Management Accounting Issues - Assignment Example

Management Accounting Issues Student name: Institutional affiliation: Date of submission: Question 1 i) Calculation of material handling rate that Eloise Smith’s predecessor For government contracts, rate = (Government direct materials cost/Total direct material cost =$2,006,000/ ($2,006,000 + 874,000) = ($2,006,000/$2,880,000)100% = 69.65% Thus, government contracts would have been allocated 69.65% of the material handling costs. Costs under old allocation formula = 69.65% *288,000 = $200,600 for government contracts But there are also costs for high-dollar, low-volume government purchases including Annual salary $36,000 Employee on cost $7,200 Phone cost $2,800 Total $46,000 Thus, total government contracts cost =$200,600+46,000 = $246,600 For commercial contracts, rate = Commercial direct material costs/Total direct material cost = ($874,000/$2,880,000)*100% =30.35% Thus, commercial contracts would have been allocated 30.35% of the material handling costs Costs under old allocation formula = ($288,000*30.35%) =$874,000 ii) Revised material handling costs to be allocated on a per purchase order basis The allocation rate for: a) Government contracts = (Government contract orders/Total orders)*Material handling costs = (80,000/242,000)* 288,000 = $95,207 b) Commercial contracts = (Commercial contract orders/Total orders)*Material handling costs = (156,000/242,000)*288,000 = $185,653 c) Support departments =(total orders support departments/Total orders)*Material handling costs = (1,800+ 2,700 +500 +1,000)/242,000)*288,000 = (6,000/242,000)*288,000 =$7,140 NB// Support department costs are reallocated as follows; Government = (Government orders/ (Government +Commercial orders)*Support departments allocation = (80,000/ (80,000+156,000)*7,140 = (80,000/236,000)*7,140 =$2,420 Add initial allocation = $2,420 +$95,207 Total government allocation =$97,627 Add high-dollar, low-volume government costs = $97,627 + $46,000= $143,627 Commercial = Commercial orders/ (Government +Commercial orders)*Support departments allocation = (156,000/236,000)*7,140 = $4,120 Add initial allocation = $4,120 +185,653 Total commercial allocation = $190,373 iii) Purchase orders might be a more reliable cost driver than dollar amount of direct material as it allocates costs more fairly. This is because a single order might be expensive but incur the same cost as a cheap order in handling the materials. In other words, though the government orders are expensive, they are low volume meaning that they require few orders. Each order requires a certain amount of money to handle regardless of whether the materials involved are expensive or cheap. Thus, the commercial contracts requiring more orders though they are expensive would incur more material handling cost than government contracts which would require fewer orders though they are more expensive. iv) The difference due to changing the material handling cost allocation formula to government contracts is given by $246,600-$143,627 = $102,973 v) Forecast for three year impact of changing cost allocation formula Year 1 Year 2 Year 3 Purchase orders G 84,000 88,200 92,610 Purchase orders C 163,800 171,990 180,590 Purchase orders s 6,300 6,615 6,946 Material costs 3,024,000 3,175,200 3,333,960 Material costs G 2,116,800 $2,222,640 $2,333,772 Material handling costs 302,400 317,520 333,396 Direct government costs Constant Constant Constant Old method Year 1 = (Government direct materials cost/Total direct material cost) = (2,116,800/3,024,000) 302,400 = $211,680 + 46,000 =$257,680 Year 2 = (2,222,640/3,175,200)/317,520 = $222,264 +46,000 =$268,264 Year 3 = (2,333, 722/3,333,960)/333,396 = 233,372 +46,000 = $279,372 New method Year1 Government = (84,000/254,100)* 302,400 =99,967 Year 1 Support Department = (6,300/254,100)*302,400 =$7,498 Reallocation of support department =( 84,000/(84,000+163,800)*7,498 = $2,542 Year 1 allocation = $2,542 +$99,967 =$102,509+ $46,000 =$148,509 Year 2 allocation = (88,200/266,805)*317,520 =$104,965 Year 2 support department = (6,615/266,805)*317,520 =$7,872 Reallocation of support department = (88,200/260,190)*7,872 =$2,668 Year 2 allocation = $2,268 +$104,965 =$107,633+$46,000 =$153,633 Year 3 allocation = (92,610/280,146)*333,396 =$110,213 Year 3 Support department = (6,946/280,146)*333,396 = $8,266 Reallocation of support department = (92,610/273,200)*8,266 = $2,802 Year 3 allocation = $2,802+ $110,213 = $113,015+46,000 =$159,015 Cumulative dollar impact Year 1 =$257,680-$148,509 = $109,171 Year 2 =$268,264 -$153,633 = $114,631 Year 3 = $279,372-$159,015 = $120,357 Cumulative dollar effect = $344,149 6. Eloise Smith has an ethical conflict since she does not know what to do now that Jones has instructed her to ensure that she should adjust her numbers to ensure they favor the government contracts so that Jones can continue getting better earnings and bonus yet she knows that this is not right since this would mean that government contracts will continue being allocated more material handling costs than they should thus making them more expensive for the government. She knows this is bad for the company as it could lead to loss of contract. But who does she please? Jones or the company? Smith could take several steps in resolving the ethical conflict. This includes obeying Jones instructions in which case she will be going against professional standards. She can also resign from the position if Jones insists that she does what is wrong. She can choose to ignore jones and go on with the right allocation method. She can also discuss this with the management and find a solution that will favor both jones and the company. Question 2 Prices to maximize profit Fixed selling and administrative expenses allocation rate Standard = Standard sales/total sales = $200,000/500,000 = 0.4 or 40% of total fixed and administrative expenses =$240,000/100,000 =$2.4 per unit Commercial = Commercial sales/total sales =$300,000/500,000 = 0.6 or 60% of total fixed and administrative expenses = 360,000/100,000 =$3.6 per unit For 100,000 units of each compound, $600,000 fixed and administrative expenses are incurred. Thus, we assume this to be the cost for each price. Standard Alternative price Units of sales Sales Selling and admin Fixed costs Fixed manufacturing costs Variable costs Total costs Profit/loss $18 120,000 $2,160,000 $288,000 $480,000 $1,920,000 $2,688,000 -$528,000 $20 100,000 $2,000,000 $240,000 $400,000 $1,600,000 $2,400,000 -$240,000 $21 90,000 $1,890,000 $216,000 $360,000 $1,440,000 $2,016,000 -$126,000 $22 80,000 $1,760,000 $192,000 $320,000 $1,280,000 $1,792,000 -$32,000 $23 50,000 $1,150,000 $120,000 $200,000 $800,000 $1,120,000 $30,000 Commercial Alternative price Units of sales Sales Selling and admin Fixed costs Fixed manufacturing costs Variable costs Total costs Profit/loss $25 175,000 $4,375,000 $630,000 $875,000 $3,675,000 $5,180,000 -805,000 $27 140,000 $3,780,000 $504,000 $700,000 $2,940,000 $4,144,000 -364,000 $30 100,000 $3,000,000 $360,000 $500,000 $2,100,000 $2,960,000 -$40,000 $32 55,000 $1,760,000 $198,000 $275,000 $1,155,000 $1,628,000 $132,000 $35 35,000 $1,225,000 $126,000 $175,000 $735,000 $1,036,000 $189,000 From the above calculations, the management should select $23 for standard compound and $35 for commercial compound as the selling prices for the remaining six months so as to maximize profit. ii) When selling price is $23 for 50,000 units of standard compound, the following will be the income statement Sales $1,150,000 Cost of sales $800,000 Gross profit $350,000 Selling and admin costs ($320,000) Net income $30,000 When the company sells 35,000 units of commercial compound @ $35, the following will be the income statement Sales $1,225,000 Cost of sales $665,000 Gross profit $560,000 Selling and admin costs $371,000 Net income $189,000 From the calculations above, it is clear that the company stands to realize some profits by selling at the stated prices. Thus, the company should not close down the plant’s operations until July 1. In making the decision on whether or not to close down the plant, the following factors ought to be considered; i) Whether the plant will still incur the fixed costs during the closure and whether this will be greater than the loss the plant is likely to make when operations are going on. ii) The effect the closure is likely to have on current and potential customers and hence the company’s future after July 1. For instance, is the competition so intense such that the customers are likely to go to the competitors thus affecting the company’s future profitability iii) Whether the company has current contracts whose forfeiture may lead to being sued for breach of contract. iv) Whether there is an alternative production the company can go on with during the six months v) Whether the company has any cost cutting alternatives that could bring the company to profitability without having to close operations vi) Whether customers can accept a price increases for the compounds so that the company realizes some profit and avoids closing the plant. Question 