The Management Accountant of FreeAir Skate Pty Ltd - Term Paper Example

Table of Contents Table of Contents 1 Introduction 2 How a management accountant can add value to Free Air Skate Pty Ltd. 2 Schedule of costs of goods manufactured 3 Income statement 4 The following expenses are mixed expenses. 5 The purpose of Activity Based Costing and whether the company should implement it 6 Conclusion 8 References: 9 Appendix 11 Introduction This report is prepared for John Eustace who is the founder of FreeAir Skate Pty Ltd. The report explains the need for the company to employ and retain a full time management accountant as opposed to just employing a part time accountant who will only be responsible for preparing year end results. The management accountant will be available in full time basis to help the management implement costing systems that will lead to better costing of its three types of skateboards. In addition, he will provide the management with decision useful information. In addition, the report looks at the purpose of the ABC system to the company. This is mainly seen as accurate costing of the company’s products hence increased profitability. The report thus recommends for its implementation. This report has also prepared the schedule of the cost of goods manufactured and the income statement in addition to explaining their purpose to the management. It is hoped that the report will help the management make informed decisions regarding the issues discussed herein hence leading to improved company performance. How a management accountant can add value to Free Air Skate Pty Ltd. It is clear that the management at FreeAir Skate Pty Ltd only views the role of an accountant as that of preparing end year financial statements for the business in a bid to determine whether the business operated at a profit or loss during the year. This is an important role played by the financial accountant. However, the role of the management accountant runs throughout the year since he gives advice to the management regarding various aspects of the business which may help the business to operate more profitably. For instance, the set of values that you (John) have handed to me as well as the set of expenses handed to me by the production manager would make more sense to the management in helping them run the company more profitably had the company employed a management accountant (Daly, 2001). In addition, the management accountant would help the company come up with better methods of costing the production process and hence the company’s three brands of skateboards would be priced in a manner that would ensure the company generates profits on each product while offering prices that will be more competitive implying that the company can generate more revenues through increased sales. In other words, the management accountant will provide the company with a full toolkit for managing the business. In this regard, the management accountant will provide accounting techniques that will make it easier formulation of financial strategies, explain financial consequences of managerial decisions while monitoring expenses in a bid to ensure good profit margins are maintained. These roles are explained below. The management accountant will help the company in formulation of financial strategies. This will be done using sales forecasts, budgeting and appropriate costing techniques among other tools while incorporating data from the financial statements in development of strategies leading to increased company earnings. Whether the company is investing in capital equipments or reducing costs of operations, the management accountant will help in formulation of effective financial strategies. The management accountant would also be able to explain the financial ramifications of the decisions taken by the management on the business performance hence ensuring that the company remains on a profitability path. Another important role the management accountant would play is in helping in monitoring of expenses through creation of various types of budgets and other relevant reports which will help management in expenses monitoring thus helping the company run in the most cost effective manner. Using such tools as break-even analysis, the management accountant will help the company run profitably (Douglas, 2002). This helps management in determining production levels, overhead costs and sales objectives among other issues that impact profitability. The management accountant will continuously examine direct and indirect manufacturing costs thus helping in optimizing the company’s cost structure. Schedule of costs of goods manufactured The cost of goods manufactured schedule has the purpose of calculating the cost of producing goods for a time period. The cost of goods manufactured is then transferred to the finished goods inventory account during the period and will be used in calculating the cost of goods sold on the income statement. The schedule reports the total manufacturing costs for the period that were added to work in process and the costs are adjusted for the change in the work in process inventory account to calculate the costs of goods manufactured (Brimson, 2007). 