The Material Handling Rate That Would Have Been Used by Eloise Smiths Predecessor at ECM - Assignment Example

Management Accounting Student name: Institutional affiliation: Date of submission 1. The material handling rate that would have been used by Eloise Smith’s predecessor at ECM Traditionally, the cost of the material handling department has been allocated to direct material as a percentage of direct material dollar value. Thus, the material handling rate that would have been used by Eloise Smith’s predecessor at ECM would be given by; Direct material dollar value for specific contact/total direct material dollar value. For instance; i) For government contracts, the material handling rate would be as follows; Government contracts material handling rate =Direct material dollar value for government contracts/total direct material dollar value Government contracts material handling rate = ($2,006,000/$2,880,000)*100% = 69.65% of the total material handling cost ii) For Commercial contracts, the material handling costs would be given by; iii) Commercial contracts material handling rate = Direct material dollar value for commercial contracts/Total direct material dollar value = ($874,000/$2,880,000)*100% =30.35% of the total material handling costs 2. The revised material handling costs to be allocated on a per purchase order basis The rate is given by -the number of orders for a specific contracts /the total number of orders Thus, the cost is given by-(the number of orders for a specific contracts /the total number of orders)*Total material handling costs Thus; i) Government material handling costs = (the number of orders for a government contracts /the total number of orders)*Total material handling costs = (80,000/242,000)*$288,000 = $95,207 ii) Commercial contracts material handling costs= (156,000/242,000)*$288,000 = $185,653 iii) Marketing material handling costs = (1,800/242,000)*$288,000= $2,142 iv) Finance and administration material handling costs = (2,700/242,000)*$288,000 =$3,213 v) Human resources material handling costs= (500/242,000)*$288,000 =$595 vi) Maintenance material handling costs= (1,000/242,000)*$288,000 =$1190 But the support department’s costs have to be reallocated to the government and commercial contracts departments as follows; Total support departments material handling costs = $2,142+ $3,213 +$595 +$1,190 =$7,140 Re-Allocation to Government contracts department= (80,000/236,000)*$7,140 =2,420 Re-Allocation to commercial contracts department = (156,000/236,000)*$7,140 =$4,720 Total allocation of material handling costs to Government and Commercial contracts departments Government contracts division = $95,207 +2,420 =$97,627 Commercial contracts division = $185,653+ $4,720 =$190,373 3. Why purchase orders might be a more reliable cost driver than the dollar amount of direct material Allocation of material handling costs on the basis of the number of purchase orders would be a more reliable cost driver than allocating the cost on the basis of dollar amount. This is because material handling costs are incurred every time an order is placed regardless of the dollar amount of the order. This means that a cheap order will most likely incur the same costs as an expensive order and the difference will only arise as more and more orders are made. Thus, though the government contracts involve a few orders, they are of great value and hence basing the material handling costs on the dollar value of the materials would mean that the government contracts will be allocated more costs than they have actually incurred owing to the few number of orders involved. On the other hand, commercial contracts which have less value but involve more number of orders would be allocated less cost than they should if this was to be based on the dollar value of orders. Thus, allocating the costs on the basis of purchase orders would be the most fair of allocating the material handling costs to the different departments. 4. The difference due to the change of cost allocation method to government contracts The difference would be given by; The cost allocated using older method-the cost allocated using new method Cost allocated using old method = 69.65%* $288,000 =$200,592 Cost allocated using new method = = $97,627 Difference between the two costing methods = $102,965 Thus, the old method would have allocated $102,965 more to the government’s department. 