3 THE MEMO Mike Jobs The Management Board Hawthorn Leisure Works Dear Sir RE: The proposed change to fee collection structure and its effect on the company’s cash management. The following issues arising from the change in fee collection structure are analyzed in this report. How the new fee collection structure and membership plan affects the company’s ability to plan cash receipts. I think the new structure will improve the company’s ability to plan its cash receipts because it is more predictable. The new structure will mean that the company will almost get all its cash projections in advance at the beginning of the year and with the expenses also being predictable, cash receipts planning is made more predictable and easier. This is because membership is renewed at the beginning of the year and no more cash receipts from the courts will be expected thus cash will be received almost once making its planning easier. How sales revenue will be affected by changing the fee collection structure The effect is analyzed by subtracting cash received in the new plan from the cash that would be received in the old plan; Old revenue collection plan Cash received from: Family membership = 1,000 members *$100 = $100,000 Student membership = 500 members *30 = $15,000 Individual membership = 500 members *50 = $22,500 Total of membership fee old structure = $100,000+15,000+22,500 = $137,500 Courts revenue Court usage per day = 12*10 hrs = 120 hours Prime usage = (90%+100%)/2 = 95% Non-prime usage = (60%+ 50%)/2 = 55% Peak time being 181 days, receipts amount to; Prime usage =120hrs* 181 days*4/12 = $82,536 Non-prime usage = 120hrs *181 days*8/12 = $63712 Total courts peak usage = $82,536+ $63,712 = $146,248 Off peak usage revenue Off peak usage = (30%+ 40%)/2 = 35% 120 hrs* $6/hr*35%*184 days = $46,368 Total court usage revenue = $46,368+ $146,248 =$192,616 Total annual revenue = $192,616+ $137,500 =$330,116 New revenue collection plan Expected family membership renewal = 1,000*70% = 700 members . However, 45% of current members take the offer = 1,000 * 45% = 450 members. Thus, those who will pay later = 700 -450 = 250 members. Since student members would join individual membership, the individual membership plan will have similar numbers with family membership plan. Collection under new plan will be; Family membership = (450 *450) + (250*500) = $327,500 Individual membership = (450*250)+ (250*300) =$187,500 300 members for each group are expected to join with equal members per month and fees being applied proportionately. Thus, new membership revenue ; Month 1= (50*500) + (50*300))*12/12 =$40,000 Month 2 = (50*500)+50*300)*11/12 = $36,667 Month 3 = (50*500) + (50*300))*10/12 = 33,333 Month 4 = (50*500) + (50×300))*9/12 =30,000 Month 5= (50*500) + (50*300))*8/12 =26,667 Month 6= (50*500) + (50*300))*7/12 = 23,333 New membership revenue = $190,000 Total revenue under new collection plan = $190,000+187,500+327,500 = 705,000 Difference between membership plans = $705,000-$330,116 =374,884 Arising from the above calculations therefore, the new plan will result in more revenue collection of $374,884 apart from making cash receipts planning easier and more predictable. Evaluating the new cash collection plan In evaluating the new plan, the management should consider how it will affect the overall company performance since if the members feel that its value is less compared to what competitors are offering, they will shift to competitors to the detriment of the company. Thus, the company must aggressively market it as being better than that of competitors. The ability of current and potential members to pay the proposed fees also ought to be considered and if they are unable, the fees ought to be reviewed to make them affordable. Financial evaluation in making complete evaluation of the proposed plan A cash receipt budget ought to be prepared as well as a complete sales forecast ought to be done in determining whether the new plan is financially better than the old plan. How company’s cash management practices will differ by adopting the new revenue collection structure The company will start operating on a cash basis rather than on the current accrual based accounting since it will now be receiving its cash projections in advance at the beginning of the year. Conclusion: Based on the above analysis, the company should adopt the new fee correction structure though the factors raised should be considered first. Sincerely, Mike Jobs CPA References; Merchant, K2011, Management control systems, London, Rutledge. Read More