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 1,050,000 Direct labor 400,000 Total direct costs 1,450,000 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 510,000 510,000 Total manufacturing costs 1,960,000 1,960,000 Add: Beginning work-in-process inventory 100,000 Less: Ending work-in-process inventory (20,000) 80,000 Cost of goods manufactured 2,040,000 2,040,000 Income statement The income statement shows the company’s management as well as investors whether the company operated at a loss or a profit or the year in review. In other words, it shows the income that the company generated for the financial period being reported. FreeAir Skate Pty Ltd Income Statement For the Year Ended 30th December 2014 Revenues $3,500,000 Opening stock 400,000 Cost of goods manufactured $2,040,000 Goods available for sale $2,440,000 Less closing stock $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 The following expenses are mixed expenses. We can use the high-low method to separate mixed costs from variable costs. This process is contained in the appendix attached. We assume that mixed cost is given by y= a+bx where a = fixed cost, b = variable cost per unit and x is number of units sold. Consequently, the following costs have been identified to be mixed costs a) Advertising –advertising is a mixed cost with part of it being fixed while the other element depends on the units sold. The advertisement cost is given by the following formula; y =32,543.5+ 0.15x b) Insurance is a mixed cost where the company pays a fixed portion whether or not it has sold anything for plants and other fixed assets while the other portion is dependent on the number of units sold. This is given by the following formula; y= 1500+0.2x c) Warranty is a mixed cost with a portion of it being fixed while the other portion is variable. It is given by the following formula; y =210+6.4x The purpose of Activity Based Costing and whether the company should implement it The method that the company is using to allocate costs is not appropriate and hence it may require some adjustments. This is because the method allocates overheads to a job or unction on the basis of direct labor hours and machine hours. However, given that the company has new technologies, the manufacturing environment has changed in a manner that the number of labor hours and machine ours can no longer be relied upon to indicate how much overhead will be needed in completing a certain job or order or even processing a certain type of a skateboard through a particular process or function. As such, I suggest that we use ABC in allocating overheads to jobs or functions (Ray, 2009). This is because ABC assumes that the activities used in manufacturing a product determine the overhead cost to be incurred such that each overhead cost whether fixed or variable will be assigned a category of costs which ensures better costs allocation. In other words, the purpose of ABC costing is to more precisely allocate overheads to the items or activities that used it. In our case for instance, we can use the following cost drivers to allocate costs more precisely as opposed to our traditional method of using labor hours and machine hours. Cost pool Cost drivers or the activity Purchasing activities Number of purchase orders made Receiving materials Number of purchase orders received Handling of materials Number of requisitions Machine set ups Number of machine set ups Inspection Number of inspections Engineering Number of engineering change orders Supervision Number of direct labor hours Using the above method (ABC) of cost allocation, the company would derive some benefits which would include; a) ABC gives better information about activity costs and hence these can be used in establishing whether activity costs have been incurred in line with industry standards. If not, ABC will be a good feedback tool as the management put their focus on cost reduction. b) ABC also gives better information with regard to customer profitability by better handling product costs and the additional costs or overheads. ABC helps in sorting through the additional overhead costs and hence helps in determining the customers that give the company a reasonable profit (William, 2011). In case we find that a certain product is not profitable enough, we will be able to adjust its prices accordingly while placing more emphasis on products that are more profitable. Using such a process, we will able to provide value added services to existing products on actual cost incurred hence increasing revenue. c) The method would help the company identify and hence eliminate the cost of maintaining non-remunerative activities thus increasing the company’s profitability. The method will also ensure that our processed and operations are compatible with our performance management scorecards through revealing per person contribution to the final value of our products and hence the organization’s profitability. In addition, using ABC, we can expose waste and inefficiency