5. Cumulative dollar impact of the change in methods over the next three years Cost/cost driver Current year Year 1 Year 2 Year 3 Purchase orders 242,000 254,100 266,805 280,145 Government orders 80,000 84,000 88,200 92,607 Commercial orders 156,000 163,800 171,990 180,589 Marketing 1,800 1,890 1,985 2,084 Finance and admin 2700 2,835 2,977 3,126 Human resources 500 525 551 579 Maintenance 1,000 1,050 1,102 1,158 Direct material costs 2,880,000 2,952,000 3,025,800 3,101,445 Material handling costs 288,000 295,200 302,580 310,145 Direct government costs 46,000 46,000 46,000 46,000 Government material costs 200,6000 2,066,400 2,118,060 2,171,011.5 Commercial material costs 874,000 885,600 907,740 930,433.5 Allocation of material handling costs to government contracts department for the three years Allocation to support departments Year 1Marketing = 1,890/254,100*295200 =$2,196 Year 2 = 1,985/266,805*302,580 =$2,251 Year 3 =2,084/280,145*310,145 =$2,307 Year 1 Finance and admin= 2,835/254,100*295200= $3,294 Year 2 =2,977/266,805*302,580 =$3,376 Year 3 = 3,126/280,145*310,145= $3,461 Year 1Human Resources =525/254100*295200=$610 Year 2 =551/266805*302580=$625 Year 3 =579/280145*310145=641 Year 1Maintenance =1,050/254100*295200= 1,219 Year 2 =1,102/266805*302580 =1,250 Year 3 =1,158/280145*310145 =1,282 Re-allocation of support department costs Year 1 Total cost = $2196+3294+610+1219 =$7,319 Allocation to Government contracts = 84000/247800*7319 =2,481 Year 2 Total cost =$2251+3376+625+1250 =$7,502 Allocation to government contracts= 88,200/260,190*7,502=$2,543 Year 3 Total cost =$2307+3461+641+1282= $7,961 Allocation to government contracts =92607/273,196*$7,961 =2,699 Initial cost allocation to government contracts department Year 1 =84,000/254100*$295200 =$97,587 Year 2 =88,200/266805*$302580 =$100,026 Year 3=92,607/280,145*310145= $102,524 Total cost allocated to government contracts department = initial allocation + support department reallocation Year 1 =$97,587+$2,481 =$100,068 Year 2 =$100,026 +$2,543 =$102,569 Year 3 =$102,254+$2,699= $104,953 Using old method (NB-The rate earlier calculated is 69.65% of total material handling costs) Thus, cost allocated to government contracts department in Year 1 =$295,200*69.65% =$205,606 Year 2 =$302,500*69.65% =$210,691 Year 3 =$310,145*69.65% =$216,016 Differences in cost during the three years owing to method change Year 1 = $205,606-100,068 =$105,538 Year 2 =$210,691-102,569 =$108,122 Year 3 =$216,016-104,953 =$111,063 Total impact in three years=$324,723 T 6. Ethical conflict i) Why Eloise Smith has an ethical conflict It is true that Smith has an ethical conflict owing to having to decide whether to favour Jones so that he can continuing higher salaries while the company continues allocating the wrong costs to both the commercial and government contract departments meaning that the contracts are charged the wrong price which has resulted in conflict between the government auditors and the company or to recommend the application of the new method that would see Jones earn less salary though the new costing method would ensure that each type of contract is properly costed and hence each customer charged the right price while assuring the company of some profits on each contract type. ii) Steps Smith should take in solving the ethical conflict Owing to the ethical conflict facing Smith, she has a number of alternative steps that she could take in solving the ethical dilemma. The first step should involve holding a candid discussion with Jones and explaining to him what the company stands to lose I the old method is continued just to retain Jones salary at the current level. Smith should also consider talking to the management about the fears that Jones has and hence the need for using another base in determining bonuses. This way, Jones bonus should be retained while the company benefits from better cost allocation and hence pricing. 