivity for instance duplicated activities thus increasing the firm’s productivity. 3. ABC will also help us to stick to our production budgets. This is by way of giving us improved information about activity costs that will enable us know whether we are sticking to the budget or the costs have not been incurred in line with our standards and hence the management should implement cost reduction strategies. Before implementing the system, the management should also consider the costs and some of the criticisms associated with the ABC system. First, the method of implementing the system is time consuming, complex and costly. In addition, the process of data collection, entry and analysis would require substantial amounts of resources which mean that the system is costly to maintain. Secondly, the reports generated by the system fail to conform to various accounting standards implying that it cannot be used for external reporting (Colin, 2012). Thus, this is an added cost to the company since two cost systems have to be maintained one for internal use while the other is maintained or external reporting purposes. This leads to duplication of effort and is also cumbersome. Conclusion This report has looked at the value that a management accountant would add to the company. The management accountant would provide the management with decision useful information that would increase the company’s profitability. In addition, the management accountant would play a major role in implementing an appropriate costing system for the company that would lead to increased profitability. In addition, although the ABC system has been observed to incur some costs, it has very many benefits that the company would derive from its implementation and hence I would advise the management to consider its implementation. The greatest benefit that we will derive from its implementation will be the achievement of better costing accuracy. This will enable us to only assign costs to the type of skateboards requiring the activity for their production. It means that we will eliminate allocation of irrelevant costs to our products which would imply improvement in productivity (Dyson, 2010). The system will also enable easier interpretation of cost for internal management which would also allow benchmarking as well as improved understanding of overhead costs. Better priced products as well as increased efficiency while maintaining quality will provide greater profitability for the company that will greatly supersede the costs described above. As such, it is important that FreeAir Skate Pty Ltd should serious consider its implementation. References: Burns, Q2013, Management accounting, London, McGraw-Hill. Clinton, M2011, Escaping professional dominance? Cost management, New York, Thomas Reuters Group. Johnson, R2015, Cost and management accounting practices, New York, Taylor & Francis. Kaplan, R2007, Time driven activity based costing, Harvard, Harvard Business School Press. Jared, B2008, Management accounting approaches, techniques and management process, London, Rutledge. Ivyn, M2011, Fundamentals of management accounting, Sydney, Prentice Hall. Colin, D2012, Management and cost accounting, Sydney, Cengage learning Dyson, J2010, Accounting for Non-Accounting Students, Sydney, Prentice Hall. Appendix We can use the High-low method to separate mixed costs as follows; Variable cost per unit is given by y2-y1/x2-x1 Where; y2 = total cost at the highest level of activity y1 = total cost at the lowest level of activity x2 = number of units at the highest level of activity x1 = number of units at the lowest level of activity But mixed cost formula is y= a+bx Where a = fixed element b= Variable element per unit x = number of units Therefore; a) Cost of goods sold = (277,500-76500)/(1850-510) =$150 hence b = 150 But mixed cost y=a+bx 277,500 = a+150*1850 277500-277500 =a a=0 hence cost is variable b) Distribution variable cost =(23,125-6,375)/ (1850-510) = 12.5 23,125=a+12.5*1850 23125-23125= a a=0 hence cost is variable c) Advertising variable cost = (32821-32620)/(1850-510) = 0.15 32620= a+ 0.15*510 32620- 76.5 = a a= 32543.5 hence cost is mixed with the formula y = 32,543.5+0.15x d) Insurance variable cost = (1870-1602)-(1850-510) =0.2 1870 = a+0.2*1850 1870- 370= a a= 1500 hence cost is mixed with the formula y = 1500+0.2x e) Warranties = (12050-3474)/(1850-510) = 6.4 3474=a +510*6.4 3474-3264=a a= 210 hence cost is mixed with the formula y =210+6.4x f) Packaging = (2405-663)/(1850-510) = 1.3 2405= a+ 1850*1.3 2405-2405 =a a=o hence cost is variable Read More