and hence eliminate it thus leading to more profitability for the company. d) Using ABC, we can be able to identify and eliminate non-value adding activities for the firms. For instance, we can eliminate needless inspections as well as duplicate activities. Despite the above benefits that would accrue from implementing an ABC system in the company, it is worth noting the costs or shortcomings that are associated with such a system. They include the following; a) It should be noted that implementing an ABC system would be expensive and time consuming. This is because we will have to analyze business activities and break them down into their individual components. Such a process could use valuable resources in data collection, measuring and entering the data into the new system. We may also require the services of consultant specialists in setting up such a system who will also train us on how to use it. In addition, we may need software for automating many of the processes that characterize ABC. b) It should be noted that reports produced by the system may vary from those produced by the method we are currently using. In addition, some of the activity based costs are irrelevant in decision making for instance, the ABC system fails to conform to the accounting standards and hence cannot be used for external reporting. In addition, interpreting ABC data along with regular accounting information may be confusing leading to bad decision making. Conclusion This report has recommended that the management considers hiring a full time management accountant. This is owing to the fact that the company would derive great value from having a management accountant as has been explained above. The information that the management accountant provides is decision useful and hence it would lead to better performance of the company and hence improved profitability. In addition, despite the above costs and shortcomings of ABC, I believe that its benefits far outweigh the costs and hence the company ought to consider implementing it. This is because it leads to improved business processes through allocation of indirect costs on the basis of the product’s cost drivers. This creates a good picture of which business processes are performing well and where improvement is required. We can also use it in identification of non-value added activities and in better allocating resources to efficient and profitable activities (Karen, 2007). Thus the process will help adding value to the company’s continuous improvement processes. Better costing of our products will be the biggest advantage that the system will bring to the company. For instance, it could be that one of our products saysSnow skate is being sold at a loss and hence eating into the firm’s profitability. Such a scenario will be unearthed by ABC thus ensuring that the company only engages in profitable activities which will ensure that the costs described above are compensated and even exceeded by increased profitability. References: Daly, J2001, Pricing for profitability: Activity based pricing for competitive advantage, New York, John Wiley & Sons. Douglas, H2002, Activity based costing: Making it work for small and mid-sized companies, New York, Wiley. Brimson, J2007, Activity accounting: An activity-Based Costing Approach, New York, John Wiley & Sons. Karolefski, F2004, Time is Money: How much are your customers costing you? Food logistics, 15 June 2004, 18. Jared, M2009, Corporate and managerial accounting, London, Rutledge. Ray, H2009, Managerial Accounting, Boston, Irwin McGraw-Hill. William, S2011, Introduction to managerial accounting, Sydney, Prentice Hall. Karen, B2007, Advanced management accounting, London, Rutledge. Appendix Using the high low method, the mixed costs have been separated as follows; Variable cost per unit = y2-y1/x2-x1 Where; y2 is the total cost at the highest level of activity y1 is the total cost at the lowest level of activity x2 is the number of units at the highest level of activity x1 is the number of units at the lowest level of activity Therefore; a) Cost of goods sold variable cost = (277,500-76500)/(1850-510) =$150 hence b = 150 But total cost y=a+bx 76,500 = a+150*510 or 76,500 =76,500 implying that a = 0 therefore, cost of goods sold is not a mixed cost b) Distribution variable cost =(23,125-6,375)/ (1850-510) = 12.5 6375=a+12.5*510 or 6375 =6375 implying that a= 0. Therefore distribution cost is not a mixed cost c) Advertising variable cost = (32821-32620)/(1850-510) = 0.15 32620= a+ 0.15*510 or 32620 =a+ 76.5 a= 32,543.5 Therefore advertising is a mixed cost with the formula given by y =32,543.5+ 0.15x d) Insurance variable cost = (1870-1602)-(1850-510) =0.2 1602 = a+0.2*510 or 1602 = a+102 a = 1500 Therefore insurance is a mixed cost with the formula given by y= 1500+0.2x e) Warranties = (12050-3474)/(1850-510) = 6.4 3474=a +510*6.4 or 3474 =a+3264 a=210 Therefore warranty is a mixed cost given by the formula y =210+6.4x f) Packaging = (2405-663)/(1850-510) = 1.3 663 = a+ 510*1.3 or 663 = a+ 663 implying that a= 0 meaning that packaging is a variable cost Read More