2. The unit selling price that the management should select for each of the company’s compounds for the remaining six months so as to maximize profit The company has alternative prices for alternative quantities of the compounds and hence their profitability should be calculated as follows; For standard compound NB// In determining the fixed selling and administration cost, we assume that the fixed selling and administration costs for a 100,000 units will be constant regardless of the size of production. Thus, 100,000 units = $240,000. For a single unit= 240,000/100,000= $2.4 The profitability at various alternative prices can be calculated as follows; At $18 Sales = $18*120,000 units = $2,160,000 Fixed manufacturing costs= $4*120,000 = $480,000 Fixed selling and admin costs= $2.4*120,000 = $288,000 Variable manufacturing overheads = $1*120,000 = $ 120,000 Direct materials = $7*120,000 =$840,000 Direct labour= $4*120,000 =$480,000 Variable selling and admin cost= $4*120,000 =$480,000 Total selling and manufacturing costs= = ($2,688,000) Loss realized = ($528,000) At $20 Sales = $20*100,000 units = $2,000,000 Fixed manufacturing costs= $4*400,000 = $400,000 Fixed selling and admin costs= $2.4*100,000 = $240,000 Variable manufacturing overheads = $1*100,000 = $ 100,000 Direct materials = $7*100,000 =$700,000 Direct labour= $4*100,000 =$400,000 Variable selling and admin cost= $4*100,000 =$400,000 Total selling and manufacturing costs= = ($2,240,000) Loss realized = ($240,000) At $21 Sales = $21*90,000 units = $1,890,000 Fixed manufacturing costs= $4*90,000 = $360,000 Fixed selling and admin costs= $2.4*90,000 = $216,000 Variable manufacturing overheads = $1*90,000 = $ 90,000 Direct materials = $7*90,000 =$630,000 Direct labour= $4*90,000 =$360,000 Variable selling and admin cost= $4*90,000 =$360,000 Total selling and manufacturing costs= = ($2,016,000) Loss realized = ($126,000) At $22 Sales = $22*80,000 units = $1,760,000 Fixed manufacturing costs= $4*80,000 = $320,000 Fixed selling and admin costs= $2.4*80,000 = $192,000 Variable manufacturing overheads = $1*80,000 = $ 80,000 Direct materials = $7*80,000 =$560,000 Direct labour= $4*80,000 =$320,000 Variable selling and admin cost= $4*80,000 =$320,000 Total selling and manufacturing costs= = ($1,792,000) Realized loss = ($32,000) At $23 Sales = $23*50,000 units = $1,150,000 Fixed manufacturing costs= $4*50,000 = $200,000 Fixed selling and admin costs= $2.4*50,000 = $120,000 Variable manufacturing overheads = $1*50,000 = $ 50,000 Direct materials = $7*50,000 =$350,000 Direct labour= $4*50,000 =$200,000 Variable selling and admin cost= $4*50,000 =$200,000 Total selling and manufacturing costs= = ($1,120,000) Profit realized =$30,000 For commercial compound Fixed selling and administration overheads given by $360,000/100,000 =$3.6/unit At $25 Sales = $25*175,000 units = $4,375,000 Fixed manufacturing costs= $5*175,000 = $875,000 Fixed selling and admin costs= $3.6*175,000 = $630,000 Variable manufacturing overheads = $2*175,000 = $350,000 Direct materials = $8*175,000 =$1,400,000 Direct labour= $4*175,000 =$700,000 Variable selling and admin cost= $7*175,000 =$1,225,000 Total selling and manufacturing costs= = ($5,180,000) Loss realized =$(805,000) At $27 Sales = $27*140,000 units = $3,780,000 Fixed manufacturing costs= $5*140,000 = $700,000 Fixed selling and admin costs= $3.6*140,000 = $504,000 Variable manufacturing overheads = $2*140,000 = $280,000 Direct materials = $8*140,000 =$1,120,000 Direct labour= $4*140,000 =$560,000 Variable selling and admin cost= $7*140,000 =$980,000 Total selling and manufacturing costs= = ($4,144,000) Loss realized =$(364,000) At $ 30 Sales = $30*100,000 units = $3,000,000 Fixed manufacturing costs= $5*100,000 = $500,000 Fixed selling and admin costs= $3.6*100,000 = $360,000 Variable manufacturing overheads = $2*100,000 = $200,000 Direct materials = $8*100,000 =$800,000 Direct labour= $4*100,000 =$400,000 Variable selling and admin cost= $7*100,000 =$700,000 Total selling and manufacturing costs= = ($2,960,000) Profit realized =$40,000 At $32 Sales = $32*55,000 units = $1,760,000 Fixed manufacturing costs= $5*55,000 = $275,000 Fixed selling and admin costs= $3.6*55,000 = $198,000 Variable manufacturing overheads = $2*55,000 = $110,000 Direct materials = $8*55,000 =$440,000 Direct labour= $4*55,000 =$220,000 Variable selling and admin cost= $7*55,000 =$385,000 Total selling and manufacturing costs= = ($1,628,000) Profit realized =$132,000 At $35 Sales = $35*35,000 units = $1,225,000 Fixed manufacturing costs= $5*35,000 = $175,000 Fixed selling and admin costs= $3.6*35,000 = $126,000 Variable manufacturing overheads = $2*35,000 = $70,000 Direct materials = $8*35,000 =$280,000 Direct labour= $4*35,000 =$140,000 Variable selling and admin cost= $7*35,000 =$245,000 Total selling and manufacturing costs= = ($1,036,000) Profit realized =$189,000 Based on the above analysis, the company ought to sell the standard compound at $23 per unit if they are to realize and maximize profits from the compound in the next six months. On the other hand, the commercial compound should be sold at $35 per unit since at this price; the company will realize the greatest profit from selling the commercial compound. b) Profit realized by selling the standard compound at $23 per unit Sales = 23*50,000 = 1,150,000 Expenses: Fixed manufacturing costs = $4*50,000= 200,000 Fixed selling and admin costs= $2.4*50,000 = $120,000 Variable manufacturing overheads = $1*50,000 = $ 50,000 Direct materials = $7*50,000 =$350,000 Direct labour= $4*50,000 =$200,000 Variable selling and admin cost= $4*50,000 =$200,000 Total selling and manufacturing costs= = ($1,120,000) Profit realized = $30,000 Profit realized by selling the commercial compound at $35 per unit Sales = $35*35,000 units = $1,225,000 Fixed manufacturing costs= $5*35,000 = $175,000 Fixed selling and admin costs= $3.6*35,000 = $126,000 Variable manufacturing overheads = $2*35,000 = $70,000 Direct materials = $8*35,000 =$280,000 Direct labour= $4*35,000 =$140,000 Variable selling and admin cost= $7*35,000 =$245,000 Total selling and manufacturing costs= = ($1,036,000) Profit realized =$189,000 Total profit realized for both the compounds Standard =$30,000 Commercial =$189,000 Total profit = $219,000 By selling both the compounds at the stated prices of $35 and $23 per unit for the commercial and standard compound respectively, the company stands to make a profit of $219,000. It is for this reason that it would not be wise for the company to close its operations for the six months period. This is due to the fact that by closing, it stands to lose the above profits. In fact, the company also stands to incur more losses since some costs such as those related to maintenance and security will still need to be incurred during the closure and there being no business activity, no profit will be generated to cover the costs. b) A number of strategic factors need to be considered in deciding whether or not to close the plant. The firm ought to look at its cost structure and see whether there can be any cost cutting measures that can be undertaken to reduce costs so that the firm can break even or even be profitable before deciding to close it. The firm should also explore better options of utilizing the plant before closing it. For instance, there can be products that can be produced without necessarily having to incur restructuring costs and which can be helpful in meeting the fixed costs during the closure period. If this is the case, then the plant should not be closed. Closing the plant might have negative effect on the company’s future profitability especially the company stands to lose customers who can go to competitors. Thus, if the company will revert back to producing the same products after the six months, then it should consider these factors. The company should also consider what to do with the current orders to avoid disappointing customers. For instance, if there are many orders, it can’t close unless the orders are contracted to another producer rest the company is sued for breach of contract. Johansen & Hannington consultants To the board Hawthorn Leisure Works Dear Sir/madam, REF: THE EFFECT THE PROPOSED CHANGE ON STRUCTURE OF FEES WILL HAVE. The board of management of HLW did raise a number of issues concerning current fee structure change which are addressed in this report. The issues raised and the response include; How changing the fees collection structure and membership plan will affect HLW’s ability of planning its cash receipts. It is our opinion that the proposed structure will positively affect HLW’s ability to plan the cash receipts due to increased predictability associated with the new collection plan. This increases the company’s ability to predict the dollars it expects to receive in a given financial year thus planning it better since the expenses are known almost in advance. With most members renewing their membership at the start of the year, most cash will be received in advance hence the company will to a great extent be planning for the cash it already has as opposed to what it expects to receive. The effect on sales revenue that will result from the change in fee structure for the next financial year In order to gauge the effect on sales revenue of changing the fee collection structure, we calculate the difference in revenue using the two methods as follows; Using the old method Family membership type, 1,000 members pay @100 per member = $100,000 Student members type, 500 members pay @30 per member = $15,000 Individual membership type, 500 members pay @30 = $22,500 The total membership received =$137,500 Receipts from student and individual membership are based on the numbers being equal. It is also assumed that each of the 2,000 members renew membership. Other receipts include court fees HLW having 10 courts with each being in use for 12 hours @10 per thus 120 usage hours daily. Peak time is 4@12 hours and non-prime hours are 8@$8. Note that prime usage is between 90 and 100% and hence the average usage rate is 95% with usage during non-prime hours averaging 55%. Peak time during the year is 181 days and thus prime usage is given by 4/12×120×95%×181 = $82, 536. On the other hand, the non-prime time usage is given by 8/12×120×55%×181 =$63,712. Thus total courts revenue during peak time is $146,248. Another court revenue is derived during off-peak with charges being $6 per hour. Usage during this time averages 30% as it is between 30 and 40% for 184 days of the year. Revenue during this period is given by120×6×30%×184 = $39,744. Adding all the courts and membership collections yields $323,942 per year. Under the new collection plan Those opting for the new membership are expected to join uniformly per month. If 70% of current membership takes the offer, then 700 family members and 700 individual members will. Bearing in mind that 45% of the members will take the offer, then 450 members of each membership class will take the offer thus paying $250 and $450 respectively while the remaining 250 of each group would pay later hence paying full fee. Thus, collection from the new structure would include family membership 450@450+ 250@500= $327,500 and for individual membership 450@250+250@300= $187,500 and hence the total receipts from the old membership will be $515,000. On the other hand, new members will be 600 joining in equal proportions per month and each membership having 300 members. Thus, monthly collection for new members will be; For first month =(50×500+50×300)×12/12 =$40,000 Second month = (50×500+50×300)×11/12 = $36,667 Third month = (50×500+50×300)×10/12 = 33,333 Fourth month = (50×500+50×300)×9/12 =30,000 Fifth month = (50×500+50×300)×8/12 =26,667 Sixth month = (50×500+50×300)×7/12 = 23,333 Total new members contribution will be = $190,000 This will bring the total contribution both from the new and old membership to be equal to $705,000. Thus, the difference between the collection plans will be $381,508. Resulting from the analysis above, it is our opinion that the new plan will result in great increase in revenue collection by $381,508 with added advantage of planning for cash receipts more predictable as discussed above. Factors to be considered in evaluating the new cash collection plan The new fee structure should be thoroughly evaluated before HLW can eventually adopt it. The new structure’s success depends on how the members will view it Vis a Vis those offered by competitors. Thus, the company must aggressively market the new plan concentrating on the points that make it better than those of the competitors. The company also ought to consider whether people will be able to pay the membership as predicted since although the new plan is more convenient, it is much more expensive than the previous one. The type of financial analysis HLW should conduct in making a complete evaluation The company ought to prepare a cash receipt budget in a bid to reveal the better option financially between the two options thus completing the financial evaluation. How HLW’s cash management practices may differ from the present if new membership plan and fee structure are adopted. The company would largely change from operating with more receivables than cash at hand to operating with more cash at hand than cash receivables. Thus, the company would largely adopt a cash basis of accounting as opposed to the current system which is largely accrual basis accounting. Conclusion: It is on the basis of the analysis above that we would recommend that HLW adopts the new system. This is based on the increased revenue likely to result from the adoption as well as the more convenient cash planning. However, there is need for thorough evaluation of the plan before the decision to adopt the plan is finally made. Sincerely, James Regen For Johansen & Hannington consultants References: Weygandt, J&, Kimmel, D2016, Managerial accounting tools for business decision making, New York, John Willey & Sons. Read More